Tag Archives: GO

Strong words from the SEC on Public Sector Pensions

As state and local governments begin to pull back the curtain on the true value of their pension liabilities with the implementation of GASB 68, Daniel Gallagher, Commissioner of the SEC issued an important statement last week, noting in plain terms that how governments measure their liabilities would have serious repercussions in the private sector. Here’s part of the remarks worth considering:

 …for years, state and local governments have used lax governmental accounting standards to hide the yawning chasm in their balance sheets…

The riskiness of a pension obligation depends on state law.[32]  If pension obligations have the same preference as general obligation debt, then the municipality’s own municipal bond yield (generally around 5%) would be the proper discount rate.[33]  Or, if as we’ve seen from Detroit, pensions will be saved before all else, then we should use a default-free measure to discount the liability:  specifically, the Treasury zero-coupon yield curve.[34]  This would result in a discount rate in the low 3% range.

Obviously, the higher the discount rate, the lower the present value of the liability.  The difference between a discount rate in the range of seven percent and one in the range of three percent is in large part responsible for the hidden $3 trillion in unfunded liabilities that are currently going unreported.

This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees,[35] or not to make the promises in the first place.

In the private sector, the SEC would quickly bring fraud charges against any corporate issuer and its officers for playing such numbers games.  And, we would also pursue and punish the so-called fiduciaries who recklessly seek yield to meet unrealistic accounting assumptions.  We should not treat municipalities any differently.”

GASB 68 asks that sponsors use a high- yield, tax exempt 20-year municipal GO bond only on the unfunded portion of the liability. This will reveal bigger funding gaps in public sector pension plans. But it does not reveal the full value of the liability since it allows sponsors to continue using the higher discount rates on the funded portion of the liability.

 In addition to using the new GASB standards, Commissioner Gallagher advises that governments should also disclose their pension liabilities on a risk-free basis. This would have the effect of showing the value of these promises on a ‘guaranteed-to-be-paid’ basis. Commissioner Gallagher’s suggestions are extremely sensible and a call to basic transparency in public sector liability reporting.

Ignoring the value of pension benefits is not going to make them cheaper to fund, and the longer a state waits to accurately measure the liabilities and payments, the worse it gets. Just ask New Jersey –  which is struggling to balance its budget and meet a fraction of a fraction of the required annual pension contribution to its state pension system. The situation is so dire that it could trigger yet another downgrade for the Garden State.


Credit Warnings, Debt Financing and Dipping into Cash Reserves

As 2013 comes to an end recent news brings attention to the structural budgetary problems and worsening fiscal picture facing several governments: New Jersey, New York City, Puerto Rico and Maryland.

First there was a warning from Moody’s for the Garden State. On Monday New Jersey’s credit outlook was changed to negative. The ratings agency cited rising public employee benefit costs and insufficient revenues. New Jersey is alongside Illinois for the state with the shortest time horizon until the system is Pay-As-You-Go. On a risk-free basis the gap between pension assets and liabilities is roughly $171 billion according to State Budget Solutions, leaving the system only 33 percent funded. This year the New Jersey contributed $1.7 billion to the system. But previous analysis suggests New Jersey will need to pay out $10 billion annually in a few years representing one-third of the current budget.

New Jersey isn’t alone. The biggest structural threat to government budgets is the unrecognized risk in employee pension plans and the purely unfunded status of health care benefits. Mayor Michael Bloomberg, in his final speech as New York City’s Mayor, pointed to the “labor-electoral complex” which prevents employee benefit reform as the single greatest threat to the city’s financial health. In 12 years the cost of employee benefits has increased 500 percent from $1.5 billion to $8.2 billion. Those costs are certain to grow presenting the next generation with a massive debt that will siphon money away from city services.

Public employee pensions and debt are also crippling Puerto Rico which has dipped into cash reserves to repay a $400 million short-term loan. The Wall Street Journal reports that the government planned to sell bonds, but retreated since the island’s bond values have, “plunged in value,” due to investor fears over economic malaise and the territory’s existing large debt load which stands at $87 billion, or $23,000 per resident.

This should serve as a warning to other states that continue to finance budget growth with debt while understating employee benefit costs. Maryland’s Spending Affordability Committee is recommending a 4 percent budget increase and a hike in the state’s debt limit from $75 million to 1.16 billion in 2014. Early estimates by the legislative fiscal office anticipate structural deficits of $300 million over the next two years – a situation that has plagued Maryland for well over a decade. The fiscal office has advised against increased debt, noting that over the last five years, GO bonds have been, “used as a source of replacement funding for transfers of cash” from dedicated funds projects such as the Chesapeake Bay Restoration Fund.


Strategy and politics in the of phrasing of bond referendum

How detailed should bond referendum be? The Arlington County Board heard comments from the public on the FY 2013 capital spending plan a few weeks ago. At issue was $153 million in local GO bond referendum that will be on the ballot on November 6th. The Arlington Sun Gazette reports there are four major “bundles.”

