South Africa and state raiders

Chistopher Castaneda is an economic historian and chair of the Department of History at California State University, Sacramento. Several years ago, CalPERS funded Castaneda to write a history of CalPERS for internal purposes. Castaneda sat down with News & Review to discuss his research on CalPERS.

How did you get involved with doing the history of CalPERS?

When I came to Sacramento, I already had lots of experience researching and writing institutional histories from when I was in Texas. The California State Library received an inquiry in 2000 about someone who might be interested and able to do a research project on CalPERS. Through that referral, they contacted me. Because I had had lots of experience doing research and writing of institutional histories, that’s how I got started.

What’s an example of prior institutional histories you had researched and written?

One of them was a history of a large energy company. At the time, it was called Panhandle Eastern Corporation, a natural gas pipeline company which had diversified over time. It’s now part of Duke Energy. We wrote a book that placed the history of that company in a regulatory context. So the company began in the late 1920s. We looked at how it had evolved during three different eras of regulatory control.

Why was CalPERS looking to have such a history written.

The initial impetus, I believe, was that they knew they were having an anniversary coming up – which is the 75th, coming up this summer. They realized that it was important to start the process of collecting historical information and documenting it. Also I think there was a recognition that there were a number of people who should be interviewed about their experiences at CalPERS – and some of those people either were moving away or elderly or not in good health. So it was a good opportunity to record their memories of the history of CalPERS on tape and get it documented.

How long did you work on the project and how many interviews did you conduct? Did you have free and open access to CalPERS’ archives?

I worked on it for about two years, and conducted approximately 25 interviews. I worked with the library at CalPERS, with Ava Goldman as my liaison person at the library information center. I had the ability to request any information that I could think of requesting. I also went to the state archives, and worked with some graduate students to produce a major bibliography and also help with the research into secondary sources.

Did CalPERS fund this research?

Yes, they did.

Did you feel any constraints on how you wrote up the research?

No, I didn’t. We had a number of discussions before the project really got started, about what the format of the manuscript would be. We agreed that I would follow a decade by decade approach, and within each decade there would be a theme bringing a focus to that decade, so it wouldn’t be just a collection of facts. That worked out well. We also agreed that this might very well possibly evolve into a university press book later, or other types of products. One of the other things I also did was to write articles for their Perspectives quarterly newsletter. But there was never any conflict at all. I got started and I was on my own basically.

In doing the research, what came most into focus for you as an area of interest?

What I found most interesting myself was the investment side of CalPERS. Having come from Houston where I had worked on a number of business history projects, it was interesting. In Houston, some of the more visionary CEOs realized there could be something of value in the history of the corporation. But when I came here to Sacramento, one of the things I realized was that there were no corporations. So in terms of the kind of work I like to do, it wasn’t really there. When this CalPERS project came about, it was a sort of an epiphany, because here was a quasi-state agency that was more powerful than any of the corporations that I had done projects for in the past. Why is it more powerful? Partly because of the tremendous amount of money they have in their fund, and then because of the benefits that they provide to their members, health care and retirement.

Early in their history CalPERS was confined to investing in only the conservative investments, like government bonds. At what point did CalPERS adopt a more pro-active and aggressive investment strategy and why?

That’s what’s really interesting. Through 1947, SERS, as it was called then, was restricted to municipal bonds. In 1947 they were able to begin investing in telephone, gas and electric utility bonds: investments with a guaranteed rate of return, very safe, very conservative. So there’s a slow progression over time. Then, at the time, on the other side, the membership is relatively small, compared to today. And inflation’s low, so there are fewer pressures on the system to generate more income to pay for those benefits. Gradually they are able to invest in different types of real estate instruments – mortgages and things. In the 1950s they begin investing in building certificates. Then they create a mortgage loan department in 1964. In 1966, there’s a proposition, Proposition 1, to allow SERS (as it’s still called) to invest in stock. Beginning in 1967, they begin investing in stock, but can only invest up to 25 percent of its funds in stock.

Whose stimulus was it to allow them to invest in stock? Did it come from within PERS or from outside forces like Wall Street wanting access to the investment capital?

I don’t think it was Wall Street. But I know one of the impetuses to do that was an interest in providing cost of living allowances.

So inflation is starting to be a factor?

So basically inflation is starting to be a factor, and the desire to adjust the benefits and the need for more funding to adjust the benefits. In order to do that, you begin looking at investments that are going to generate more income.

And there was something of a bull run in the stock market during the 1960s.

There was. The other thing that happened, in 1962 the Myers-Getty Act is passed. Also known as the California State Employees Medical and Hospital Care Act, the bill allows voluntary group coverage of medical and hospital benefits. So in the early 1960, PERS also enters an era of beginning to diversity itself. It’s not just providing retirement benefits. It’s also providing medical and hospital benefits. So you have cost of living increases and medical health care benefits, and that puts some pressure on the organization to begin investing in other instruments to provide more return.

Did you get any sense that there was active opposition to allowing them to move into the stock market back in the mid-1960s?

That’s a good question. I didn’t look at that so much. The proposition passed, but there was definitely some opposition. You had some people with the frame of mind that PERS was going to be risking their retirement funds if they go into the stock market. Reagan was governor when the authority to invest in common stock was approved.

At the time he vetoed other bills that would have increased member benefits, because they had to make sure they could fund the cost of living increases.

There is an interesting tension between the state needing to look after the welfare of its retired workers, but there also has to be money in the system to pay for it. CalPERS has been, I think, very successful at being fiscally prudent and at the same time being able to fund increasingly generous benefits.

