Schwarzenegger embraces idea of private retirement accounts.

Gov. Arnold Schwarzenegger's controversial proposal to privatize California's two giant pension funds is designed to help reduce the state's $9.1 billion budget deficit--without raising new taxes--by cutting benefits and shifting liability for investment decisions to risk-averse state employees.

Last week, the board of the California Public Employees' Retirement System, the largest pension fund in the U.S., rejected the governor's plan to move public workers into individual investment accounts beginning in July 2007. Earlier this month, Schwarzenegger fired four appointees to the California State Teachers Retirement System who had voted against his privatization plan for that pension fund.

This year, the governor faces $2.6 billion in required payments to the two pension funds, up from $160 million in 2000. But neither Calpers, with 1.2 million members and $182 billion in assets, nor CalStrs, with 1.4 million members and $126 billion in assets, are in a financial crunch. The payments represent the unfunded liability of the systems based on a formula; the potential shortages they represent wouldn't occur for years.

The issue is further muddled because none of CalStrs' members and only one-third of Calpers' members pay into Social Security.

Many supporters of privatization blame the situation on Democratic legislators and former Gov. Gray Davis, who approved a slew of bills in 1999 and 2000 that increased retirement benefits for public employees and gave more control over payouts to localities.

The cities of Oakland and San Diego, along with Contra Costa County, face huge unfunded pension liabilities because they approved benefit increases at the height of the stock market.

Orange County Supervisor Lou Correa, a former Democratic Assemblyman from Santa Ana who authored one of the bills, said its original goal was to give local authorities the ability to negotiate with unions. "This is about a major public policy shift where you place the risk of retirement back onto the workers," he said.

Steve Frates, a senior fellow at the Rose Institute at Claremont McKenna College, supports privatization. "What are the priorities for the citizens of California--a wealth transfer to public employees or providing goods and services to citizens?" he said.

Schwarzenegger wants the state Legislature to propose a constitutional amendment that would place public employees hired after July 2007 into individual retirement accounts, with local school districts contributing matching funds. The changes would not affect retirees. Existing employees would be "allowed" to shift into defined-contribution plans, according to language in the bill proposed by Assemblyman Keith Richman, R-Granada Hills.

In the absence of legislative action, the governor plans to use the initiative process to bypass the Legislature and get citizens to vote directly on the issue.

Both Calpers and CalStrs are legally limited in their ability to mobilize their members against a ballot initiative because they act solely at the discretion of their board members.

Sanford Jacoby, a management professor at UCLA, said privatizing public pensions would create massive personnel problems for the state and have a radical impact on the education system. State-funded pensions were created in the 1930s to entice highly-educated employees into low-paying public sector jobs, he said.

"These white-collar employees are supposed to get a pension to make up for the fact that pay in the public sector is not as high as pay in the private sector," he said. "This might be a short-term solution that creates long-term personnel problems."