MuniLand

Public pensioners everywhere should be worried today. There is devastating news from Central Falls, Rhode Island as the city’s receiver has cut the monthly pension payments to retirees. From WPRI.com:

Central Falls slashed one in three of its retirees’ pension checks by more than half this month, with the majority of the city’s former public-safety workers set to lose tens of thousands of dollars a year.

Receiver Robert Flanders reduced 48 of the city’s 141 police and fire pensions by 50% or more, with all but three of those cut 55% from their original amount, according to financial records obtained by WPRI.com.

This is not a surprise as Central Falls had filed for bankruptcy on August 1st and the receiver for the city had announced he would be taking this action. He stated at the time that the city’s pension funds were far from funded but has never given a public account of their finances. There are also deeper issues for Central Falls and Rhode Island as they intend to pay bondholders 100 cents on the dollar while reducing pension benefits.

The plague of underfunded public pension plans is spread across America. Retirees and taxpayers everywhere should be worried. There are many reasons for widespread underfunding and they have been covered up by the opaque disclosure and accounting requirements pension funds have.

Meredith Whitney’s prediction last November of hundreds of billions of dollars in municipal defaults over the next 12 months was totally wrong. But she was right on one thing: pension plans for state and local workers are unsustainable. I totaled up the data in a new paper by Robert Novy-Marx and Joshua Rauh (page 50) and got a nationwide funding shortfall of approximately $1.19 trillion. This data is from June 2009; pension fund data is only reported every three years, so it wouldn’t reflect the large equity-market increases over the last two years. But it’s still a whopping sum. On average U.S. public pension funds are only 61% funded.

The chart above shows the ten states with the least funded pension plans on a percentage basis. Illinois has the worst problem, as it does on many muniland metrics.

There are not any easy solutions to this problem. Options for states include cutting other expenses or raising taxes to make larger pension contributions. States generally cannot lower or terminate already promised benefits as these are rights enshrined in state constitutions. There have been cases where future increases have been lowered or withdrawn, and this can help make up the shortfall.

It’s hot in Washington DC and Congress will return soon to figure out how to balance the federal budget. Part of the equation is likely to include raising more tax revenue. It’s easy to picture the thousands of lobbyists on K Street polishing their Gucci loafers and sharpening up their arguments to protect the interests they are hired to lobby for. There is no more epic battle in Washington than when tax benefits are being redrawn. The federal pie is getting smaller, and the battles will be fought in close combat.

As the struggle around taxation heats up you hear two recurring arguments. First is the idea that if you raise taxes on the upper-income earners you would kill the incentive to invest in job creation. And because job creation is the most essential need of our economy, raising taxes on the wealthy would kill the golden goose. Saying that raising taxes hurts the “job creators” is generally a Republican talking point. The other common argument is one of fairness. This is a liberal talking point, although it should be one embraced by all elected officials representing “the people.”

In his well-circulated New York Times op-ed, Warren Buffett talked about the unfairness of the low tax rate for those who earn income from their wealth as opposed to those who earn their income from their wages:

New Jersey downgraded again

Yesterday Fitch joined Moody’s and S&P in downgrading the state of New Jersey to AA-, the fourth lowest investment-grade rating. This places New Jersey in the lowest 10% of states in terms credit quality and deflates the story of Governor Chris Christie’s repair of the state’s unfunded pension liabilities. From Bloomberg:

A bill putting more of the pension and health-care burden on employees, signed by Governor Chris Christie in June, won’t prevent the need for increased state contributions, Fitch said yesterday in a report. Other negatives were a weak economic recovery, persistent deficits and high debt, the company said.

Christie, a 48-year-old Republican, signed a $29.7 billion budget in June in which he vetoed about $1 billion in spending added by Democrats who control both the state Senate and the Assembly. The spending included a pension payment of about $480 million, below the $3 billion recommended by actuaries. The state hasn’t made full payments into its pension system for most of the past decade.

“The unions are buying power”

This is a great video of Stephanie Gomes discussing her experience as a member of the City Council in Vallejo, California, as they struggled through a municipal insolvency and bankruptcy. She talks about the power of the police and firefighter unions and their stranglehold on local politics. Gomes comes across as passionate citizen who was willing to confront some of the deep-seated problems in her community. She highlights the importance of local and national media attention on the “dirty laundry” of municipal finances like high salaries and generous pensions for union workers. Her experience is an important lesson for anyone interested in muniland.

Video via Vallejo Independent Bulletin and WPRI.com.

Jefferson County nearly files bankruptcy but instead ditches negotiator

The Birmingham News ran this above video of Jefferson County Commission President David Carrington discussing the commission’s meeting on Friday when they voted to delay filing Chapter 9 bankruptcy, cut out their court appointed receiver and deal directly with bond creditors. From what President Carrington says, it sounds like they almost filed bankruptcy at the meeting::

I thought we were going Chapter 9. I think I could take a test on Chapter 9 I know it so well.

