MuniLand

Has Detroit over-inflated its pension liabilities?

Joshua Pugh, a writer and contributor to the Detroit News Politics Blog, has written about a topic that is a big one among muniland professionals. That is the question of whether Detroit’s Emergency Manager Kevyn Orr inflated pension liabilities to make the city’s debt appear larger, allowing for more aggressive haircuts for bondholders and pension holders. Pugh points out a Bloomberg Businessweek piece on his personal website:

How much does the city owe? Orr says Detroit has nearly $20 billion in debt and long-term obligations. Pension funds and bondholders have said in the past he’s inflating the numbers. Why would Orr do that? Because the more dire the city’s finances seem, the more aggressive he can be in pushing for concessions. Also, to be eligible for bankruptcy protection, the city must prove that it’s insolvent, meaning it has no way to pay its debts.

In 2004 and 2005, Detroit issued two sets of pension obligation bonds (Certificates of Participation) to fully fund the city’s pensions with an additional $1.5 billion. This is why, when I started looking at Detroit about 18 months ago, the pensions were surprisingly well-funded. Those pension bonds have now been lumped with general obligation bond debt, pension shortfalls (unfunded liabilities) and retiree health care as unsecured debt, which Orr intends to haircut.

The retiree health care value has been carried on Detroit’s books at the level that Orr cites for some time. But the unfunded pension liability has always been listed on Detroit’s financial documents as $650 million, rather than $3.5 billion that Orr claims. The pension shortfall was even listed as $650 million in February by the state’s Detroit Finance Review Team. What happened? Here is Blackrock’s Peter Hayes on the topic:

There is question as to whether the EM’s plan is inflating pension and OPEB liabilities. The unfunded pension liability was adjusted from $650 million reported in 2011 to approximately $3.5 billion—increasing more than five times over two years through unspecified changes to accounting assumptions. This $3.5 billion now represents nearly one-third of the amount Detroit owes to its unsecured creditors, and raises required pension contributions to approximately 100 percent of the city’s $1 billion forecasted budget deficit over the next five years. OPEBs, which were never funded in the past, now have the largest claim at an estimated $5.7 billion.

Muniland spends 12 percent of U.S. GDP, but not on creating jobs

It’s mind-boggling how much of the national economy is held up by state and local governments. From the Federal Reserve Bank of Atlanta:

State and local governments together spend more on directly consumed public goods and services (excluding grants and national defense) than the federal government does, said Tracy Gordon, a fellow at the Brookings Institution. The economic impact of that spending is significant—state and local governments account for approximately $1.8 trillion, or about 12 percent of U.S. gross domestic product, she added.

The Fed chart above shows data for the southeast states, but it mirrors national trends. State and local governments are not increasing employment. What is increasing is the amount of employee wages that is going to benefits. The Bureau of Labor Statistics wrote:

Pensions: Looking at the big picture

There is a lot of debate in muniland about how state and local governments should calculate pension liabilities. But I have not heard much discussion about the asset side of the pension story. It is a generally-accepted assumption that investment earnings are about 60 percent of the annual increase in pension funds. But what about the other 40 percent that represents the contributions made by governments and employees? We’re often told that state and local governments are under-funding their pensions. How much are they really contributing?

The U.S. Census collects this data about state and local government pension plans on a delayed basis. The most recent is for 2011. I thought it might be a good exercise to compare 2011 data with 2008 data. With the financial crash, 2008 was a tough year for public pensions.

The data shows everything moving in the right direction, including increased contributions made by governments and employees. In 2011, combined investment earnings and contributions of $616 billion far outstripped the pension payment outflow of $231 billion.

Chicago’s fiscal headache

Chicago has nearly identical fiscal challenges to its home state of Illinois: pension underfunding, massive school deficits and recurring deficits. But unlike the state, many of the decisions that need to be made in Chicago are out of the control of leaders, especially related to pensions. These decisions are made in the state legislature. Chicago Mayor Rahm Emanuel seems to have had little success lobbying for the city’s interest. Chicago political writer Greg Hinz described it in Crain’s Chicago Business last year:

In a rare mayoral visit to Springfield, Rahm Emanuel today told lawmakers that they need to act now on pension reform for government workers, and he laid out some specifics as to what he wants.

Testifying before a House committee, Mr. Emanuel called for a 10-year holiday on paying cost-of-living increases in Chicago’s four pension funds and other government retirement systems around the state. That freeze would apply to both current workers and those who already have retired.

