Boomerang: Travels in the New Third World

by Michael Lewis

  In Paul’s view, Arnold Schwarzenegger had been the best test to date of the notion that the problem with California politics was personal; that all the system needed to fix itself was an independent-minded leader willing to rise above petty politics and exert the will of the people. “The recall was, in and of itself, an effort by the people to say that a new governor—a different person—could solve the problem,” says Paul. “He tried every different way of dealing with the crisis in services. He tried to act like a Republican. He tried to act like a Democrat. He tried making nice with the legislature. When that didn’t work he called them girlie men. When that didn’t work he went directly to the people. And the people voted against his proposals.”

  The experiment hadn’t been a complete failure. As governor, Schwarzenegger was able to accomplish a few important things—reforming worker compensation, enabling open primaries, and, at the very end, ensuring that legislative districts would be drawn by an impartial committee rather than by the legislature. But on most issues, and on virtually everything having to do with how the state raised and spent money, he lost. In his first term Schwarzenegger had set out to cut spending and found he could cut only the things that the state actually needed. Near the end of his second term, he managed to pass a slight tax increase, after he talked four Republicans into creating the supermajority necessary for doing so. Every one of them lost his seat in the next election. He’d taken office in 2003 with approval ratings pushing 70 percent and what appeared to be a mandate to fix California’s money problems; he’d left in 2011 with approval ratings below 25 percent, having fixed very little. “I was operating under the common sense kind of thing,” he says now. “It was the voters who recalled Gray Davis. It was the voters who elected me. So it will be the voters who hand me the tools to do the job. But the other side was successful enough for the voters to take the tools away.”

  David Crane, his economic adviser—at that moment, rapidly receding into the distance—could itemize the result: a long list of depressing government financial statistics. The pensions of state employees ate up twice as much of the budget when Schwarzenegger left office as they did when he arrived, for instance. The officially recognized gap between what the state would owe its workers and what it had on hand to pay them was roughly $105 billion, but that, thanks to accounting gimmicks, was probably only about half the real number. “This year the state will directly spend thirty-two billion dollars on employee pay and benefits, up sixty-five percent over the past ten years,” says Crane later. “Compare that to state spending on higher education [down 5 percent], health and human services [up just 5 percent], and parks and recreation [flat], all crowded out in large part by fast-rising employment costs.” Crane was a lifelong Democrat with no particular hostility to government. But the more he’d looked into the details, the more shocking he found them to be. In 2010, for instance, the state spent $6 billion on fewer than 30,000 guards and other prison system employees. A prison guard who started his career at the age of forty-five could retire after five years with a pension that very nearly equaled his former salary. The head parole psychiatrist for the California prison system was California’s highest-paid public employee; in 2010 he’d made $838,706. The same fiscal year that the state spent $6 billion on prisons, it had invested just $4.7 billion in its higher education—that is, 33 campuses with 670,000 students. Over the past thirty years the state’s share of the budget for the University of California had fallen from 30 percent to 11 percent, and it was about to fall a lot more. In 1980 a Cal student paid $776 a year in tuition; in 2011 he would pay $13,218. Everywhere you turned, the long-term future of the state was being sacrificed.

  This same set of facts, and the narrative it suggested, would throw an ordinary man into depression. He might conclude that he lived in a society that was ungovernable. After seven years of trying and mostly failing to run California, Schwarzenegger is persuasively not depressed. “You have to realize the thing was so much fun!” he says. “We had a great time! There were times of frustration. There were times of disappointment. But if you want to live rather than just exist, you want the drama.” As we roll to a stop very near the place on the beach where he began his American bodybuilding career, he says, “You have to step back and say, ‘I was elected under odd circumstances. And I’m going out in odd circumstances.’ You can’t have it both ways. You can’t be a spoiled brat.”

  The odd circumstances were the never-ending financial crises. He’d come to power in the bust after the Internet bubble; he’d left in the bust after the housing bubble. Before and after our bike ride, I had sat down with him to get his view of this second event. It was in the middle of 2007, he said, when he first noticed something was not quite right in the California economy. He’d been finishing up budget negotiations and arrived at a number, however phony, where the budget could be declared balanced. An aide walked into his office to give him a heads-up: the tax receipts for that month were less than expected. “We were all of a sudden short three hundred million dollars in revenue for the month,” says Schwarzenegger. “I somehow felt, Uh-oh. Because there was something in the air.” Soon after that he visited the George W. Bush White House, where he gave a talk that was, as ever, upbeat. “At the end of it this guy—he was the guy who was in charge of housing, I forgot the name. Great guy. For some reason or other he was very honest with me. I don’t know why. He probably didn’t think I’d go out and blab, which I didn’t. He says, ‘That was a great speech you gave, but we’re heading to a major problem.’ I said, ‘What do you mean?’ He said, ‘I looked at some of the numbers, and it’s going to be ugly.’ That’s all he said. He wouldn’t elaborate.” A housing price decline in the United States meant a housing price collapse in California; and a housing price collapse in California meant an economic collapse, and a decline in tax revenues. “The next month our revenues came in short six hundred million dollars. By December we were short a billion.”

