Tag Archives: Alabama

More labor market freedom means more labor force participation

The U.S. labor force participation (LFP) rate has yet to bounce back to its pre-recession level. Some of the decline is due to retiring baby-boomers but even the prime-age LFP rate, which only counts people age 25 – 54 and thus less affected by retirement, has not recovered.

Economists and government officials are concerned about the weak recovery in labor force participation. A high LFP rate is usually a sign of a strong economy—people are either working or optimistic about their chances of finding a job. A low LFP rate is often a sign of little economic opportunity or disappointment with the employment options available.

The U.S. is a large, diverse country so the national LFP rate obscures substantial state variation in LFP rates. The figure below shows the age 16 and up LFP rates for the 50 states and the U.S. as a whole (black bar) in 2014. (data)

2014-state-lfp-rates

The rates range from a high of 72.6% in North Dakota to a low of 53.1% in West Virginia. The U.S. rate was 62.9%. Several of the states with relatively low rates are in the south, including Mississippi, Alabama and Arkansas. Florida and Arizona also had relatively low labor force participation, which is not surprising considering their reputations as retirement destinations.

There are several reasons why some states have more labor force participation than others. Demographics is one: states with a higher percentage of people over age 65 and between 16 and 22 will have lower rates on average since people in these age groups are often retired or in school full time. States also have different economies made up of different industries and at any given time some industries are thriving while others are struggling.

Federal and state regulation also play a role. Federal regulation disparately impacts different states because of the different industrial compositions of state economies. For example, states with large energy industries tend to be more affected by federal regulation than other states.

States also tax and regulate their labor markets differently. States have different occupational licensing standards, different minimum wages and different levels of payroll and income taxes among other things. Each of these things alters the incentive for businesses to hire or for people to join the labor market and thus affects states’ LFP rates.

We can see the relationship between labor market freedom and labor force participation in the figure below. The figure shows the relationship between the Economic Freedom of North America’s 2013 labor market freedom score (x-axis) and the 2014 labor force participation rate for each state (y-axis).

lab-mkt-freed-and-lfp-rate

As shown in the figure there is a positive relationship—more labor market freedom is associated with a higher LFP rate on average. States with lower freedom scores such as Mississippi, Kentucky and Alabama also had low LFP rates while states with higher freedom scores such as North Dakota, South Dakota and Virginia had higher LFP rates.

This is not an all-else-equal analysis and other variables—such as demographics and industry composition which I mentioned earlier—also play a role. That being said, state officials concerned about their state’s labor market should think about what they can do to increase labor market freedom—and economic freedom more broadly—in their state.

Banking on risky investments is no way to guarantee a public pension

Over the past several years I’ve spent a lot of time studying public pension systems. That’s involved diving into the economics and actuarial literature, reading through many individual plan reports, and analyzing the trends in those systems in the context of the principles of financial economics. Why do this? It isn’t just a public finance problem. Twenty million Americans participate in these plans. If research points to systematic structural weaknesses in public sector plans, that under the right conditions, can lead to plan failure, then it is an imperative to point it out and recommend solutions to ensure that retirees receive the pensions they’ve been promised without placing unnecessary burdens on taxpayers or forcing painful budget tradeoffs at the worst possible time: during a recession.

The only way to protect pensions is to accurately assess their true value and funded status and then contribute what is needed to pay out those benefits. Unfortunately, the story of US public sector pension is that they are built on investment risk and accounting illusions.

Pension finance is not without controversy. Misunderstandings can arise in part due to the very different approaches taken by financial economists and traditionally trained actuaries over how to most appropriately value pension liabilities and assets, as well as the nature of investment risk.

However, some of the conflict is due to the implications of the pension literature. Applying the economic approach to valuing pension fund liabilities reveals trillions more in obligations and far bigger funding gaps for states and cities. It shows how public sector plans have exposed themselves to an unwise amount of investment risk effectively linking guaranteed pension payments to market volatility and putting taxpayers on the hook for losses. Some state and local governments have responded to this debate either through small accounting reforms or policy changes meant to shore up pension systems. These reforms are not necessarily sufficient but it’s a tacit recognition that the math really matters.

There are some plans that continue to staunchly defend a “More investment risk = safe and guaranteed pension with no downsides” approach. And at least one system has gone on the offense against any suggestion that increasing investment risk in a government-guaranteed pension system amounts to gambling with employees’ pension benefits.

