BY JERAMY GORDON
Daily Post Associate Editor

Despite massive investment gains for pension funds over the past two years, many Californians and their elected officials agree that something needs to be done to put an end to an era of ballooning public-sector benefits that far outweigh the private sector and threaten to leave our society in debt for many generations to come.

And while furor over the state of public pensions may have peaked during the Great Recession, uncertainty surrounding the over-promised benefits of government workers still have agencies scrambling to find a solution. Government entities and the people they serve seem to agree that meeting the obligations of public pension debts is one of the biggest challenges they face.

But when it comes to knowing exactly how much money each city, county or school district actually owes, opinions start to vary drastically.

That disparity is due to the simple fact that pension systems involve assumptions -- and lots of them.

The California Public Employees' Retirement System, or CalPERS, the nation's largest public pension system, estimates the amount of money employers and employees need to contribute toward an employee's pension based on the assumption that the money CalPERS invests will yield at least a 7.5% return every year.

Unfortunately, many experts believe the $300 billion fund's 7.5% return expectations don't match reality.

"Pension governance is what got us here; it's not bad math, virtually everyone knows the math, but we, collectively, continue to make poor choices," said Stanford professor Joe Nation, an advocate of pension reform. "CalPERS wants to run a public-sector pension fund like it's a private-sector fund, and that just doesn't work."

He said the problem is bigger than the average citizen could imagine.

"This is like an alcoholic who had to acknowledge he has a drinking problem," Nation said. "No one wants to acknowledge there's a problem. No one wants to say, 'We can't afford to pay what we've promised.'"

CalPERS announced upbeat news in July that the mega fund saw an 18% return for the fiscal year ending June 30. Despite those glowing numbers, CalPERS estimates that it is still only 76% funded -- meaning it has no ability at this point to fund the remaining 24% of its obligations to pensioners.

Worse yet, the fund would have to see 18% returns for years in order to get back into the black, and even CalPERS knows that's a long shot, Nation said.

The defined pension plans from CalPERS guarantees government workers a percentage of their highest salary for the rest of their lives.

A government agency and its employees pay into CalPERS, which in turn invests those funds in order to pay lifetime pensions to those employees when they retire as young as 55. For years, cities such as Palo Alto paid both the employer and employee contributions. That changed in 2012 when Palo Alto forced city workers to pay their share.

But despite double-digit gains over the past two years, projections show CalPERS won't have enough money to completely pay the pensions promised to employees. The amount CalPERS is short is called an "unfunded liability." The Post tallied up the total unfunded liability for public pension programs on the Peninsula, including cities, counties, school districts and other special districts, such as the Menlo Park Fire Protection District. And the results may shock you. (See sidebar.)

Using figures from CalPERS, the city of Palo Alto is $295.5 million short in its pension fund, including $105 million for police and fire employees and $190 million for all other employees. That means that each one of Palo Alto's 66,363 residents are in debt to their public servants for approximately $4,452.

That's money each resident owes to government employees because there's not enough money in their pension funds to cover the retirement benefits the employees have been promised.

But Nation, a former three-term Democratic state Assemblyman representing Marin and Sonoma counties, says the unfunded liability could, in reality, be two to three times that.

"The pension funds are all driven by very optimistic, probably overly optimistic, expectations," he said. "If you look over 75 to 100 years, you're closer to a 6% return. But what the market tells you today, is that you can probably expect to earn 4.5%." That's a far cry from the 7.5% CalPERS predicts, he said.

Using Nation's calculations, which he claims are much more realistic, Palo Alto's unfunded liability is $600 million -- double what CalPERS predicts.

Nation says Palo Alto made some mistakes, such as:

-- increasing pension benefits to "unsustainable" levels;

-- not contributing anything to any city employees' pensions, except police, in 2001, 2002 or 2003;

-- being overly optimistic about how much its pension fund would grow.

Nation related the pension fiasco to managing a simple credit card.

"Imagine you have credit card debt of $25,000," he said. "And the minimum payment with interest is $500 a month, but you work out a deal with the credit card company to only pay $100 a month. Then that balance just grows and grows. That's the situation CalPERS is in."

Peter Carpenter, a member of the Menlo Park Fire Protection District board and an outspoken proponent of pension reform, called CalPERS' long-term projections "ridiculous."

"It's unrealistic in the long term that CalPERS is going to receive the high rates of return that they're projecting," Carpenter said. "It's just ridiculous."

In order to begin to unravel the situation and see the extent of the problem, it's important to understand how we got into this mess in the first place -- and it has been a couple decades in the making, according to Nation.

He said that years of bad decisions in the state Legislature came to a head when the economy was booming and California lawmakers couldn't spend money fast enough.

In fact, in the late 1990s, CalPERS' investment returns were so good that cities weren't required to contribute toward pensions at all.

California's rich pension increases were first offered to the California Highway Patrol by former Gov. Gray Davis more than a decade ago. The move set off a chain reaction, with California's politically influential prison guard union soon clamoring for the deal, and then local police and fire departments all over the state wanted in.

Davis pushed a CalPERS-sponsored bill, SB400, through the Legislature in 1999, giving the CHP a 50% pension increase. The bill made it so that CHP officers could retire at the age of 50 and earn 3% of their highest salary multiplied by the number of years worked. Known as "3% at 50," the plan was retroactive for all officers no matter when they were hired and allowed many to retire while still earning up to 90% of their highest salaries. For example, a CHP officer earning $100,000 a year, who retired at age 50 after 30 years on the force, would earn $90,000 a year in retirement.

"It blew benefits out of the water," Nation said. "Then local governments came along two years later and said, 'Look, we can't compete with the state to maintain workers.'"

Due to a 37% pension increase, California's prison guards have become the state's largest personnel expense, creating a situation in which the government's cost to house each prisoner is an astounding $45,000 per year, according to National Affairs, a quarterly political publication.

Local governments were urged to match the new benchmark as a way to remain competitive in the job market.

In Palo Alto, in 2001, the city increased benefits for police and firefighters by about 50% when it went to 3% at 50, effective retroactively. It did the same favor for SEIU, its largest employee union, in 2007, giving all non-police and non-fire employees a 35% increase in lifetime benefits by going to 2.7% at 55.

The landmark SB400 also gave all state employees a large retroactive pension increase. And current retirees received a 1% to 6% increase in their pensions. All this could be done, said a CalPERS brochure given to legislators, without costing taxpayers "a dime."

"I foolishly voted 'yes' on this bill," Nation said.

But when the dot-com bubble burst in late 1999 and early 2000, the stock market plummeted, and CalPERS experienced two straight years of investment losses, causing unfunded liabilities to skyrocket and sending government leaders all over the state into panic mode.

More than 80 retirees from the city of Palo Alto earn $100,000 a year or more from their pension, but not all of that is Palo Alto's responsibility. Many employees worked in other government agencies before transferring to Palo Alto or left Palo Alto to work elsewhere. In those cases, the pension liability is split between employers.

For example, former Palo Alto city manager Frank Benest gets a $174,947-a-year pension. But since Benest only spent eight years of his 34-year career in Palo Alto, the city is only responsible for a percentage of that.

CalPERS does not view benefits as a key driver of pension costs, pointing instead to rising pay and market cycles.

Between 2009 and 2011, CalPERS' investments bounced from 15% losses to 20% positive returns back to double-digit losses. And while CalPERS' investments have stopped the roller- coaster ups and downs and have seen substantial gains, Nation and Carpenter said government entities are far from being out of the hole, and it's time for sweeping reform.

Here's Part 2 of our series