Category Archives: Debt

Is the mortgage crisis to blame for San Bernardino’s bankruptcy?

The LA Times contains a new kind of argument on why cities like Stockton and San Bernardino are in bankruptcy. To date, politicians, analysts and journalists have drawn a direct line from rising employee costs and declining revenues to municipal fiscal stress. Harold Meyerson takes another path to reach his own destination – to burnish the image of unions and  politicians. His bankruptcy diagnosis gets lost along the way.

He blames the banks. These cities went bankrupt because, “banks were peddling subprime mortgages to poorly-paid workers.” While the banks are certainly involved in the economic and fiscal train wreck he is upfront that the goal is to weave a counter-narrative, challenging the “right and center right” story of fiscal irresponsibility and overpaid public employees.

The problem with narratives (on either the right or the left) is when they cobble together related events and actors without a theoretical framework and empirical evidence. Mr. Meyerson is holding several of the puzzle pieces but then forces them together without regard to how they fit.

Some puzzle pieces he correctly identifies: a housing bubble, the role of banks, the economic fortunes of the Inland Empire, and the fiscal effects of California’s Proposition 13. What he airbrushes or ignores are the roles of Fed Policy, government lending, regulatory and land-use interventions, the short-term incentives of politicians, the hand of special interests, unions, and erroneous accounting assumptions that generated the perfect storm for a fiscal fallout in 2008.

Stockton’s troubles are plain for all to see. Steven Malanga discusses them here. The municipality’s spending spree can be traced to an overheated housing market which drove Bay Area homebuyers into Stockton in search of cheaper properties. That lead to a 20 percent population growth and a surge in property tax revenues fueling Stockton’s appetite for redevelopment. In 2003 the city borrowed for a waterfront revitalization and a 5000-seat sports arena. They bonded for pension enhancements. In total the city issued $700 million in debt.

Part of the pension deal allowed workers to retire at 50 with 90 percent of their final pay plus COLAs. To pay for this, Stockton invested some bond proceeds into CALpers on the bet it would earn more than the interest payments on that debt. They lost that bet. The housing boom – itself the creation of decades of government interventions – created the mirage of ever-increasing revenues that encouraged politicians to play fast and loose with bonds and future promises to workers.

The next claim is that defined benefit plans have been “demonized” also misses the mark. Defined benefit plans – or annuities – have been destroyed by those who champion them most loudly. Faulty government actuarial assumptions made them appear cheap to operate. That encourage politicians to offer workers (in union negotiations) increasingly generous retirement terms all while underfunding those benefits and taking risks with plan assets. This is accounting chicanery, and sadly, it was not (and still isn’t fully) recognized as such. The blame there can be pinned on the esoteric but well-documented trouble with defined benefit pension accounting. This case has been made in great technical detail by economists and practitioners.

The right salary for a public worker can really only be determined with reference to a private sector counterpart. It isn’t backed into based on area housing prices. Biggs and Richwine find public teacher salaries are on par with a private sector counterpart (in terms of SAT scores and skills). But, salary is only one component of total compensation for public sector workers. Compensation also includes (undervalued and underfunded) pension benefits and (largely unfunded) health benefits. Public sector compensation is a big and growing part of many municipal budgets. What can be said is that the cost of San Bernardino’s police and firefighters represent three-quarters of the city’s expenditures and revenues are flat.

Again, Meyerson is holding one of the right puzzle pieces: the revenue bust that followed the housing bubble. But he fails to note that it was the government-induced housing bubble and subsequent revenue boom that tempted public officials to overextend themselves. This house of cards was supported by flawed accounting and incentivized by short-term gains. This is why to make those pieces fit one needs a theory and empirics otherwise the diagnosis of San Bernardino’s and Stockton’s bankruptcy is cast aside in service of the meme. It is “politics with romance.”

What caused these two cities to tank? A host of economic and fiscal factors and scores of regulatory interventions over many decades. Some of that can be found in the accounts and CAFRs. They are no fun to comb over but they reveal choices, bargains, and tradeoffs under constraints and contain the record of the evasions and faulty assumptions of “public choosers.”