In May 2014 I authored a paper that made the case for economic accounting and better funding for Alabama’s three state-run pension plans.[1] My study was featured in The Advisor in July 2014, the newsletter the Retirement Systems of Alabama (RSA) provides to its members.[2] One article written by “RSA staff” purports to debunk my paper, but ends up missing the implications of both the literature and my analysis.

The RSA staff’s main complaint revolves around one sentence in which I cite a peer-reviewed 2010 study in the National Tax Journal by Joshua Rauh entitled, “Are State Public Pension Plans Sustainable?[3] Rauh finds that, without policy changes, Alabama might run out of assets to pay benefits by 2023, necessitating the move to a pay as you go system. To be sure, that is a sobering claim.

The RSA staff argues that the runout date calculated by Rauh is based on “bad data” from 2006, when Alabama offered a 3.5 percent ad hoc Cost of Living Adjustment (COLA). It further contends the runout date is based on the assumption of a risk-free discount rate and asset values from 2009, and this all unfairly inflates liabilities and cherry-picks a low-point for asset values. In addition, Rauh assumes that the plan only pays for normal costs going forward (not for past benefits), in keeping with the contribution behavior of most plans at the time of the study.

The first two claims by the RSA staff are incorrect. In the “run-out dates” paper, Rauh’s data is assembled from, “the individual plans and the Center for Retirement Research on a plan-by-plan basis.”[4] This dataset was originally developed for a previous peer-reviewed paper with Robert Novy-Marx entitled, “Public Pension Promises: How Big Are They and What Are They Worth?” which drew from the individual Comprehensive Annual Financial Reports (CAFRs) of 116 state-sponsored pension plans.[5] Nine data items were taken from the pension plan CAFRs that were available as of December 31, 2008. (The FY 2008 CAFR contains data for 2007 that the authors project to 2009). These CAFR-derived items are:

  • the plans’ stated liability
  • its state-chosen discount rate
  • the actuarial method (EAN or PUC)
  • a benefit factor
  • a Cost of Living Adjustment
  • an inflation assumption
  • the share of active workers in the plan;
  • the share of retired workers in the plan; and
  • the dollar amount of benefits paid in the most recent year.

The third item – the actuarial method – was drawn from both the CAFR and information from the Center for Retirement Research at Boston College as of 2006.[6]

Novy-Marx and Rauh estimated a total of $42 billion projected liabilities as of June 2009 for all three of Alabama’s plans. [7] The authors’ estimate closely matches the reported value of $41.6 billion in September 30, 2009 in RSA’s FY 2010 CAFR. Novy-Marx and Rauh re-calculate the value of state promised pension liabilities when valued based on risk-free Treasury bonds. They find that Alabama’s total liabilities of $42 billion increase to $61.8 billion when discounted using the risk-free Treasury rate.

Their paper triggered a lot of attention. Clearly, the finding that GASB 25 was leading state plans to obscure the true size of their pension liabilities generates a lot of follow-up questions, such as, “When will they run out of money?”

In a subsequent paper Rauh (2010) tackles this very question. His assumptions are key to interpreting the run out date. Beginning with the data that he and Novy-Marx assembled, Rauh models the cash flows of these pension plans under the rate of return assumed by the plan itself, in the case of Alabama: 8 percent. A further assumption is made that future contributions to the plan will be equal in value to the benefits earned by employees in that year, “an assumption broadly in keeping with states’ recent contribution behavior.”[8] If the state fully funds benefits as they are accrued how long will the assets last under the assumption that the plans earn 8 percent each year?

Under an 8 percent discount rate with no COLA, and only funding the normal cost, Rauh projects that the RSA will run out of assets in 2023. The implication is that state contributions will have to increase, placing a greater demand on state budgets, necessitating increased taxes or cuts to spending. One thing going in Alabama’s favor is that they have a history of making the full contribution each year. However, this contribution amount is calculated under optimistic assumptions that I demonstrate in the paper are based on assuming a large amount of investment risk. And that is where the danger lies.

Contrary to the RSA staff’s claim:

  • There is no COLA assumption in Rauh’s 2010 run-out date study
  • The run out date of 2023 is based on a discount rate of 8 percent.

The RSA staff is correct to note that Rauh’s calculation is based on only paying the normal cost. Since Alabama has a history of making the full annual contribution this will help the system to forestall a run-out. The question is by how much, by how many years? As long as the RSA assumes an 8 percent discount rate and embraces a risky investment strategy they are operating under an accounting illusion that leads them to low-ball the annual contribution needed to fund the system.

