MIKE GREEN: It's almost inevitable that the problem is so large that it can't really be solved.

JOHN MOORLACH: And so now you see it manifested. Poverty rates, unaffordable housing, homelessness, all these things that have just kind of been growing and growing and growing. And here we are trying to react as quickly as possible. They are relying on door number one, which is that investment returns will take care of the problem. Once the stock market levels out or declines, we'll start seeing negative returns. We'll start seeing larger requirements for contributions. A train wreck is coming.

MIKE GREEN: Mike Green. I'm here in Sacramento for Real Vision. I'm really excited sit down with John Moorlach. John, you're the California state senator representing the 37th district of California, which Huntington Beach, the Orange County, Costa Mesa area. Wanted to briefly dig back into your background, though, because you didn't start in public service. You actually started as a certified financial planner, right? A CPA, actually. I'm sorry.

JOHN MOORLACH: Yeah, a certified public accountant. I was an accounting major--

MIKE GREEN: Yep.

JOHN MOORLACH: --and was with the firm for a number of years, actually 10 years, as a partner, and also acquired my certified financial planner license. And didn't sell product, but just to help my clients with their other professionals to make sure that they were focused on an estate plan.

MIKE GREEN: And then you were recruited to run for state treasurer, is that correct?

JOHN MOORLACH: That's correct. I had moved into a home, a larger home, in Costa Mesa, and my neighbors across the street were involved in the local Republican Club. And I still had my Reagan Bush bumper sticker on the back of the car, and so I kind of got recruited. And over time, I was involved with their club. And they said run for central committee, and I did and got elected. And then chairman of the central committee one night said, why don't you run for treasurer? And I said, no, I'm treasurer of enough board.

And he said, no, no, no, we're talking Robert L.-- Bob-- Citron, Orange County treasurer tax collector. And I didn't react well to that, either, so I had to kind of take some time. I found myself backpacking out of Tuolumne Meadows, Young Lakes, and on the way home on the 395, a good friend of mine who's now here in Sacramento, as well-- he's the CEO of the fairgrounds, the state fair-- he said, John, you've been complaining about this idea. Why don't you just look at it and make a decision? You'd be home every night if you got elected, and then you could work with the supervisors to help them out. You'd have the kings here.

And so I said, OK, Rick, I'll do some research. And then when I saw the portfolio that was being managed-- I was able to get a copy-- I was rather astounded that there was so much leverage being utilized. I would never put a widow or an orphan in a portfolio like this. Why are all the taxpayers of Orange County involved? And so that sort of triggered me to run.

MIKE GREEN: And so you and I know this situation very well, right? In 1994, Bob Citron, who was the treasurer for the county of Orange County, had invested his assets, the cash that he had on hand, effectively, into an interest rate swap that offered a slightly higher return than money markets at that time. We'd experienced a significant decline in interest rates, from roughly 9% in 1990 to about 4.5%, if I remember correctly, maybe 5%, in 1994. And Citron effectively placed a very large levered bet that interest rates were not going to move higher in order to get a little bit extra yield on the cash. Is that correct?

JOHN MOORLACH: It was an arbitrage play. He would borrow at the short end of the yield curve, pay maybe 3%, buy at the four-year level, which was paying about 5%. So you'd make the 200-basis point spread. And that's all great if the short end of the yield curve cooperates. And he anticipated that it would even decline. But in fact, Alan Greenspan said, I think inflation is starting to raise its head, we ought to do something about that, we ought to raise rates. And so during the year, he did.

And it coincided with my campaign saying, look, he's raising rates. You're losing value. You took $7 billion in assets based on what the county had and what 187 other municipalities decided to chip in, and yet you levered it up to 21 billion. You know, it's just amazing. And if those short end rates go up, then you're in trouble.

He had collateral calls, but I only had beat reporters following the whole thing. So like I said, it was sort of like the-- I said in a conversation we had earlier that it was like The Big Short. You know, you're trying to explain to everybody what's going to happen, what could be a massive implosion, and they're all looking at you like, oh, you're just a gadfly. You're just a kid.

MIKE GREEN: Well, you mentioned The Big Short, and this really was. I mean, this was kind of the original Big Short. We actually created a situation in which derivatives blew up a significant financial entity and caused widespread distress across Wall Street. It wasn't just that Greenspan had raised interest rates. We actually saw the financial consequences of Orange County being unable to meet its financial obligations, right?

JOHN MOORLACH: Right. And they were inverse floaters, a derivative, kind of unique. And when rates would go down, the yields would go up inverse, and plus the leverage. And then once Greenspan decided to start-- you know, not being aware of what Citron was doing, but just doing what he had to do for the economy then, most people in the carry trade would have disengaged. They would have started paying off the lenders and getting out of it. But Citron basically doubled down.

MIKE GREEN: So when you brought this up, you were widely dismissed. And you were actually-- in a conversation we had earlier, you mentioned that reporters would call you up and say, is there anyone that you have that is of a similar caliber to S&P, for example, to comment on your-- in support of your side of this story, or are you just being political in this analysis?