The Ravitch Volker report: State Budget Crisis is Real

The recession of 2008 pulled the mask off of state budget pathologies that had been identified as institutional weaknesses in the decades leading to the crisis.

The “new normal” for state and local governments does not look like the booming 1980s and 1990s but in fact is riddled with many fiscal challenges.  Revenues aren’t what they were before 2008 though they are expected to reach pre-recession levels in FY 2013. The Medicaid and employee benefits bill is rising. The stimulus pushed forward budgetary reforms. These are some of the findings of the Ravitch-Volker Report, an effort of the State Budget Crisis Task Force which assembled in 2010-2012 to diagnose the major problems facing six states: California, Illinois, New Jersey, New York, Texas and Virginia.

Much of the analysis is non-controversial: Medicaid is eating up budgets, as are pensions costs and health care benefits.

Medicaid, currently at 24 percent of state spending, will continue to increase as enrollment, medical inflation and the increasing caseloads that come with higher unemployment increase costs. This is not a surprise. What is new is that the federal government is making it harder for cost-saving measure to be enacted, and “entrenched provider groups in each state resist reductions in Medicaid provider rates….”  I do not believe this is the intention of the authors of the report but the diagnosis of Medicaid’s future highlights the dysfunctional aspects of this federal-state pact which has led to the creation of special interests that benefit from inflating costs.

On the pension front the Ravitch-Volker report points to the the role discount rates have played in the pension funding problems facing the state and local governments, in particular in New Jersey. And they also note the reliance on budgetary gimmicks that may even result in a kind of budgetary “cynicism.” A point I have made in the past.

But the report also makes a few assumptions about the interplay of federal, state and local spending that I think could benefit from an expanded debate. The authors warn that cuts in federal discretionary spending will doom subsidiary governments. On the surface, that’s true. Cuts in aid mean less money in state coffers for education, transportation and other areas. But the larger question is what are the fiscal effects of grants-in-aid between governments? There is the public choice literature to consider on the role of fiscal illusion in finances. And further, does the current model of delivering these services actually work as intended?

Their recommendations are largely sound. Many of them have been made before: more transparent accounting, a tightening of rainy day fund rules (see our recent paper on Illinois), broad-based tax systems should replace narrow ones, the re-establishment of the Advisory Commission on Intergovernmental Relations (ACIR). Abolished in 1995 ACIR was concerned with evaluating the fiscal impact of federal policies in the states. Further the commission recommends the federal government work with the states to help control Medicaid costs, and the re-evaluation by states of their own local needs including municipal finances and infrastructure spending.

The report is timely, contains good information and brings many challenges to the fore. But this discussion can also benefit from a larger debate over the current federal-state-local spending model which dates largely to the middle of last century. This debate is not merely about how books are balanced but how citizens are governed in our federalist system. The Ravitch-Volker report is sober but cautious in this regard. The report sketches out the fiscal picture of the U.S. in broad strokes and offers general principles for states to follow and it is sure to create discussion among policymakers in the coming months.

 

 

 

 

 

Two cities down to their bottom dollars

This week, two large cities dealt with the consequences of fiscal irresponsibility. On Monday, Scranton, PA joined the state capital of Harrisburg in the list of municipalities that have run out of money to meet their commitments. The city has a budget deficit of $17 million, leaving the Mayor Chris Doherty without enough money to pay his employees.

He made an executive decision to slash all city employees’ compensation to reflect minimum wage in the paychecks they received this week because the city now has just $5,000 in the bank. Full payroll costs the city about $1 million, he said.

On Tuesday, the City Council in San Bernardino, CA gave approval for the city to file for bankruptcy. Investigation is underway in San Bernardino to determine whether fraud was involved in the budgets of the previous 13 years that reported surpluses when in fact there were deficits each year.

In both cases, cities have gone the extreme route of nearly spending their last dollars before making abrupt and drastic decisions. While no public investigation for criminal activity is underway in Scranton, Gary Lewis, an accounting consultant closely tracking the city’s financial crisis questions whether recent federal grants to Scranton have been managed appropriately.