If the market has a great run over the next decade with returns exceeding 8 percent per year and the RSA continues to to pay 100 percent of the ARC under these conditions it would stay solvent. The RSA points to the fact that between 2009 and today its assets have grown by 46 percent, or $35 billion. [9]

But there’s another problem. The RSA’s funded status continues its decade-long drop. Let’s look at Alabama’s assets, liabilities, and funded status of the plan between 2008 and 2013 (the most recent data available) taken from the plan CAFRs, with no adjustments to the data. The trend is clear. Liabilities are growing faster than the assets. Funding ratios are falling.

For Teachers’ Retirement System (TRS) over the period the total actuarial value of assets fell by six percent from $20.8 billion to $19.6 billion, while total liabilities grew from $26 billion to $29 billion (11 percent), leaving the system with a funded ratio of 66 percent.

Table 1. Teachers Retirement System Actuarial Accrued Liability and Actuarial Assets (2008-2013) Adjusted for Inflation

($ mil) 2008 2009 2010 2011 2012 2013 % change 2008-2014
TRS Liabilities $26,804 $27,537 $28,299 $28,776 $28,251 $29,665 11%
TRS Assets  $20,812 $20,582 $20,132 $19,430 $18,786 $19,629 -6%

Source: Comprehensive Annual Financial Report (CAFR) for Retirement System of Alabama (RSA) FY 2009-2014.

The same story can be told of the Employees Retirement System (ERS). Assets fell by 4 percent as liabilities grew by 11 percent over the period. The ERS is currently funded at 65 percent, down from 77 percent in 2009. Four years of increased returns have not reversed the decline.

Table 2. Employees’ Retirement System Actuarial Accrued Liabilities and Actuarial Assets 2008-2013

($ mil) 2008 2009 2010 2011 2012 2013 % change 2008-2014
ERS Liabilities $13,078 $13,756 $14,248 $14,366 $13,884 $14,536 11%
ERS Assets $9,905 $9,928 $9,739 $9,456 $9,116 $9,546 -4%

Source: Comprehensive Annual Financial Report (CAFR) for Retirement System of Alabama (RSA) FY 2009-2014

The Judicial Retirement Fund (JRF) had the steepest increase in liabilities. Assets fell by 6 percent and liabilities grew by 28 percent. JRF is the most weakly funded at 58 percent.

Table 1. Judicial Retirement System Actuarial Accrued Liability and Actuarial Assets (2008-2013) Adjusted for Inflation

($ mil) 2008 2009 2010 2011 2012 2013 % change 2008-2014
JRF Liabilities $323 $340 $358 $393 $380 $414 28%
JRF Assets $259 $252 $246 $235 $234 $243 -6%

Source: Comprehensive Annual Financial Report (CAFR) for Retirement System of Alabama (RSA) FY 2009-2014

Looking back at the decade shows an even more dramatic trend. These systems began 2003 with funding levels of 90 percent. They have fallen every year since to their current levels of between 66 percent and 58 percent.

The RSA has stated in the past that 80 percent funding is good enough and that investing assets in a risky portfolio currently comprised of 70 percent equities will enable the system to comfortably meet its obligations. But as these funding trends show a volatile portfolio comes with a downside. The assets may be back to where they were five years ago, but in the meantime, liabilities continue their steady growth.

The next observation the RSA staff makes is that these numbers are too bleak since they are based on 2009 asset values. Since then the assets have grown by 11 percent on average over the period. To be sure, once you exclude 2008, things look better. But that’s a bit like excluding the F when you calculate your average grade for the semester. Ignoring the downturn doesn’t mean it didn’t happen or that it didn’t erode the assets. It takes exceptional and sustained performance to make up for it.

The five and 10-year period tell a less bullish story.

Annualized returns for the RSA for the Fiscal Year ended September 30, 2013. (p. 60)

Total Portfolio 1 year Last 3 Years Last 5 Years Last 10 Years
TRS 14.93% 11.45% 6.68% 6.29%
ERS 14.6% 11.4% 6.17% 5.97%
JFR 14.05% 10.89% 8.74% 7.06%

While investments have rebounded for the RSA, plan funding status is falling despite increased contributions. Since 2012 employers and most employees are making bigger contributions to these plans. Alabama now operates a Two-tiered pension system. Tier 1 TRS and ERS employees (those hired before January 1, 2013) saw their individual contributions rates increase from 5 percent of pay in 2011 to 7.5 percent of pay in 2013. JRF members, firefighters, police officers and correctional officers contribution rates increased from 6 percent in 2011 to 8.25 percent of pay in 2013. Tier II members (those hired after January 1, 2013) will have lower contribution rates and diminished benefits. Both tiers will give something up.

