The shadows of muniland
There is a shadowy part of muniland. It is populated by liabilities that are absent from balance sheets and municipal debt that was contracted by circumventing the law.
Muniland’s biggest unknown liabilities are unfunded pensions and retiree health care benefits that until recently were not required to be on issuers’ balance sheets. The information related to these often enormous future expenses had previously only been reported in footnotes. Muniland’s accounting overseer said in 2012:
GASB Chairman Robert H. Attmore. ‘Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.’
Market commentators have been fighting about the discounted value of these liabilities, but we at least see them on balance sheets now. See a problem; fix a problem.
On a smaller level, Moody’s has issued a report that discusses contingent debt liabilities. These are a government’s guarantee for non-affiliated entities that don’t provide “government services.”
Local governments generally do not report contingent liabilities on their balance sheets, although recently adopted Government Accounting Standards Board changes will improve disclosure and make it easier to identify governments at risk. Moody’s includes contingent liabilities for non-essential, non-core enterprises in a local government’s direct debt figures and debt ratios.
Moody’s says these issuers can get big knocks on their credit quality from these liabilities.
‘Only a small percentage of local governments take on contingent liabilities for nonessential enterprises. But for those that do, the effects on those governments’ credit quality can be devastating,’ says Josellyn Yousef, the Moody’s Assistant Vice President who wrote the report.
Then there is the astonishing development in the Detroit bankruptcy case in which the emergency manager Keyvn Orr is suing an agency that was established by the city to funnel payments for pension debt that was issued in 2005 and 2006. Reuters reports:
The lawsuit contends the city and its retirement systems violated Michigan law when they set up ‘sham’ service corporations and funding trusts to facilitate the debt sales in 2005 and 2006. All other contracts or obligations connected to the debt are also void, the lawsuit claims.
Detroit in its lawsuit said the pension debt was ‘nothing more’ than a borrowing by the city, and it violated borrowing limits imposed on Detroit by the state of Michigan.
In the suit, Detroit asked bankruptcy judge Steven Rhodes to issue a judgment declaring the city is not obligated to continue making payments on the so-called pension certificates of participation (COPs). The COPs were issued during the term of former Mayor Kwame Kilpatrick, now in prison on federal corruption charges.
It’s unclear if this lawsuit is merely a negotiating tactic within the bankruptcy proceeding, but it raises substantial questions about bonds issued while circumventing state laws on debt limits. These are the shadows of muniland; A place where clever legal and financial engineering pervert the law and obscure transparency.