JOHN MOORLACH: Yeah, it was tough. I mean, I was staying awake at night looking at the ceiling saying, OK, God, what kind of mess is this where no one can understand how this works, and why don't they do the heavy lifting? Why doesn't a reporter figure it out, or at least hire someone, you know, to figure it out? But Standard and Poor's said, you know, the leverage didn't cause them any concern. Moody's was in the same place. And it was a real awkward kind of deal. So when everything went and hit silly hill, right, everyone's going, oh, is that what he was talking about? You know, and it's like, ugh.

MIKE GREEN: Now, you ultimately lost that election--

JOHN MOORLACH: Right.

MIKE GREEN: --before it blew up.

JOHN MOORLACH: We had 40%-- a little under 40% of the vote. So I didn't do too bad for someone who came out of nowhere against a long-term incumbent.

MIKE GREEN: And then you ultimately transferred into the public sector following this. And so you've spent the better part of 25 years here now representing the state of California in one form or another.

JOHN MOORLACH: Right.

MIKE GREEN: That's fair. You have done a couple of things, I think, that are pretty unique. And one, we had a conversation earlier, you used to host a podcast. Hopefully, you're going to come back and do that again. And you run a blog that is very transparent in terms of what you're working on, what's being done on the Hill, et cetera. How engaged do you think your constituents are? How aware do you think the average politician-- or the average citizen is with local politics as compared to national politics?

JOHN MOORLACH: Well, we're certainly seeing newspaper readership decline, certainly seeing a lot more being done on iPhones and iPads and, you know, terminals, computer terminals to see-- laptops, you know-- what your news is. We're not getting the kind of information that we used to get 25 years ago. In fact, newspapers were even wider and bigger and heavier. We used to have a business section, once upon a time, that was multiple pages.

So I would say that most of my constituents are relying on social media. And it's sort of a, you know, selective process of what you want to actually read and know about. And so it kind of focuses more on the national level than the local level.

MIKE GREEN: I think that's very true. And I think that's one of the challenges that we have with social media, because you can leverage the digital information, right-- you know, the digital information superhighway-- to get something out to a much larger audience. Advertisers are obviously more interested in the wider audience. The platforms are built up for this. It doesn't seem like we have a great mechanism for sharing the information of what's going on in the local situation.

You, about five years ago, gave a speech, or a very short segment, about 2 and 1/2 minutes, actually, on public access television in which you brought up the idea of accountability or responsibility. You were discussing legislation that was being introduced that was-- there was a proposal that there would be a report, right, with the conclusion of this.

And you brought up a really great question, one that I don't have an answer to, and I'm not sure if it's been answered for you. How do we measure accountability in the public sector? How do we think about we pass a law, we do something that establishes a standard that has to be followed, how do we decide if that standard has been met? Who's held responsible for it?

JOHN MOORLACH: Great question, Mike. I even did a bill just to have the state have a CFO. You know, just who runs-- there's no CEO.

MIKE GREEN: Right.

JOHN MOORLACH: No, C-- it was actually a COO is what I was asking for. Cities have city managers. Counties have county executive officers. State of California, you know, has a governor, who has cabinet secretaries who has department of finance, and maybe it's got some balance with the Legislative Analyst's Office. But yeah, who's looking at the big picture? Why does Caltrans have 3,500 architects and engineers too many, and why aren't they being moved over to help schools start planning their next building project or something? Or why aren't they even laid off?

We don't have that kind of managerial structure. We have to tell departments what to do through bills. I'm no longer an executive. I'm a legislator now. But that takes a year to tell a certain department to follow a certain format or prepare a certain report. So it's sort of an awkward way to run a state, especially one with 40 million people.

MIKE GREEN: Well, the analogy is used in financial markets, right, the Federal Reserve talks about the dynamics of interest rate cuts or monetary policy as working with long and variable lags, right? The idea being you are operating a shower handle at the very top of a building, and the water heater is 40 floors below-- although it's unusual in California to see that height-- and the lags are perverse. That's magnified when we start talking about governing by legislation, because by the time something needs to be done or we're made aware that something needs to be done, it's almost inevitable that the problem is so large that it can't really be solved.

JOHN MOORLACH: And so now you see it manifested. Poverty rates, unaffordable housing, homelessness, all these things that have just kind of been growing and growing and growing. And here we are trying to react as quickly as possible as a legislature, as best we can with some kind of-- I wouldn't say superficial, but very limited legislation to try to address certain things. And we're not getting to the right answers. We don't know how to deal with people that are severely mentally ill that are on the streets that are walking around. We would never let someone with Alzheimer's walk around on the streets.