Employers are also contributing more. The state’s contributions have increased. For the TRS (Tier 1 employees), the state’s contribution has risen from 6.3 percent of payroll in 2000 to 11.7 percent in 2014. Employer contributions for the ERS (Tier 1) rose from 4 percent to 12 percent of payroll over the same period. JRF has the largest employer contribution “In 2000, the state contribution to the JRF was 21 percent of payroll. It reached 35% by 2014.”

Rauh’s 2010 study points to a trend worth monitoring. Funding levels are dropping. Assets are not growing fast enough to keep up with the growth in liabilities necessitating more revenues, higher contributions or some other action. Yet the RSA staff points to its recent returns of 11%, as if that is something the RSA can sustain. The stock market does reward risk-taking with high returns in bull markets, but at a cost of negative returns in recession years like 2008. Increasing the risk of RSA assets to chase high stock market returns is banking on something neither the RSA nor anyone else can guarantee.

Valuing a guaranteed pension based on the expected returns of risky and volatile assets increases the chance of a funding shortfall. It is likely that Alabama will find it will need more revenue to fund the RSA. Already inadequate funding levels are falling. The investment portfolio is heavily exposed to market risk. And contribution rates are rising.

The RSA staff’s response to my research is part of a more general problem. Many of those responsible for public sector pensions think that investment risk can be ignored or it can just be passed on to taxpayers. The point of this entire body of literature drives home one theme consistently: public sector pension accounting flaunts the established principles of finance by claiming that there is no price for assuming investment risk. Financial theory can be abstract. But recent history gives us a demonstration of these core principles. Many pensions systems, the RSA included, have ignored the lessons of the Great Recession and are exposing pensions to even more investment risk.

[1] Eileen Norcross, “Pension Reform in Alabama: A Case for Economic Accounting,” in Improving Lives in Alabama: A Vision for Economic Freedom and Prosperity, The Johnson Center at Troy University, May 2014 (https://nebula.wsimg.com/35b439dc51fd0dae2bd46e38024dadd2?AccessKeyId=F0B126F45D4E1A4094F7&disposition=0&alloworigin=1)

[2] “Troy University Report on RSA has Erroneous Assumptions,” by RSA Staff, The Advisor, July 2014 (http://www.rsa-al.gov/uploads/files/Advisor_July2014.pdf)

[3] Joshua Rauh, “Are State Public Pension Plans Sustainable? Why the Federal Government Should Worry about State Pension Liabilities,” National Tax Journal 63(3) p. 585-601, May 2010. (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1596679)

[4] Ibid, p. 6 and p. 9.

[5] Robert Novy-Marx and Joshua Rauh, “Public Pension Promises: How Big Are They and What Are They Worth?” Journal of Finance 66 (4), 1211-1249, 2011 (http://www.jstor.org/stable/29789814?seq=1#page_scan_tab_contents)

[6] Ibid p. 1224, “The actuarial method (item 3) combines our own data collection with information from the state and local pension data made available by the Center for Retirement Research (2006.)

[7] Ibid, p. 1239

[8] Rauh, (2010) “Are Public Pensions Sustainable?” p. 2.

 

Varying Priorities in Municipal Bankruptcy

On Monday Reuters reported that a federal judge has found Stockton, CA to be eligible for bankruptcy protection. This decision came despite protests from Wall Street arguing that the city had options available that would have allowed it to pay its creditors in full, such as raising taxes or cutting benefits for city employees:

Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.

The expected move by the California city of 300,000 – along with Jefferson County in Alabama and San Bernardino in California – breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.

While both the judge and city manager Bob Deis have harshly criticized bondholders who refused to negotiate with the city before bankruptcy proceedings began, other cities have taken a very different approach to their creditors in the bankruptcy process. In 2011, the Rhode Island policymakers adopted a law that puts municipal creditors at the head of the line in municipal bankruptcy proceedings. In the state’s  Central Falls bankruptcy, the requirement to pay bondholders 100 cents on the dollar has meant that the city’s pensioners have taken steep benefit cuts, in some cases losing nearly half of their defined benefit pensions.