  • $31.946 million for Metro, neighborhood traffic calming, paving and other transportation projects
  • $50.533 million for parks, including the Long Bridge Park aquatics and fitness center and parkland acquisition
  • $28.306 million for Neighborhood Conservation and other “community infrastructure” projects
  • $42.62 million for design and construction of various school projects.

At issue was the language accompanying the bond packages. The Arlington County Civic Federation contends the $45 million dedicated to the acquatics center be listed as a separate item rather than bundled under the general category of park improvements.

Scott McCaffrey writes that the County Board has been bundling bonds under thematic groupings for many years as a strategy to lessen voter opposition, an interesting claim.

How explicit does language have to be in municipal General Obligation bond offerings? States typically require GO bond debt be subject to voter approval before issuance, but how does ballot language matter to the outcome?

While not addressing the matter specifically a few related questions have been pursued in the literature. Damore, Bowler and Nicholson in their paper, “Agenda Setting by Direct Democracy: Comparing the Initiative and the Referendum” (State Politics and Policy Quaterly, forthcoming) considers if agenda setters use the referendum process to extract greater spending than the median voter desires. Some of this research indicates that voters are less likely to support state referendum for tax increases but that between 1990 and 2008, 80 percent of bond referendum received voter approval.

As to the need for particular language, there are strategies. The Government Finance Officers Association (GFOA) lists six steps governments can take to improve their chances of getting a bond approved. This includes, “measure design” or “developing ballot language that appeals to voters and clearly explains how this measure addresses the particular issue targeted by the bonds meets the needs of the community.”

I did find anecdotal evidence that politicians struggle with language on ballot questions, in an effort to strike a balance between clarity and increased likelihood of passage. The Rockford Illinois School Board appears to be hemmed-in by how it phrases bond questions. The more detailed the questions the more legally-bound the board is to spend the money as specifically approved by voters.

Speaking of language, in writing this post I was unsure if I should be using”referenda” as the plural of “referendum”. “Referenda” sounds more natural to me but “referendum” appears to be used more often.

Given the difficulty of the original Latin grammar (referendum is a “gerund” and has no plural), it turns out there is an unsettled debate over this. Either is correct according to the Irish paper The Daily Edge. I felt better knowing that even The British Parliament debated over which plural form to use back in 1998. It turns out whether one uses the Latin “referenda” or the Anglicized “referendum” is purely a matter of taste.

Fiscal Tactics and the Columbia Pike Trolley

The Columbia Pike Trolley does not have a reputation for popularity among some local residents of Arlington County, VA. In a previous post, I noted the concerns voiced on local blogs and community boards that the $261 million trolley is several times more expensive than the alternatives. In addition, it is feared the trolley will not relieve congestion but will interrupt spontaneous economic development. The Green Party calls it, “the urban renewal trolley for the rich.” Part of the economic development plan involves demolishing older apartment buildings, raising rents.

How will officials try to finance the streetcar?  The plan requires the majority of funds come from local sources (seed money is being provided by a federal program). One possibility is they will dodge voter approval by raising revenue bonds instead of general obligation bonds (GO bonds). The reason is that in order to issue GO debt (which is backed by the full faith and credit of the government), the County would need to put the bond issue on the ballot. But they are worried about voters rejecting it. Revenue bonds don’t require voter approval since they are backed by an independent revenue stream; in this case, future revenues from the government’s surcharge on commercial real estate.

Locals may not have their chance to approve or reject the project, however. The Arlington Sun Gazettte reports that according to Virginia law Arlington as a county – not a city – government, “does not have the power to have a referendum on a topic or subject matter, like cities [do].” The decision to move forward or stop the project thus rests with the County Board.

Map of proposed Columbia Pike streetcar system

The plan is an example of what I define as “fiscal evasion.” These are maneuvers governments employ to defer or obscure the full costs of spending by evading rules or constructing loopholes. Not to be confused with venal gimmicks, fiscal evasion is often built into the rules. It is undertaken by, “circumventing statutory or constitutional budget rules, or through the weak design of such rules.”  In other words this approach is perfectly legal. Since revenue bonds don’t need voter approval revenue bonds present the “funding path of least resistance,” from the viewpoint of trolley advocates.



Will Harrisburg, PA make its next bond payment?

Harrisburg, PA’s next bond payment of $3.3 million is due on September 15. A bill they may miss according to The Wall Street Journal absent a $7.5 million payment from the city authority that runs parking facilities. With $1 million cash on hand, Harrisburg’s other big ticket item is $3 million in monthly payroll expenses. The city owes its fiscal problems to a $221 million incinerator project (five times the size of the general fund budget)  that has saddled Harrisburg with an enormous amount of debt.

