Tuesday, November 24, 2015

GASB 68 dead ahead POB bonds?

    A series of articles highlight the pressure on Government officials facing severe pension under funding and the recognition of the long awaited GASB 68 fix. Below are some examples:


 November 20,2015

$3 Trillion Municipal Pension Burden
It’s About Time:
Public Pension Reform Needs Space to Work


Joseph H. Arnall
Arnall is managing partner of Public Pension Consultants, LLC and is a former Rules Committee Chairman in the Florida House of Representatives.
428 Words
              The growing public pension funding crisis facing most of our cities and states leaves the important decision-making constituencies – elected officials, fund managers, and union representatives - in the precarious position of “we have to do something, but what?”
              Political expediency, inefficiencies built into the pension process, and inaction are contributing to the $3 to $4 trillion unfunded liability problem now facing cities and states.  Municipalities and states are also confronted with a perfect storm in which new accounting rules, sub par investment results and lack of reform have merged. 
Additionally, much like NOAA posts storm warning days ahead of landfall, the Governmental Accounting Standards Board (GASB) and the rating agencies forecasted several years ago what would befall government-sponsored defined benefits plans if they did not make rapid and certain changes.
Employee unions are often portrayed as the culprit, yet neither fund fiduciaries nor plan sponsors are without fault.  At this point, the cooperation of all parties will be needed, along with the political will to develop a plan that will work for current and future benefit recipients.  So how do we buy the time necessary for long-term reform to work?
One of the more promising new solutions is the asset backed contract.  The contract places a major asset within a defined benefit plan that is paid for in digestible budget installments without an offsetting liability.  This low-cost method places a GASB-defined asset  in the plan which will help stabilize credit and allow plan investment advisors to re-balance existing plan assets in favor of lower risk investments.
Another important benefit of the asset backed contract plan is that it should help stabilize agency ratings because it presents a consistent and reasonably brief time period in which to solve a large portion of pension liabilities.  Likewise, it compares favorably with a pension obligation bond (POB) currently being considered by several states because the asset is placed inside the plan and there is no corresponding billion-dollar bond liability and no risks inherent in an arbitration play (POB proceeds placed inside the plan must outperform the interest charge on the bonds).  And, such borrowing threatens future credit ratings.

              If anyone in a decision-making capacity in government has ever said, “If I knew 15 years ago what I know now, I know that I would have voted differently on pension plan administration,” this new concept offers a mulligan and buys the space needed to enact corrective pension reforms.  The light these important constituencies see at the end of the budget tunnel will be a better tomorrow and not a train.  It’s about time!

Joe Arnall  is right!!!!

 Pension Obligation Bonds are never a good idea, rather they are almost always a last resort. But now with accounting rules slowly forcing balance sheet recognition of Pension and OPEB (healthcare) liabilities combined with historically low interest rates Wall Street will be pitching these POB bonds. Pension Obligation Bonds  are a fantasy solution and first governments in line to use them are almost always the least capable of paying them back. The market adjusts for this  risk by charging cities or states with poor economics higher interest rates eliminating what first appears to amateur finance directors as an arbitrage.

   The reasoning goes like this ..."Hey, with interest rates so low why don't we borrow at zero percent and invest at our predicted return rate of 8.25%." 

Don't laugh, this discussion is going on in cities all over the U.S. First the reality is Providence RI cant borrow at 3% much less zero and would likely have to pay more than 5%. Second they are not likely to earn 8.25% and  could lose money. What then? If that scenario were to play out then Pension Obligation bond debt  would eventually further crowd out the local services funded by taxpayers such as public safety,transportation and sanitation. 

As John Corzine said about POB's  before he blew out MF Global: 

 " It's the dumbest idea I ever heard,” Jon Corzine told Bloomberg.com in 2008 when he was still governor of New Jersey. “It’s speculating the way I would have speculated in my bond position at Goldman Sachs.”

No doubt Rhode Island voters will be facing this issue head on. If Providence wanted  to issue these bonds in order to rescue their pension plan the state assembly would have to allow the issuance. There would be no vote by the People of Providence or Rhode Island but the liability clearly will be on State Taxpayers. Given the proclivity of Mattiello and Raimondo to casually issue debt without a public vote we have to consider this possibility as very real. 

POB bonds are not issued as tax exempt. The Tax Reform Act of 1986 ended that strategy by prohibiting state and local governments from reinvesting for profit the money from tax-free bonds. When the concept resurfaced in the late 1990's, the strategy called for states or localities to issue a taxable bond and leverage the higher interest rate of that bond against higher return but riskier equity market plays. So long as markets boomed, the new tactic seemed savvy.
Later, in the last decade , several cities that had recently issued pension obligation bonds subsequently filed for Bankruptcy protection. Examples include Stockton and San Bernadino in California and Detroit Michigan. http://www.governing.com/gov-data/municipal-cities-counties-bankruptcies-and-defaults.html

The  pressure on poorly funded local pension plans to "do something" will ramp up as GASB 68 calculations are released to the public for the first time. One way or another poorly rated cities and States will need to tap credit markets and could push all municipal rates higher, The timing of this potential flood of borrowings is of concern as the Fed for the first time in 7 years is about to tighten.

Consider the timing in the case of Oakland California the original POB issuer.

 "In 1997, Oakland followed up its 1985 invention of the POB with a $417 million pension bond. the bond was designed to buy the city a 15-year “holiday” from its police and fire pension contributions.
The timing was poor. As noted earlier, bonds issued in 1997 were, on average, underwater in 2007, even before the stock market crash. And so was Oakland’s. In 2010 Oakland’s city auditor did a careful analysis of the 1997 POB and found that “the amount still owed by the City is approximately $250 million higher than the scenario where the POBs were not issued in 1997 and the same payments were made to the pension fund instead.”
With the “pension holiday” over, Oakland’s City Council approved a new $210 million POB to be paid off in 2026 -- once again borrowing money -- cash that it would have had in hand had it not borrowed the last time."
                                         Bankruptcy in Providence 

Before we discuss why Providence, RI  is among  the walking dead, we need a primer on Bankruptcy. This Article provides a background for discussion:
A full discussion of Providence will begin in our next RIshrugs blog.


  1. This comment has been removed by a blog administrator.

  2. Mike, do you plan on writing about the specifics of the Woonsocket situation due to their poor use of PABs?

  3. This comment has been removed by the author.