California Dreamin'

By Mary Williams Walsh

The following piece was reported and written by Mary Williams Walsh, who covered the pension crisis for The New York Times and now serves as the managing editor of News Items. I don’t think it’s an exaggeration to say that no reporter knows the ins and outs of the public pensions story better than Mary.

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After Silicon Valley Bank fell into the arms of the federal government three weeks ago, I went to the website of California Governor Gavin Newsom to check something I thought I’d seen there last fall.

Yes: In October, Newsom issued a press release, boasting that California was overtaking Germany as the world’s fourth largest economy.

“I feel tremendous pride in California’s resilience, leadership, and our formula for success,” said Newsom, a businessman and Napa Valley vintner whose name often comes up as a presidential contender if President Biden doesn’t run in 2024.  

Interesting, I thought as I contemplated the Fed and Treasury lunging to halt the contagion emanating from Silicon Valley: Did we just bail out the world’s fourth largest economy?

Check the numbers and you’ll see that Silicon Valley really is like a tent pole holding up the whole state. And it’s a heavy lift. The Golden State has big public costs to cover, not least of which are the costs of a public pension system that makes French President Emmanuel Macron look mean for raising the retirement age to 64. In California, some cops and fire fighters can retire at 50, with 90 percent of their final salary for the rest of their lives. Other public workers get very good deals too.

It's been that way since 1999, when lawmakers approved a big pension increase near the end of one of the richest bull markets in history. Investments were doing so well that Calpers—the state’s biggest pension fund—seemed to have billions more than it needed. Calpers’ president assured lawmakers the increase would not cost “a dime of additional taxpayer money.”   

So they approved it, and then the dot-com bubble burst, Enron and other companies collapsed in a wave of accounting fraud, terrorists struck, and the markets plunged. The billions of surplus dollars melted away, leaving Calpers with a shortfall—just in time for the baby boomers to start retiring in burgeoning numbers and drawing their newly enriched pensions.

It’s been a problem ever since. Thank heavens for Silicon Valley! Last year The New York Times reported that of the 100 wealthiest people in the United States, 26 lived in California, 19 of them in the Bay Area. “There are 724 billionaires in the United States and California is home to 189.”  

It allows California to pursue an energetic “tax the rich” strategy, much as Biden and some members of Congress now propose for financing Medicare and other third-rail federal entitlements. California doesn’t have a wealth tax (though one has been proposed); it uses a steep progression of personal income-tax brackets that tops out at 13.3 percent.

And since the rich tend to live off investments, not paychecks, California treats capital gains as ordinary income. There isn’t a lower rate. If you cash out of an investment in California, you just add the realized gain onto your earned income and pay tax on the total.

Upshot: In most years, the “one percent” in California provide a little less than half the state’s personal income tax revenue.

It works … sometimes. Taxing the well-off is a funny thing. Because they live on investments, not paychecks, the tax revenue they send to Sacramento is volatile. When there’s a bull market, the budget balances. When there’s a bear market, tax revenues dribble in, and the world’s fourth biggest economy suddenly finds that it can’t afford anything. People start calling California “ungovernable,” and “a failed state.” Rich residents of the Bay Area, like Elon Musk, get fed up and move to no-income-tax Texas.

Things got so bad after the crash of 2008 that California officials called the Treasury and the Fed to ask for a bailout. The answer was no, but California managed to borrow its way out of the hole once the feds got the credit markets moving again.

And borrowing wasn’t expensive. After the Global Financial Crisis, the Fed kept interest rates close to zero. Free money can work wonders. Eventually the stock market recovered and grew. Tech founders and executives exercised options, sold shares, paid their taxes, and stashed their excess cash at Silicon Valley Bank. California had no trouble balancing its budget. Easy money felt normal.

The pandemic threatened to end that, but Washington came through with an enormous fiscal stimulus. Billions went directly to states and large cities. They were told not to use the money to shore up their pension funds—but since money is fungible, the pensions got funded anyway. In many places, including California, there was so much federal stimulus money that officials made bigger pension contributions than they had to.

In June 2022, California announced its biggest budget ever, with a $97 billion surplus to play with.

“Cha-ching! You just received a deposit,” said the governor’s press release, promising to spend $9.5 billion on a “Middle-Class Tax Refund,” to help people cope with inflation. (States were told not to use the stimulus money for tax relief, either.)

The Fed was by this time concerned about inflation, and was raising interest rates to brake it. The stock market skidded. Tech companies began laying off people by the thousand. Bonuses dwindled. Initial public offerings dried up. It wasn’t widely apparent yet, but Silicon Valley Bank’s investments were losing value, putting at risk deposits in excess of the FDIC’s $250,000 insurance limit. Because Silicon Valley Bank catered to deep-pocketed venture capitalists and tech executives, it had many such deposits.

In January, just six months after boasting a $97 billion surplus, Governor Newsom warned of a $22 billion deficit. The forecast was to be updated in May, after April’s tax payments came in.

But before that could happen, Silicon Valley Bank had its fatal run. Regulators closed it on a Friday. On Saturday Governor Newsom called the White House to discuss the situation with President Biden. What they said is not known, but in Silicon Valley, entrepreneurs were warning that if they couldn’t withdraw their money right away, they wouldn’t be able to make their next payroll. (They presumably wouldn’t be able to pay their taxes in April, either.)

Governor Newsom could surely empathize. The Intercept has reported that he and his businesses are SVB depositors, and the bank is a donor to his wife’s nonprofit.

On Sunday the Treasury, Fed and FDIC announced that all deposits would be available starting Monday morning. They said it wasn’t a taxpayer bailout, eliciting hoots and eye rolls. Of course we didn’t bail out Silicon Valley Bank. We bailed out Silicon Valley.

On Monday, Governor Newsom praised the Biden administration for the rescue, saying, “California is a pillar of the American economy, and federal leaders did the right thing.”

It’s not that I think they did the wrong thing. I certainly wasn’t hoping for a cascade of bank failures, any more than I wanted to see, in 2020, what would happen if we shut down the economy without any fiscal stimulus.

The problem is that we keep getting used to the stimulus—or the monetary easing—and we can’t bear the withdrawal symptoms when it ends. We get years of cheap money and start to think cheap money is normal. We see the endlessly rising asset prices and believe we’re skilled investors. We attribute our good fortune to American exceptionalism, when it’s really just that the Fed left the faucet running too long. And when the Fed turns off the faucet, the markets skid, or the budget won’t balance, or a bank fails, and we want another bailout.

It just happened again. Jay Powell has made clear that he thinks inflation is still a problem. He wanted a 50-basis-point rate hike, but had to settle for 25 because 50 might have caused more bank failures.

It isn’t just California. The whole country has been living beyond its means on cheap money; otherwise we wouldn’t have amassed a $31 trillion public debt in just 20 years. We wouldn’t now be facing the risk that the Treasury will exhaust its “extraordinary measures” before Congress and the administration can have a rational talk about spending. We wouldn’t be wondering whether missing a debt payment could set off the Debt Bomb.

If we really did just rescue the world’s fourth biggest economy, then I want to know: Who’s going to rescue us?