Something doesn’t seem right in Central Falls, the Rhode Island city that declared municipal bankruptcy yesterday. Now that the state receiver has filed Chapter 9, all the town’s dirty laundry has been hung out in public, and, like any bankruptcy, it’s not pretty. Overspending and declining tax revenues doomed this poor town, along with liberal doses of alleged corruption.

Here is what doesn’t seem right in Central Falls. The city is dead broke and those they owe money to are lined up at City Hall to collect. But for some odd reason, the city’s bondholders have pushed ahead of all the others in line to claim full repayment of their debts; those later in line must settle for 50 cents on the dollar. Retired police officers and firemen will have their pensions cut by 50%.

It wasn’t Central Falls’s decision to give preferential treatment to bondholders. Last year legislators in the state capitol passed a law making the claims of bondholders superior to all other claims in bankruptcy. The Rhode Island General Assembly’s action flies in the the face of common bond market practice, which is that bondholders get in line with everyone else and a judge overseeing bankruptcy proceedings gives a fair resolution to all the creditors.

Central Falls, Rhode Island — the smallest city in the smallest state — filed for bankruptcy today after years of decline. It is the fifth U.S. municipality this year to seek protection from the courts under the bankruptcy law. The Governor of Rhode Island stood with city officials as the bankruptcy process commenced. Reuters quoted him as saying in a statement:

“The current situation is dire and it necessitates decisive steps to put the city back on a path to solid financial footing and future prosperity,” Rhode Island Governor Lincoln Chafee said in a statement.

Central Falls’s population peaked in 1930 and has declined ever since; it currently has only 19,000 inhabitants. The town is extremely poor with median household income of $22,628 and per-capita income of $10,825, according to the 2000 Census. Central Falls, like many hidden American towns, is at the end of municipal row.

Singing the passion song

Kathleen Kennedy Townsend, the former lieutenant governor of Maryland, writes passionately in The Atlantic about the need to create jobs in the United States, especially those linked to infrastructure. I welcome her opinion as we need more passionate voices drawing attention to the need to stop outsourcing American jobs. We will never recover if we make economic decisions solely on the the basis of manufacturing costs. Ms. Townsend says:

As a country we have to decide what our values are. Do we really want to be a nation that funds our spending spree through the Chinese, who then make our goods and do our work while we go into debt and remain unemployed? Work is more important than saving tax dollars. Jobs are critical. Work, not an unemployment check, is what makes people feel they are worth something.

I hope the combined forces of politicians, the unions, and the Chamber [of Commerce] will eventually overcome the resistance to the infrastructure bank. We need to create jobs, and we need to rebuild our roads, railways, sewage, and water systems. Most of all, we need to revive our sense of energy and excitement — the deep fulfillment that comes of making things we can touch and feel, things that really improve our lives.

Decades-long infatuation with financing our spending

Sheila Bair, who served as Chairman of the Federal Deposit Insurance Corporation for five years through the financial crisis, has completed her term. In a weekend op-ed in the Washington Post, she urges America to rid itself of its addiction to financing consumption and “growth” with debt. This is the core requirement for America to become financially stable again and to return to “real” growth. From Bair’s Washington Post oped:

Now that I’m stepping down, I want to sound the alarm again. The common thread running through all the causes of our economic tumult is a pervasive and persistent insistence on favoring the short term over the long term, impulse over patience. We overvalue the quick return on investment and unduly discount the long-term consequences of that decision-making.

Our decades-long infatuation with financing our spending through ever-growing debt, in the private and public sector alike, is the ultimate manifestation of short-term thinking. And that thinking, particularly in business and in government, is actually getting worse, not better, as we look for solutions to put our economy on a sounder footing.

Insurers have “manageable” muniland risk

Meredith Whitney has made many assertions about muniland, but the only one that I had not heard from others before she stepped onto the national stage was her contention that insurance companies would be forced to sell their municipal bonds into a declining price spiral. She alleged this would collapse muniland, so it’s very interesting to see Moody’s assess the risk for insurance industry. From Property Casualty 360:

Property and casualty insurers remain the most exposed sector among financial institutions to volatility within the municipal-bond market, holding about $355 billion in municipal bonds, but the overall level of risk should be manageable, Moody’s says.

In a Special Comment, Moody’s says municipal bonds represent 60 percent of the industry’s equity capital base, as measured by policyholders’ surplus. This figure is down from the prior year, when the industry held about $370 billion in municipal bonds, representing about 70 percent of policyholders’ surplus.