It appears inevitable that Scranton will follow San Bernardino into bankruptcy filings, as it’s likely impossible to raise taxes sufficiently to cover the city’s current deficits and past debts. While these two cities have few options remaining, other cities should learn from these practices to avoid the costly and painful bankruptcy process.

This difficult situation could be avoided with increased transparency in budgets and with accrual budgeting. This budgeting process requires that cities set aside money for expenses as they agree to pay for them rather than when the bills are due. Following this process would prevent policymakers from spending money in the present that will have negative consequences down the road.

Pension Reform in Pennsylvania and a book recommendation

Last week I testified before the Pennsylvania General Assembly on their pension reform efforts. In my testimony I covered the valuation problem. While the state reports an unfunded liability of $39.5 billion. I calculate it is $116 billion. Like many other state and local pension systems, the mis-valuation problem caused Pennsylvania lawmakers to undertake a series of measures over the past several decades that further weakened the system. These include benefit enhancements when the market was booming and creating a “funding collar” which capped annual contributions to the pension plan effectively pushing that bill forward. to the present

Pennsylvania has run out of time and costs are rising rapidly. In my testimony I cite the work of M. Barton Waring, whose book, Pension Finance, I highly recommend as an analysis of why economic valuation matters to the very existence of defined benefit plans. Without it, plans are subject to often questionable and arbitrary accounting choices. His analysis is well-grounded, consistent with theory and cogently explained.

He states his findings as a series of propositions that should guide how defined benefit plans are structured, valued and funded.

Proposition 1: Measures of the pension plan based on conventional accounting methods will always follow measures based on economic accounting sooner or later, even with a lag. The accounting will follow the economics sooner or later.

I think that proposition can been seen in the funding schedule for Pennsylvania’s two main pension plans: SERS and PSERS. As a result of artificially capping the state’s annual contribution to the plan, future contributions are slated to increase by 267 percent in the next five years. (And that is an underestimation since it is working off of the misvalued liability). Lawmakers know there is a serious hole ahead and as Waring’s book shows that is something that could have been avoided if plans had used economic valuation from the start.

 

 

The Appearance of Fiscal Prudence in Maryland discussed on WBAL-TV

Yesterday I did an interview with David Collins of  WBAL-Baltimore on my recently published paper co-authored with Benjamin VanMetre in Maryland Journal on Maryland’s Spending and Affordability Committee (SAC). Set up in 1983, the SAC was put in place to help legislators control the growth of spending. Over the interim, spending has grown beyond the capacity of annual revenues to keep pace. Thus, the SAC, created to ensure spending discipline, has presided over the creation and continuation of a structural deficit in Maryland. In 2010, the effectiveness of the SAC was called into question by the SAC itself. In this TV report the reasons for the SAC’s poor performance are discussed as well as what a rule to control spending might look like.

You can check out the video here.

 

 

 

Detroit’s Financial Future

This post originally appeared at Market Urbanism.

After flirting with Chapter 9 bankruptcy or a state takeover of its finances, Detroit has reached a deal with the state of Michigan that will allow it to remain independently managed with a requirement for state oversight. The Detroit Free Press reports:

The city has seven days to create the positions of chief financial officer and program management director and 30 days after that to make a hire from a list of three candidates from the mayor and state treasurer. Lewis said the city is compiling a list of candidates.

“We’ve got a lot of requirements that are in the agreement,” Lewis said. “We’ve got a lot of work to do (with the agreement) and then getting to the work of fixing the city. Our focus is on executing the plan and getting the resources here to execute the plan.”

Snyder reiterated that the city “shouldn’t expect” a cash bailout, adding that Detroit is one of many troubled communities in the state. But he said the state would use its resources in a variety of ways to help the city.

Snyder said the agreement assures the things that need to be done will get done, describing it as a “progressive series of steps” that first allow the mayor and the council to make the decisions, and then empowers the project manager to do so if they don’t. “This is a legal document designed to deal with situations when they don’t go right,” he said.

While bankruptcy protection offers the advantage to cities of achieving a more manageable debt load, it doesn’t come without a cost. Bankruptcy would add an additional stigma to Detroit, already known for municipal financial distress, encouraging business disinvestment.