We haven't figured out how to free up the marketplace to build housing. We don't have housing because we have a lack of supply, but we have a lack of supply because you can't make a profit. The amount of time you need, the amount of infrastructure fees that you have to pay to your local city, you know, at the end of the day, doesn't pencil out. So why should someone go through all the hassle if you're going to break even on a project? So we haven't figured that out. And you know, we have to deal with a new leader every four to eight years. And so yeah, it's an interesting paradigm.

MIKE GREEN: Who, to your point, is not actually a leader in the executive sense, right? They don't have key performance indicators that they're being held to standard. Their compensation is unchanged, regardless of the underlying performance. They may get voted out of office, but that compensation pales in response to everything else.

JOHN MOORLACH: Correct.

MIKE GREEN: One of the things we're really interested in is the public pensions as indicative of a broader question around American retirees, because we are facing something that's relatively unprecedented. California is somewhat of a unique picture. When I was born in the state of California, there were 19 million residents. Today, there's roughly 46, if I have my math correct. But we don't think that's going to grow that much anymore.

The type of growth that we experienced over that time period, which-- I think I was born in 1500, but it's not quite that long, but we've slowed down dramatically. And suddenly the pensions, the promises that were made in an environment of extraordinary growth are becoming due. How, as a legislator, do you think about the obligations that the state has incurred, our ability to meet those, and simultaneously the obligations to the taxpayers to not place too onerous of a burden on them, as we try to resolve this crisis?

JOHN MOORLACH: Big questions, big answers. I served on a retirement board for 12 years, one of the 200 top retirement systems in the nation, while I was the county treasurer, tax collector. There was a bill in 1999 called SB-400, which passed on the last night of session, which is usually when all the garbage kind of gets passed here in California. And it said for CHP officers, you have a formula that's 2% at 50 when you retire.

So if you're making $100,000 at age 50 and you've been there 25 years, the math works out and you get $50,000 a year when halved. And they changed that formula from 3% at 50 to-- from 2% at 50 to 3% at 50. So all of a sudden, now you're making 75,000. But they never funded for it. They made it retroactive to the date of hire. So when your pension plan was fully funded in roughly 2,00 because of the dotcom boom, it now is 2/3 funded.

MIKE GREEN: Right.

JOHN MOORLACH: And you don't do that to a defined benefit pension plan. You do not change the formulas. You at least don't go retroactive. You may want to go prospective, but you would then make the participants pay a little more for their share. So we created this massive unfunded liability. And we're still looking at, after all these years later, what, 70% funded. And we're still at two thirds funded.

So we're relying on yields from the marketplace, which are supposed to exceed 7% per year. That's kind of tough to do, especially when you have interest rates that are so low. You're relying so much on equities. I think maybe California has been lucky the last four years that the stock market's gone up 50% since Donald Trump was elected president. You know, kind of lucky it's kind of deferred the problem.

But we're seeing cities, because CalPERS, the state's largest pension plan system, is slowly reducing the investment assumption from 7 and 1/2 to 7, they're seeing their contributions then go up, because the-- when you do the math, if you reduce your assumption, then your liability goes up. And then you therefore have to have a larger contribution for your unfunded portion.

And so now cities are struggling. They're raising sales tax. School districts are struggling, even though Prop 98, which provides 40% of the state's revenues to schools, it's still not enough. So a train wreck is coming, and there are telltale signs everywhere. Cities asking to go beyond the sales tax limit and raise their sales tax even higher just to try and meet their budget. So we've got something on the horizon. And we've got a state, if I could keep going--

MIKE GREEN: No, please.

JOHN MOORLACH: --that's got, what, this year a $21 billion surplus, next year 7 billion. But you can kind of see that trend going maybe next following year minus 14 billion, but giving nothing really to the cities and schools to try to start undoing or unworking this massive juggernaut that's coming down the road.

MIKE GREEN: Well, and the state of California also has a unique dynamic with Prop 13, right? Where the ability to raise property taxes on the value of properties is limited to a stated inflation rate, right? Or--

JOHN MOORLACH: 2% max

MIKE GREEN: --a 2% max. CPI has been running below that. So I actually believe it's less than 2%, is my understanding.

JOHN MOORLACH: If CPI is less, then the number-- percentage is less.

MIKE GREEN: Yeah. So when you think about that type of dynamic, where the liabilities that have been guaranteed and then expanded under SB-400, as you pointed out-- and that has continued, right, we've not entered into any form of restructuring where we've reduced the pensions-- what you're referring to on the unfunded dynamic is those liabilities are pretty much set in stone. And then the question is, how much do we need to contribute based on our expectation of what our future earnings are on the assets that have been invested.

JOHN MOORLACH: Correct.

MIKE GREEN: Bonds are somewhat straightforward. It's difficult to argue that they'll deliver returns well in excess of existing yields. Equities become that flex point. And so CalPERS, for example, just announced in the last year that they were actually going to increase their allocation in equities in the hopes that that would offset the decline on the bond side, right? So we're effectively speculating even more to try to meet those obligations.

When you think about how this ends, where does it stop? Does it stop with us miraculously earning the returns that are required to keep this funded? Does it stop