$3
Trillion Municipal Pension Burden
It’s
About Time:
Public
Pension Reform Needs Space to Work
by
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.
This comment has been removed by a blog administrator.
ReplyDeleteMike, do you plan on writing about the specifics of the Woonsocket situation due to their poor use of PABs?
ReplyDeleteyes I do.....
DeleteThis comment has been removed by the author.
ReplyDelete