  The hope that California would generate the tax revenues needed to pay for even newly reduced services vanished. “This crisis consumed the last three years,” says Schwarzenegger. “All of a sudden you are pissing off everyone. The parks don’t get money and all of a sudden everyone is in love with parks. People pay attention so much to how does it affect them immediately: that’s just the way the human mind works.”

  How the further degradation of public services affected people immediately would not have been immediately obvious to a governor sitting in Sacramento. As Meredith Whitney had pointed out, the state has great ability to paper over its financial problems by pushing them down to cities. In May 2011, to take just the most cinematic of countless examples, the U.S. Supreme Court upheld a ruling that California’s prison conditions constituted cruel and unusual punishment and violated the Eighth Amendment. The ruling ordered the state either to build more prisons or to release thirty thousand inmates. The state—still overpaying its prison guards—has chosen to release the prisoners and, with them, their social cost. There will probably be more crime, and heavier dependency on local public services, but it must be paid for by local communities. At some point in our talks I had asked Schwarzenegger how much time he had spent, as governor, grappling with the on-the-ground local implications of the big state crisis. The question pretty clearly bored him. “I’m not into the local stuff,” he’d said. “I was born for the world.”

  ABOUT AN HOUR into the weekly meeting of the San Jose City Council I find myself wishing that I, too, was born for the world. A hundred citizens yawn and text as the council honors National Farmer’s Market Week; the few people who seemed to be paying attention get up and leave after the honor is bestowed. The council commemorates August 7 as Assyrian Martyrs Day, “honoring the massacre of three thousand people in August 1933, and recognizing 2,000 years of persecution of Assyrian Christians.” Maybe thirty people turn their attention from their cell phones to the ceremony but then they, too, rise and exit the chamber. A mere handful of people are left to hear the San Jos
e city manager offer the latest bleak financial news: the state of California was clawing back tens of millions of dollars more, and “one hundred and forty employees have been separated from the city.” (New times call for new euphemisms.) A pollster presents his finding that, no matter how the question is phrased, the citizens of San Jose are unlikely to approve any ballot measure that raises taxes. A numbers guy gets to his feet and explains that the investment returns in the city’s pension plan are not likely to be anything like as high as was assumed. In addition to there not being enough money in this particular pot to begin with, the pot is failing to expand as fast as everyone had hoped, and so the gap between what the city’s employees are entitled to and what will exist is even greater than previously imagined. The council then votes to postpone, for six weeks, a vote on whether to declare the city’s budget a “public emergency,” and thus to give to the mayor, Chuck Reed, new powers.

  In between each motion an obese man not so much dressed as enshrouded in blue jean overalls maximizes his right to be heard for five minutes on every subject: over and again he rises from the front row of the audience, waddles to the podium, and delivers sophisticated-sounding but incomprehensible critiques of everything. “The absolute reduction in competence of government is predicated on what happened today . . . ”

  The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt.

  It’s late afternoon when I meet Mayor Chuck Reed, in his office at the top of city hall tower. The crowd below has just begun to chant. The public employees, as usual, are protesting him. Reed is so used to it that he hardly notices. He’s a former air force fighter pilot and Vietnam veteran with an intellectual bent and the clipped manner of a midwestern farmer. He has a master’s degree from Princeton, a law degree from Stanford, and a lifelong interest in public policy. Still, he presents less as the mayor of a big city in California than as a hard-bitten, upstanding sheriff of a small town who doesn’t want any trouble. Elected to the city council in 2000, he became mayor six years later; in 2010, he was reelected with 77 percent of the vote. He’s a Democrat, but at this point it doesn’t much matter which party he belongs to, or what his ideological leanings are, or for that matter how popular he is with the people of San Jose. He’s got a problem so big that it overwhelms ordinary politics: the city owes so much more money than it can afford to pay to its employees that it could cut its debts in half and still wind up broke. “I did a calculation of cost per public employee,” he says, as we settle in. “We’re not as bad as Greece, I don’t think.”

  The problem, he explains, predates the most recent financial crisis. “Hell, I was here. I know how it started. It started in the 1990s with the Internet boom. We live near rich people, so we thought we were rich.” San Jose’s budget, like the budget of any city, turns on the pay of public safety workers: the police and firefighters now eat 75 percent of all discretionary spending. The Internet boom created both great expectations for public employees and tax revenues to meet them. In its negotiations with unions the city was required to submit to binding arbitration, which works for police officers and firefighters just as it does for Major League Baseball players. Each side of any pay dispute makes its best offer, and a putatively neutral judge picks one of them. There is no meeting in the middle: the judge simply rules for one side or the other. Each side thus has an incentive to be reasonable, for the less reasonable they are, the less likely it is that the judge will favor their proposal. The problem with binding arbitration for police officers and firefighters, says Reed, is that the judges are not neutral. “They tend to be labor lawyers who favor the unions,” he says, “and so the city does anything it can to avoid the process.” And what politician wants to spat publicly with police officers and firefighters?