After Rhode Island enacted this law, the Wall Street Journal explained:

Despite the financial failure, Central Falls suddenly is attractive to some investors because the law makes them more confident about getting paid.

“If we can find someone selling, we will be a buyer” of Central Falls bonds, says Matt Dalton, chief executive of Belle Haven Investments, a White Plains, N.Y., firm with $800 million in municipal-bond investments under management.

The difference in legal climates for bondholders in Rhode Island and California unsurprisingly fosters different attitudes from creditors.  Former Los Angeles Mayor Richard Riordan explains the dangers of cutting off a city’s access to credit by failing to pay bondholders in full:

“I think the unions ought to be scared stiff. This could be a lot worse than just the pensions. What about government bonds? If government bonds can also be restructured, who will buy them?

“The city and the state all issue tax anticipation bonds to meet their payrolls, but if those can be restructured, no one will buy them. Think about what that means for libraries, parks, street paving, police. It will all be on the line.

While cities on both coasts are facing insolvency in their efforts to meet their obligations to their employees and their creditors, they vary in their approaches as to who is first in line for scarce tax dollars.

New Research on Streamlining Commissions

Tomorrow I’ll be at the Association for Public Policy Analysis and Management Fall Research Conference to present research on streamlining commissions with Carmine Scavo. Carmine and I have written one paper developing a methodology for studying these commissions, and we’re now working on case studies of commissions in nine states.

Well over half of states have appointed one or more streamlining commissions in efforts to find budget savings or to improve state programs. We’re studying streamlining efforts in California, New Mexico, Louisiana, Alabama, Colorado, New York, Maine and Virginia. We hope to get an idea of how effectively these commissions have reduced the size of state government and found efficiencies in existing programs. We also hope to identify the characteristics that make commissions most likely to meet their goals.

In our first paper, we hypothesized that commission success would depend on the following characteristics:

1) clearly defined objectives regarding their final product;

2) a clear timeline for this deliverable with an opportunity to publish interim advice. Preliminary findings indicate that the commission should have at least one year to work;

3) adequate funds to hire an independent staff to study some issues in depth;

4) a majority of the commission members from outside the government. The commission chair certainly should be from outside the government in order to help to get around the challenges that inherently restrict the ability to find streamlining opportunities while working in government. Preliminary findings indicate that representatives from the state legislature and administration should be involved as a minority of the membership to ensure that the commission’s recommendations have buy-in from policymakers.

So far, our research indicates that funding for commissions may not be as important as we’d though. Some commissions have achieved successes with essentially no budgets while others that were well-funded developed recommendations that didn’t go anywhere.

Tomorrow we will be presenting our preliminary findings on the California Commission on the 21st Century Economy, the Colorado Pits and Peeves Roundtable Initiative, and the Virginia Commission on Government Reform and Restructuring. Once we finish this research I will write up our findings in more depth here. If any of you will be attending the APPAM conference, I hope to see you there.

SEPTA and interest rate swaps

Interest rate swaps became a relatively popular means for municipal governments to save some money during the 1990s and into the 2000s. The basic idea is that an issuer (the government) enters into a contract with a bank to exchange interest rate payments on a cash flow. These can be structured to exchange a fixed payment for a variable payment in return, or vice versa.

These interest payments are calculated based on an underlying asset or instrument, such as a bond. That makes interest rate swaps a derivative, as their value is derived from an underlying financial instrument.

The issuer’s goal is to hedge against fluctuating interest rates and impart some stability to their budget.The bank’s incentive is to make a fee. It works for the issuer when they guess correctly and – by way of example -the issuer agrees to a payment based on a fixed rate of interest that is low relative to the adjustable rate of interest the bank pays to the municipality in return.

But that’s not what happened as rates began to fall after 2008. Many municipal issuers found themselves paying banks a fixed rate that was high relative to the variable rate the bank was paying in return. Jefferson County, Alabama is the most notorious example, as my recent article in US News explains. At work in this larger story is the role the LIBOR interest rate rigging scandal played in suppressing the variable rate leading some governments to sue banks for damages.

Pennsylvania governments were particularly keen on interest rates swaps, with 626 swaps having been entered into across the Commonwealth. Depending on how they were structured, some entities have come out ahead. The majority have lost on the contracts. That includes SEPTA, as Pennsylvania Watchdog explains.