Vallejo, CA filed for bankruptcy in 2008, and as the New York Times explains, the city is still in a difficult financial position. After bankruptcy cities have less room in their budgets to provide public services such as infrastructure, parks, and schools while their tax rates don’t fall accordingly. This contributes to further erosion of the tax base as businesses and residents leave the city.

Municipal bankruptcy is always a two-sided issue involving both revenue and debt. At The Atlantic Cities, Emily Badger covers the equation from the revenue side. While cities often both subsidize and enforce sprawl through road-building, parking requirements, and minimum lot sizes, these policies are detrimental to their property tax equations. She cites the positive example of Asheville, NC as a city that has taken advantage of denser downtown redevelopment to improve its ratio of property taxes to infrastructure costs:

Asheville has a Super Walmart about two-and-a-half miles east of downtown. Its tax value is a whopping $20 million. But it sits on 34 acres of land. This means that the Super Walmart yields about $6,500 an acre in property taxes, while that remodeled JCPenney downtown is worth $634,000 in tax revenue per acre. (Add sales tax revenue, and the downtown property is still worth more than six times as much as the Walmart per acre.)

[. . .]

All of this is also just looking at the revenue side of the ledger. Low-density development isn’t just a poor way to make property-tax revenue. It’s extremely expensive to maintain. In fact, it’s only feasible if we’re expanding development at the periphery into eternity, forever bringing in revenue from new construction that can help pay for the existing subdivisions we’ve already built.

[. . .]

“The thing is it all works fine when you have all this new growth and the new gap is met by all these new permit fees – that’s like free money,” Joe Minicozzi [of Public Interest Projects] says.

Cities should not be in the business of requiring the sort of development that is most expensive for them to support. However, this analysis ignores the debt side of Chapter 9, one that may be even more difficult to tackle politically. Despite the harm that poor financial management causes, local elected officials simply do not have the proper incentives to avoid it.

Politicians operate on election cycles, and during their time in office they generally seek to provide their constituents with the best possible services at the lowest tax rate. This leads them to put off payment on long term debt and liabilities using accounting gimmicks and fiscal evasion techniques to spend more on goods that residents will see in the near term.

A combination of debt and declining revenue has put Detroit in the position it’s in today. Its urban development strategy must be a part of the property tax revenue solution. Perhaps the new officials that the city hires will help with debt management, but this additional oversight is unlikely to overcome the incentives of election cycles.

Monday morning links

Demographic shifts in American metropolitan areas since 1950 via Demographia

Public Sector Inc post: The consequences of investment risk in public sector plans

Woonsocket, Rhode Island and talks of bankruptcy 

New federal school lunch rules: students must buy fruit and vegetables (even if they throw it in the trash)

The True Cost of the Columbia Pike Trolley: Priceless

A proposal to build a trolley car system on Columbia Pike in Arlington, Virginia continues to provoke strong reactions from residents. The County Board estimates it will cost between $214 million and $261 million to build and between $19.5 million and $25 million to operate and maintain.

As the PikeSpotter calculates, that’s $200 million more to build than the next best option: an enhanced bus line. Why the County Board’s push for a $50 million per mile streetcar system?

According to advocates, the Pike Transit proposal will relieve area congestion, spur economic activity and promote environmental sustainability.

However, residents from all sides of the political spectrum appear to disagree with the County Board. Arlington Yupette says the Pike Transit plans are “elitist” and intended to drive out middle class and working class residents by driving up rents. The end result: the “Clarendonization” of South Arlington. Some point to the need for resources to be directed to the overcrowding in county schools. And still others highlight the high likelihood of such projects becoming boondoggles.

Given the anecdotal lack of popular support expressed by area residents, why are officials persisting? Public finance holds a key. Should the county go ahead and commit to build a rail line here is how it will be financed. Thirty percent of funds will come from the  New Starts/Small Starts federal grant program and 14 percent from the state of Virginia. The remainder is to be provided by Arlington and Fairfax Counties.

Is this fiscal illusion at play? The Small Starts Program will provide up to $75 million if the local government provides a match. County Board officials are confident that Arlington and Fairfax can foot $140 million (Arlington will pay 80 percent of that) with the state of Virginia kicking in a further $35 million. Because a chunk of the cost of building the rail line can be externalized, that is, passed on to state and federal taxpayers, it looks like a bargain…at least for a fleeting moment. It’s still about $170 million dollars more than what it would cost to add more buses.

