This chart my colleague Sam Hodgson just put together based on this news tells an interesting story:

As is common knowledge by now, the size of the city of San Diego’s pension deficit grew dramatically from 2000 until 2004. And as that unfolded, the pension system was the setting for a roiling drama. Eventually, the state and federal government brought criminal charges against pension officials for a 2002 funding deal that granted increased benefits to employees. It helped lead to the resignation of former Mayor Dick Murphy. And the city’s failure to disclose the deficit led to civil securities fraud charges against former city officials.

But, as the chart shows, that deficit had begun to shrink in recent years as city and pension officials reformed the system, putting more money into it, stopping practices that siphoned investment money from the fund, eliminating some benefits, and closing some loopholes. The fund also did well with its investments.

The steady progress from all those tweaks just got pummeled by recent investment losses, according to estimates released today by the City Attorney’s Office. (It’s important to note this isn’t a formal evaluation of the system, rather an estimate prepared by a consultant for internal use in the City Attorney’s Office.)

To put today’s news in perspective, the pension fund in 2004 had a deficit of $1.37 billion and was 65.8 percent funded. Today’s figures peg the shortfall at $2.78 billion and have the fund at 58 percent funded.

There’s another twist to this story, too. Murphy and current Mayor Jerry Sanders both wanted to borrow hundreds of millions of dollars to plug into the pension system in recent years, but have been unable to because of the city’s lack of a credit rating and, to a lesser extent for Sanders, Mike Aguirre’s legal opinions. (Sanders, for example, wanted to borrow $674 million for the pension when he took office.)

It’s probably a good thing they couldn’t — at least when they wanted to.

Such borrowing plans, known as pension obligation bonds, work like this: A government borrows money for its pension system so that it can invest it. It’s basically a bet that the government can earn more on investments than it pays in interest on the borrowed money. It’s known as arbitrage.

If the city had done that, it’d likely be paying tens of millions of dollars a year to finance those bonds out of its budget, while at the same time losing big on the hundreds of millions of dollars of investments.

Now, the pension system invests for the long term so sudden shifts in the market are to be expected and planned for. And, if the pension fund had invested those loans, it will still own assets for the long haul.

City and pension officials are hoping that the market recovers and make these conversations moot — or at least less painful. But for now, it looks like a good thing Sanders didn’t make that bet with borrowed money right before the global economic meltdown.

ANDREW DONOHUE

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