Is the problem with the interest rate swap concept? I’d argue that the answer lies in how they are used. What might be a good hedging instrument for the financial sector exposes the public sector to a set of risks that aren’t fully appreciated. The risks -including the real hazard that the municipality incorrectly guessed the direction interest rates would travel- are passed on to taxpayers or service users.

 

 

Red ink flows in state-run prepaid tuition programs

In three years the Prepaid Alabama College Tuition Program (PACT) will run dry. The State Treasurer reports PACT which pays $100 million in tuition a year, has $347 million in investments remaining. To fulfill its obligations to all 40,000 participants over the next 20 years, PACT needs an additional $843.9 million. The state Supreme Court recently struck down a potential solution put forth by the legislature: cap payouts to 2010 tuition levels and have beneficiaries make up the difference. The remedy didn’t pass scrutiny due to a 2010 law that promises PACT be 100 percent funded.

PACT worked for about 20 years until hit with the combination of unrelenting tuition inflation and a bear market which halved the plan’s investments.

Unfortunately, Alabama isn’t the only state with a prepaid program in the red. The Wall Street Journal reports South Carolina’s plan expects to run out of funds in 2017. Tennessee’s budget seeks an infusion of $15 million into its program. And West Virginia recently transferred funds from an unclaimed-property program to shore up its struggling prepaid plan.

In remarkably bad shape is IllinoisCrain’s Chicago Business finds that Illinois’ 12-year old $1.1 billion prepaid plan has the largest shortfall in the entire nation. Worse still, plan managers are making up for losses by embracing a huge amount of risk. In 2011, 47 percent of Illinois’ prepaid tuition plan was shifted into alternatives and investment expectations set at 8.75 percent. An expectation that far outstrips any other prepaid plan by a long-shot. (Florida has the country’s largest prepaid tuition plan and operates with an expected return of 4.3 percent on plan investments).

This year the agency that runs the prepaid program, the Illinois Student Assistance Commission ,has dropped that return assumption to 7.5 percent.  According to its actuarial report College Illinois! has enough money to pay out tuition for a few more years.

Prepaid plans are a type of 529 plan (the other is the college savings program) that allow parents to purchase contracts (or credits) for their children’s education.  The prepaid tuition plan locks-in tuition for the current year for eligible in-state colleges. Contributions are invested and benefits paid from those funds. To remain well-funded asset performance must track or exceed tuition increases. Given the rapid increase in college tuition which on average has increased 5.6 percent per year over the rate of inflation in just the past decade, it’s easy to see why so many plans have gone bust.

PACT participants who may not recoup their initial investments are understandably upset, “everything about the way the plan was promoted implied it was backed by the state.”

But, just how good is the state’s guarantee?

That is often in the fine-print. The WSJ finds three levels of guarantee in operation. 1) Full Faith and Credit – the state promises to pay for shortfalls if the fund goes dry. (Washington, Texas, Ohio, Mississippi and Florida)  2) Legislative appropriation – the legislature must consider an appropriation to cover shortfalls. (Illinois, Maryland, Virginia, South Carolina and West Virginia)  and 3) Fund Assets – the plan is solely backed by the assets in the plan. (Alabama, Michigan, Nevada, Pennsylvania, and Tennessee.)

Alabama’s PACT participants found they had little recourse in 2009.  Since the state doesn’t guarantee payment of tuition,they were technically out of luck. However, after a series of demonstrations and hearings in 2010 the Alabama legislature granted a $548 million bailout, tiding the plan over for the next three years. And then what? The state legislature filed a bill last week to tweak the previous solution to the court’s liking. It is again proposing to cap tuition payouts at 2010 levels.

Strangely, in spite of the risk present in pre-paid tuition plans they continue to provide a “flight to safety” for some investors. Last year growth in pre-paid plans outstripped growth in 529 college savings plans. The lure of higher returns attracts some who are banking on the ability of governments to keep their promise to pay it out regardless of market performance or the fine-print.

Bankruptcy in Birmingham

Jefferson County, AL has filed for bankruptcy protection, joining the ranks of Vallejo, CA; Central Falls, RI; Boise, ID; and Harrisburg, PA. In this case, the debt that the county used to finance a new sewer system is the main driver of insolvency. The county currently owes about $4.15 billion on the sewer system.

The Associated Press reports:

The problems were years in the making.