And there are more complications that arise from mingling federal, state and local dollars as noted by the Sun-Gazette. Virginia is a right to work state. Are union employees required to work on the rail line since the project will receive federal dollars? If yes then the increased labor costs will make the project even more costly to the county. (Lieutenant Governor Bolling believes Virginia state law trumps federal law in the matter.)

While new estimates continue to push the costs higher, at least one Arlington County Board member is undeterred by fiscal considerations, “This is a project that has the most potential to help us achieve our environmental goals and livability goals. We think it will have a very high return.”

That is, the costs of building the streetcar line are concrete, and the returns are mired in the counterfactual.

 

 

 

Don’t Bailout the States

Last week the Illinois House adopted HR 0720 which was part of a growing effort to remove the possibility of a federal bailout for the states. The synopsis of the House Resolution reads:

Urges the federal government to take no action to redeem, assume, or guarantee State debt; and the Secretary of the Treasury should report to Congress negotiations to engage in actions that would result in an outlay of Federal funds on behalf of creditors to a State.

Senior Director of Government Affairs at the Illinois Policy Institute, Collin Hitt, offered committee testimony on the resolution. While writing about his testimony, Collin correctly argues that

Illinois’ problems are its own. Illinois has the tools to fix its finances. The state is seeing record reviews. Pension reform and Medicaid reform are possible, and there are concrete ideas to fix these debt-ridden programs. The prospect of a federal bailout only forestalls those solutions. If a federal bailout is considered imminent – or even possible – then the urgency to actually solve our problems ourselves is diminished. This resolution sends a message throughout state government that a bailout is not a solution that the State of Illinois can plan on.

That last part is absolutely essential, as it gets at a serious issue currently taking place in Illinois and other troubled states across the U.S. When politicians and law makers are dealing with a state that is on the brink of fiscal collapse they have two options: 1) make lasting intuitional and structural reform or 2) avoid significant reform and hope that most of the issues fix themselves. As a federal bailout becomes more likely, however, avoiding reform becomes politically easier. This, therefore, becomes a race to the bottom scenario where the states that end up in the worst fiscal shape are “rewarded” with a federal bailout… A very bad incentive structure and a scary road to head down.

Hopefully HR 0720 gains more traction and Illinois and begins to change the growing federal bailout expectations. If it is successful, other states should surely follow.

Central Falls Receiver: Bankruptcy can be a good thing

Central Falls, Rhode Island receiver Robert Flanders addressed the Rhode Island Statewide Coalition this weekend and took the opportunity to praise the process of bankruptcy for municipalities in deep distress. Reports The Pawtucket Times, “It’s not a horrible thing, it’s a thing we ought to be doing,” From his view bankruptcy allows a municipal government to make the necessary change to come back stronger. The stigma attached to bankruptcy he argues is short-lived. Another lesson offered: Rhode Islands small governments have built up expensive debts in the form of promises to public sector workers and it might be worth school districts and municipalities merging administrative expenses.

The core problem in cash-strapped, economically struggling Rhode Island towns is how to pay for the increasing costs for government without putting even more pressure on residents and businesses.

Richard Brodsky, who is currently on a board advising Yonkers, NY as the city tries to bridge a massive budget gap, writes at The Huffington Post, that the problems afflicting many municipal governments can be traced to budget gimmicks and attempts to “kick the can down the road,” noting that blame tends to be shifted to overly-generous employee pensions.

I tend to agree. Pension and health care costs are driving many (but not all) municipal fiscal crises. Years of misleading accounting gave all parties a false sense of fiscal security. This has led to benefit enhancements negotiated by unions and politicians, governments skipping payments, and excessive risk-taking with plan assets. There is plenty of blame to go around.

How to fix it? Begin with accurate numbers. Recently Mayors and executives from across New York State met in Albany to discuss the unforgiving and unavoidable math behind rising pension costs, with the Mayor of White Plains noting, “The road to hell is paved in amortizing pensions,”