Warning Signs on the Horizon

 A Financial Wakeup Call for City Council

This week we witnessed a series of financial alarm bells being triggered that should cause the City Council to take notice. The first was the release of the California Public Employees Public Retirement (CalPERS) System’s 2022 Annual Review of Funding Levels and Risks. This report (which WOM Berkeley brought to the attention of City Council, the City Auditor and City Manager) is intended to assist participating employers, like the City of Berkeley, in assessing the soundness and sustainability of the Public Employees’ Retirement System for ongoing pension plans. 

As WOM Berkeley has documented previously the Financial Officers Association and the State Auditor consider Berkeley’s pension liabilities to be the greatest threat to the city’s credit [bond] rating. The State Auditor ranked Berkeley among the worst in the state for pension cost risk (giving the city a score of 0).

Pertinent findings in the CalPERS report include:

With the lower-than-expected investment returns for fiscal year (FY) 2021-22, the funded status of the system has decreased from 81.2% as of June 30, 2021 to an estimated 72% as of June 30, 2022. 

The recent decrease in funded status has increased the risk that plans will fall to low funding levels. In addition, employer contribution levels are expected to increase in response to the investment loss for fiscal year 2021-22.

We have determined that required contributions may increase 5%-12% of payroll over the next several years depending on how long the high inflation period lasts and how quickly it returns to Federal Reserve targets. 

City Council recently signed off on a labor agreement that requires the city to increase contributions towards pensions, so it is likely Berkeley will be on the higher end of the 5%-12% range. These required contributions are on top of over $660 million in existing liabilities. The potential consequences are service cuts or, more likely, voters will face a bond measure with the sole purpose of “shoring up” the city’s finances.

A second report from the state’s Legislative Analyst’s Office projects a $41 billion state deficit across 2022-2024. The state budget challenges emanate from our progressive tax system where there is significant reliance of the General Fund on capital gains and on taxes paid by a small portion of the population. Disastrous market returns in 2022 have flipped the state’s surplus to deficit with little relief in sight for 2023. As a consequence, city windfalls received as a result of a state surplus have disappeared.

City Council appears slow to recognize the gravity of the situation. Currently, they are advocating for extending retirement benefits to part time workers. When council members expressed a desire to better understand the fiscal implications of expanded benefits, other members responded by suggesting they make binding long-term financial decisions “without understanding the [budget] implications.” One rationale for extending benefits without complete informations is that “we have fluff in the budget.” Such a cavalier attitude toward the city’s financial situation may no longer be tenable in light of these most recent reports.

A rapid decline in state revenues from capital gains is putting increased pressure on the state, and by extension, local budgets