Moody’s flawed estimate on public pension liabilities

As the debate continues over public pension funding levels, we have this headline from the Financial Times this week: “US States need $980 billion to fill pension gap, says Moody’s.” This is not exactly news. A number of studies, including ones from the Pew Trust and the Public Fund Survey, have identified a massive shortfall for public pension funds. In fact, the Pew Trust said that the shortfall in 2010 was $1.38 trillion, so perhaps we should be applauding state legislatures for improving the gap since then.

The shortfall numbers in these studies, to put it simply, are all over the place. There are many variables that go into these models, but the main factor that causes variation is the expected rate of return on the assets in the plans. The official assumed return on the assets that are held in trust to pay pension liabilities is 8 percent, according to the Public Fund Survey. Fiddling with this projected rate of return can cause swings in the amount of unfunded liabilities. The Moody’s study uses an unconventional assumption. According to the Adjustments to state pension liabilities document:

Accrued actuarial liabilities will be adjusted based on a high-grade long-term taxable bond index discount rate as of the date of valuation (of the fund).

Municipalities try to throw off pension plans

Two California cities, Pacific Grove and Canyon Lake, are trying to end their participation in CalPERS – the statewide public pension plan. The communities are unable to bear the cost increases in their retirement systems, which they are unable to control today. Now we hear news of another community and a non-profit group on the other side of the country that are trying to untangle themselves from established pension plans.

Ted Nesi, reporting for WPRI, details Coventry, Rhode Island officials who are trying to walk away from a non-teacher school worker pension plan:

Elected officials in Coventry have taken an apparently unprecedented step by washing their hands of responsibility for one of their employee pension plans, saying taxpayers have no obligation to come up with enough money to stop it from running out of cash within 12 years.

Pensions, retiree health costs and municipal debt

Bloomberg Link recently hosted a panel on the costs of healthcare for public retirees, pensions and public debt. Panel members included Richard Ravitch, who helped manage the New York City fiscal crisis in the 1970s when the bond market stopped lending to the city, and Ed Rendell, former governor of Pennsylvania. These men are two of muniland’s strongest war horses who have fought big governance battles. Bloomberg provided background for the discussion:

These so-called OPEB promises made by the 15 biggest cities alone total $115 billion, with an average burden of $2,300 for every man, woman and child, according to data compiled by Bloomberg. How will local governments manage to make good on their pledges without becoming insolvent? Will we see governments reduce benefits and raise their cost for current workers, as has been the case in several cities and states?

Is it time to restructure CalPERS?

A canary is singing in a coal mine in California. Canyon Lake, a city of about 11,000, has announced its intention to terminate its contract with CalPERS, the statewide retirement system. The small city has outsourced most of its public services and has two employees on its payroll, which it will shift from full time to part-time employment. According to Reuters:

Canyon Lake said it has looked at Calpers’s website, which states that its unfunded liability to the fund is $661,000.

Richard Rowe, Canyon Lake’s interim city manager, said the city decided it would be cheaper to borrow money to pay off Calpers rather than continue to pay the fund.

We need to know more about the risk of public pension assets

There has been a lot of discussion about the general underfunding of public pensions in muniland. Now credit rater Moody’s is reviewing cities in light of this:

The potential fiscal drag that under-funded pensions can have on cities is very important, but several other issues need to be examined further. First is the level of fees that public pensions are paying to investment managers and hedge funds, and the second is the level of risk in specific assets that the funds hold. Kevin Roose of NY Magazine wrote about the excessive fees that pension funds pay to outside “active managers”:

Pain for Stockton taxpayers

After proving it was insolvent, the city of Stockton, California entered the municipal bankruptcy process last week. The judge hasn’t yet delivered his formal ruling, but here are some of the most relevant reasons for the city’s insolvency, according to Judge Christopher Klein (page 556 most of which you have read here at MuniLand over the past year):

Excessive public employee compensation levels:

Some of the problems were also the incrustation of a multi-decade, largely invisible or non-transparent pattern of above-market compensation for public employees. Among other things, the City offered generous health care benefits, to which employees did not contribute. Retirees had their entire health bills paid for by the City. The City permitted, to an unusual degree, so-called “Add Pays” for various jobs that allowed nominal salaries to be increased to totals greater than those prevailing for other municipalities.

The enormous explosion of retirement liabilities:

Some of the problems were also rooted in generous retirement practices. The pensions, of course, are themselves a form of implicit compensation. Pensions were allowed to be based on the final year of compensation, and only the final year of compensation, and that compensation could include essentially an unlimited accrued vacation and sick leave. So it was possible to engage in the phenomenon that’s become known as ‘pension spiking,’ in which a pension can wind up being substantially greater than the annual salary that the retiree ever had.

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