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In an age in which government spending is measured in hundreds of billions of dollars, the potential shortfall in California pension plans is shocking. A new study from the Stanford Public Policy Program estimates that three state funds could be short of their obligation by $350 billion.

It concludes that “the state would need to invest more than $200 billion, and possibly as much as $350 billion, today to return the fund to a minimum responsible level of funding,”

The forecasts do not even cover all the California pensions. Stanford only looked at three: the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS) and the University of California Retirement System (UCRS). These funds cover 2.6 million beneficiaries.

The solutions to the problem is going to deeply trouble the people covered by the plans. The first is that “reducing pension benefits.” The second is that “retirees receive a smaller fixed pension combined with a 401(k)-style plan.” The second option would theoretically cut the funds’ liability.

The California disaster is hardly isolated. Public pension plans for state and municipalities across the country are underfunded by trillions of dollars. To become fully funded, the tax bases in these regions would have to pick up sharply or the investments held by the funds would need to sharply outperform the bond, derivatives, and equities markets over the next several years.. It is possible, but not likely that the administrators of the funds will be able to outsmart skilled investors even if markets drop. Unless the US economy rebounds at a record rate and stays strong for a decade, tax income in states and cities will not rise enough to solve the taxation  problem, That is a problem that the funds share with the US government which is forecast to run multi-year deficits and a growing national debt.

The harsh view of the issue, which is also probably the accurate one, pensioners, both public and corporate, will have their benefits drop like the retirement nest eggs of many Americans with personal retirement plans. The effect of that on consumer spending between now and 2020 when the federal government needs a pick-up in GDP will be negative.

The debt problem in America is a cascading one which demonstrates that the deleveraging of debt across the country is only partially over. Pension funds that cannot meet obligation will need federal assistance. The government can only cover the deficits through more borrowing of its own. Or, the US can turn away from the needs of the pensions and allow their payouts to fall sharply. That will undermine the tax base represented by retired workers and their spending power as well.

All of it adds up to growing federal deficits and a nation debt which is already threatening the US sovereign credit rating and America’s eventual ability to raise money in the global capital markets.

Douglas A. McIntyre