When was the 25 percent limit on stock investments get removed?

That was in 1984 when CalPERS was freed from that 25 percent limit by Proposition 21. That’s also when the corporate governance movement starts. That’s why looking at corporate governance historically is really important. Today we see CalPERS as this giant fiscal elephant who can influence corporate policy and corporate board structure. But how did that start and why did that start? In the early 1980s, as CalPERS begins investing more in stock, it makes an awful lot of sense for CalPERS to start wanting to have some influence on corporations as a shareholder activist. Any shareholder wants his or her investment to be safe, secure and likely to grow in value. As CalPERS takes on the ability more and more to invest in corporate stock, of course it’s going to want to influence the value of that stock – it’s completely natural. So shareholder activism is something that flows naturally, logically out of the ability of CalPERS to invest more in stock.

Was there something happening in corporate America or in the economy at that point which was also a background stimulus to CalPERS’ entering into shareholder activism?

There’s always going to be issues of corporate behavior and how it’s going to benefit stockholders, or not. But I think, in a way, even the bigger thing that was happening, or at least the more high profile events that were happening, was the merger-acquisition movement. So you had CalPERS investing in corporations that are either being subject to takeover or are launching takeover bids. In that environment, all sorts of things are happening. Corporations that are being subject to takeover will sometimes employ the “poison pill,” where they’ll use tactics to depress their own stock price in order to remain independent. So CalPERS is in this really interesting situation of having a significant investment in a corporation that’s purposefully trying to devalue its own stock in order to avoid a takeover. So what does CalPERS do? Ultimately, CalPERS would oppose poison pills because that causes a problem for the value of the stock, and ultimately to the members of the system. So CalPERS first would oppose these takeover measures, particularly takeover measures that influence that negatively influence the stock, and they also oppose something called “greenmail.” When some corporations that were subject to takeover would try to pay off the hostile suitor. The payoff, you can call it whatever you want, but technically the corporation subject to being taken over pays a premium to the takeover corporation that’s a higher value of the stock than anyone else can get on the open market. So again CalPERS opposes those, because why should the corporation should get a premium on its stock just because it’s trying to take you over? So those sorts of things go on in the 1980s, definitely motivating CalPERS to become a more activist shareholder.

In 1982, when the state legislature added the state treasurer to the CalPERS board, then-state treasurer Jesse Unruh, a character in and of himself, becomes very active in CalPERS’ relationships with corporations. He also, along with the New York City Controller and a member of the Wisconsin state investment board, found the Council of Institutional Investors in 1985. The Council of Institutional Investors is basically a clearinghouse policy institute, a collection of institutional investors who realize they have a common interest in making sure that the corporations in which they invest are operating in the best interests of the stockholders. This is all part of the corporate governance movement, which comes out of the mid-1980s.

Was there some initiative which finally took all the controls and limits off of what CalPERS could invest in?

For all practical purposes, it was Proposition 21 in 1984 that took the restrictions off of the stock investments.

The next turning point is this 1992 initiative, Proposition 162?

Yes. But there are other things along the way. In 1987 CalPERS decides to stop investing in businesses doing business in South Africa. What’s interesting about that is – this is really such an important issue – when you invest, and you have to have an investment policy, do you invest only in the corporations that are going to provide the greatest return to our fund, or can you take into account social issues, environmental issues? With South Africa, there’s a moral issue, and what does CalPERS do? Ultimately I think the argument in all of these cases is, in the long term socially responsible investing, environmentally responsible investing is, in the long term, going to be better business. I think that’s part of the argument for also considering other factors in doing investment. Maybe in the short term, these investments might be somewhat problematic; but in the long term its better for society, and ultimately will be more profitable because everyone’s going to recognize it.

But with South Africa wasn’t there also a calculation that this divestment policy would actually help cause the end of apartheid.

That’s true. I can’t speak to how successful that was.

In 1991, the legislature and Governor Pete Wilson tried to raid the CalPERS fund to cover a state budget deficit?

Basically, the state had a $14 billion deficit, and was desperately trying to figure out how to deal with it. One of the things they tried to do is stop making contributions to some CalPERS accounts, such as cost of living increases. The state had tried to raid CalPERS before in 1982 and 1986, similarly by stopping the contributions. But in 1991, you have Assembly Bill 702, and with that the governor tried to go beyond raiding CalPERS and take control of CalPERS. The governor was going to re-organize the board and have the authority to appoint the actuary, and have the actuary answer to the governor. That would have been a significant change. CalPERS and others reacted very quickly. In 1992 you had Proposition 162, which passed and formally and specifically gave plenary authority and fiduciary responsibility to the CalPERS board. It made it specifically very clear that the governor didn’t have control over the administration of the fund.

Was it the California State Employees Association which was the most active force behind Proposition 162?

CSEA is certainly there. CSEA is certainly interested. Under an earlier name, they were the group that got a retirement system instituted in the first place.

What happened next that was significant?

During the 1990s, CalPERS investment returns are huge. During that period they become more active in international markets. They develop an international corporate governance program.

With CalPERS now being so large, where, if anywhere, do you perceive the risks to the fund to be?

think CalPERS is so big right now that if an event was devastating enough to create a risk to the fund, the risk would be to much more than just the fund. Because it’s a highly diversified investment portfolio and they’re so smart at investing that they are an index themselves. I think their riskier times were earlier when they were really branching out with their investments. But it’s an amazing organization because it’s essentially a state organization that’s investing in corporate America and able to influence practices in corporate America. —Ralph Brave