Bloomberg reports that the city council is now deciding on a rescue plan. Harrisburg avoided defaulting on its GO debt last year with state aid. The plan to stabilize the long-term finances of the city includes selling the incinerator and other assets, job cuts, renegotiation of labor agreements and the imposition a commuter tax. To date, the city council has rejected Mayor Linda Thompson’s plan. She will again ask the council’s approval on August 31.

In the meantime, hearings will be held. Creditors want to be paid back and the incinerator turned over to a receiver. The incinerator has received two bids to date.

California’s Hercules Municipal Utility in trouble

For about a decade, the Hercules Municipal Utility (HMU) in Hercules, California has been bleeding money. Journalists Bob Porterfield and Jackie Ginley have been following the story since last summer when City Hall officials met to discuss how to deal with the drain on the city’s budget.

Hercules Municipal Utility was created to be a profitable venture for the city: a subsidized utility with the power to issue debt. And it is only one of several publicly funded (and uncompleted) projects on Hercules’ books. Porterfield and Ginley report that the city has spent $16 million over the course of a decade for an unbuilt  substation. HMU represents $13 million in bond debt for Hercules. The redevelopment agency is $18 million in debt. The city has cut services, laid off workers, and watched its credit downgraded to junk by S&P.

The problems of Hercules stem from a few sources. First, as Porterfield and Ginley note the town mixed its general fund budget with the budgets of special authorities. A related problem is the how such  quasi-public entities are used to avoid debt limits by municipal governments. Allowed to issue debt that is then backed by the authorities’ revenues, in the event the authority cannot pay, revenue debt becomes the “moral obligation” of the municipal government. (I discuss the history of the moral obligation bond here. They were a creation of the Nelson Rockefeller gubernatorial administration. Revenue bonds now far outstrip General Obligation bonds as a total of state debt.)

Why was HMU created?  Rising electricity prices were another attraction for the city council. In 2003 they reasoned operating a utility would deliver cheaper prices to consumers. But the deal was a money-loser. The plant wasn’t built. Revenues did not flow. And then the finances got even more convoluted.

The city tried to pay back the bonds with revenue-lease bonds from a swim facility using the Hercules Public Financing Authority (PFA) as the borrower (on paper) to raise money. The PFA issued the bonds which were to be repaid from revenues from a specific project: a swim complex built a few years earlier totaling $7.4 million.This maneuver was to avoid the 2/3rds majority needed for the city to issue General Obligation bonds. In fact, the city of Hercules was the borrower, not the PFA, and the city remains responsible for paying back the $7 million it raised through the deal to finance the electric utility.

(This kind of sidestep to avoid issuing GO debt and getting around tax and spending limits is one of the reasons off-budget enterprises have proliferated in state and local governments as Bennett and DiLorenzo note in their study. OBEs have increased to 37,389 entities over the past several decades.)

Porterfield and Ginley detail what happened next. The project ran up costs, made almost no money with 840 customers and will continue to operate at a loss. For 2010 the city must pay $750,000 in interest on the HMU bonds (far more than it brings in) plus $10 million in interest and principle on other borrowed money. Hercules’ general fund budget is about $15 million. Read here for more details on the various debt-backed projects of Hercules


Harrisburg’s new attitude towards GO debt

Nicole Gelinas writes at Public Sector Inc that Harrisburg, PA may simply choose to writedown some of the city’s incinerator debt to bondholders. The reasoning to paraphrase one city councilwoman, “they took an investment risk”. If this is the way the city intends to go, there are implications. Creditors now no longer should only consider whether the issuing authority is likely to have the money to pay back the bond, but whether or not they are willing to pay it back.

Central Falls, R.I. “staring down bankrtupcy”

In October Central Falls, Rhode Island’s pension system will run dry. It’s the second town in the U.S. to face this scenario since Prichard, Alabama. The small town has a $80 million pension bill. Currently payouts represent one-quarter of the town’s budget. That will increase quickly once the fund runs out. As The New York Times reports Rhode Island’s municipal bankruptcy/pension dilemmas is unique. Rhode Island is a small state with 39 small municipalities.

Thirty-six of these cities operate their own pension funds and 23 of these are considered “in distress.” The question now is: what is Rhode Island’s responsibility should these cities ask the state for help? Some place the blame on Rhode Island’s collective bargaining laws – set in state statute- that put everything on the table for negotiation. But then there is the problem of the pension plan itself, instituted by the local government in 1972. Consider also the role that accounting standards  have played in underestimating liabilities. To date, Rhode Island has taken measures to reassure bondholders giving GO bonds priority over other forms of debt.

It is unclear how this will play out and the extent to which Central Falls’ deep fiscal problems could trigger problems throughout the state. In addition to multiple independent local plans. The state operates its own Municipal Employee Retirement System in which several towns participate. The state-run plan is less than 36 percent funded with an unfunded liability of over $12 billion.