  Over the past decade the city of San Jose had repeatedly caved to the demands of its public safety unions. In practice this meant that when the police or fire department of any neighboring city struck a better deal for itself, it became a fresh argument for improving the pay of San Jose police and fire. The effect was to make the sweetest deal cut by public safety workers with any city in northern California the starting point for the next round of negotiations for every other city. The departments also used each other to score debating points. For instance, back in 2002, the San Jose police union cut a three-year deal that raised police officers’ pay by 10 percent over the contract. Soon afterward, the San Jose firefighters cut a better deal for themselves, including a pay raise of 23 percent. The police felt robbed and complained mightily until the city council crafted a deal that handed them 5 percent more pay in exchange for training to fight terrorists. “We got famous for our antiterrorist training pay,” explains one city official. Eventually the antiterrorist training stopped; the police just kept the extra pay, with benefits. “Our police and firefighters will earn more in retirement than they did when they were working,” says Reed. “There used to be an argument that you have to give us money or we can’t afford to live in the city. Now the more you pay them the less likely they are to live in the city, because they can afford to leave. It’s staggering. When did we go from giving people sick leave to letting them accumulate it and cash it in for hundreds of thousands of dollars when they are done working? There’s a corruption here. It’s not just a financial corruption. It’s a corruption of the attitude of public service.”

  When he was elected to the city council in 2000, Reed says, “I hadn’t even thought about pensions. I can’t say I said, ‘Here is my plan.’ I never thought about this stuff. It never came up.” It wasn’t until San Diego flirted with bankruptcy, in 2002, that he wondered about San Jose’s finances. He began to investigate the matter. “That’s when I realized there were big problems,” he says. “That’s when I started paying attention. That’s when I started asking questions: could it happen here? It’s like the housing bubble and the Internet bubble. There were people around who were writing about it. It’s not that there aren’t people telling us that this is crazy. It’s that you refuse to believe that you are crazy.”

  He hands me a chart. It shows that the city’s pension costs when he first became interested in the subject were projected to run $73 million a year. This year they would be $245 million: pension and health costs of retired workers now are more than half the budget. In three years’ time pension costs alone would come to $400 million, though “if you were to adjust for real-life expectancy it is more like six hundred fifty million dollars.” Legally obliged to meet these costs, the city can respond only by cutting elsewhere. As a result, San Jose, once run by 7,450 city workers, was now being run by 5,400 city workers. The city was back to staffing levels of 1988, when it had a quarter of a million fewer residents to service. The remaining workers had taken a 10 percent pay cut; yet even that was not enough to offset the increase in the city’s pension liability. The city had closed its libraries three days a week. It had cut back servicing its parks. It had refrained from opening a brand-new community center built before the housing bust, because it couldn’t pay to staff the place. For the first time in history it had laid off police officers and firefighters.

  By 2014, Reed had calculated, a city of a million people, the tenth largest city in the United States, would be serviced by 1,600 public workers. “There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the
entire city, presumably with a focus on paying pensions. “I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever.

  This wasn’t a hypothetical scary situation, said Reed. “It’s a mathematical inevitability.” In spirit it reminded me of Bernard Madoff’s investment business. Anyone who looked at Madoff’s returns and understood them could see he was running a Ponzi scheme; only one person who had understood them bothered to blow the whistle, and no one listened to him. (See No One Would Listen: A True Financial Thriller, by Harry Markopolos.)

  In his negotiations with the unions, the mayor has gotten nowhere. “I understand the police and firefighters,” he says. “They think, We’re the most important, and everyone else goes [gets fired] first.” The police union recently suggested to the mayor that he close the libraries for the other four days. “We looked into that,” Reed says. “If you close the libraries an extra day you pay for twenty or thirty cops.” Adding twenty more police officers for a year wouldn’t solve anything. The cops who were spared this year would be axed next, in response to the soaring costs of the pensions of city workers who already had retired. On the other side of the inequality is the taxpayer of San Jose, who has no interest in paying more than he already does. “It’s not that we’re insolvent and can’t pay our bills,” says Reed. “It’s about willingness.”

  I ask him what the chances were that, in this pinch, he could raise taxes. He holds up a thumb and index finger: zero. He’s recently coined a phrase, he says: “service-level insolvency.” Service-level insolvency means that the expensive community center that has been built and named cannot be opened. It means closing libraries three days a week. It isn’t financial bankruptcy; it’s cultural bankruptcy.