Its debt ballooned after a federally mandated sewer project was beset with corruption, court rulings that didn’t go its way and rising interest rates when global markets struggled.

Since 2008, Jefferson County tried to save itself the cost and embarrassment of filing for bankruptcy. But after three years, commissioners voted 4-1 to bring the issue to an end.

“Jefferson County has, in effect, been in bankruptcy for three years,” said Commissioner Jimmie Stephens, who made the motion to file for protection in federal bankruptcy court in northern Alabama.

While the last few years have seen a few cases of municipalities filing for Chapter 9, Jefferson County’s case represents by far the largest. Unlike other recent bankruptcies that were a result of both poor financial management and the economic downturn, Jefferson County’s problems were in part a result of corrupt public officials. Twenty-two people have been convicted for illegally refinancing the sewer bonds to benefit local and Wall Street financiers. Residents in Alabama’s largest county will likely face higher sewer rates as a result.

But the biggest problem for residents when municipalities file for bankruptcy protection is the resulting policy uncertainty. Businesses are typically reluctant, with good reason, to move to a bankrupt municipality. The shadow of Chapter 9 means that for years, residents and businesses will be paying higher taxes in exchange for fewer services because of the remaining debt burden. This will put the county and even the state in a poor competitive standing for new jobs.

In 1994, Orange County, CA, filed for Chapter 9 protection on $1.7 billion in debt, and residents there are still paying taxes toward that debt today. In the short term, Jefferson County will face painful and immediate cuts. The Birmingham Business Journal spoke with Commissioner Jimmie Stephens on what the future holds for the county:

“We’re looking at all of these services that are not mandated by the constitution and, from there, we will begin the reductions and take it as far as we need to, keeping in mind the services that the citizens need,” he said.

 

Jefferson County, Alabama works towards negotiated settlement

Jefferson County, Alabama is continuing negotiations with creditors in order to avoid a bankruptcy filing over a $3.14 billion sewer debt that emerged in 2008.  The Governor has urged Jefferson County Commissioners to avoid Chapter 9 because he fears it will hurt the credit of the entire state. Creditors have proposed turning the sewer over to an independent authority. According to The New York Times, the new authority would issue $2.07 billion in new bonds to redeem the defaulted securities. Governor Bentley has offered to back the debt as “moral obligation” bonds which would make the state a (soft) guarantor. The deadline to arrive at an agreement is now September 16.

Jefferson County, Alabama postpones bankruptcy meeting

A meeting was to be held today to decide whether Jefferson County’s government would file for bankruptcy over a $3 billion sewer project. The meeting was canceled on the news of a potential deal from JPMorgan Chase & Co that would cover $1 billion of the debt. Municipal bond markets are not likely to react much to the troubles in Jefferson as they have been obvious since 2008 when the county found itself unable to pay its debts. If the deal works Jefferson County may avoid filing the largest municipal bankruptcy in U.S. history.

The State of Laziness

According to Bloomberg, here are the top ten laziest states:

Louisiana, Mississippi, Arkansas, North Carolina, Tennessee, Kentucky, West Virginia, South Carolina, Alabama, Delaware.

(I have no idea whether this survey method is valid).

Though it is provocative to label the good people of Louisiana “lazy,” I suspect that much of the observed difference in behavior can be traced not to inherent differences in the people but to differences in the institutions in which those people operate: the laws, the economy, the culture, etc. that constrains and shapes their actions.

A few years back, the Nobel laureate economist Ed Prescott (of Arizona State) analyzed the difference between American and European working habits. There was a time, in the early 1970s, when Europeans worked more than Americans. Now this is reversed: “Americans work 50 percent more than do the Germans, French, and Italians.” Prescott finds that differences in marginal tax rates are the predominant factor. So Europeans aren’t any lazier than we; they just face different incentives.

I wonder what institutional differences can explain differences in work effort across the U.S. states?

One can’t help but notice the over-representation of the South. Two centuries ago, Montesquieu wrote:

You will find in the climates of the north, peoples with few vices, many virtues, sincerity and truthfulness. Approach the south, you will think you are leaving morality itself, the passions become more vivacious and multiply crimes… The heat can be so excessive that the body is totally without force. The resignation passes to the spirit and leads people to be without curiosity, nor the desire for noble enterprise.

I seem to recall a similar observation from John Adams, but can’t locate it just now…or maybe I just don’t want to put in the effort to find it.