Archive for the ‘cities’ Category

The Grand Jury of San Diego issued a report of this title yesterday.  Also, at yesterday’s GFOA (Government Finance Officers Association) business meeting, the group voted  that the Government Accounting Standards Board should stay away from the topic of sustainability.  The only conclusion one can draw from the Grand Jury report is: the city of San Diego’s current trajectory is UNSUSTAINABLE.  Here, are a few choice passages (please read as if these too, were fully capitalized):

The City has yet to articulate structural solution to close the multi-million dollar budget deficit in fiscal year 2010.  More than 50% of this gap in financing was filled by using one-time solutions, such as skipping reserve payments and deferring projects.

In summary, this investigation is presented to the City and its citizens because the status quo is not going to resolve the crisis of financial instability, unbalanced budgets and reduction of the city’s obligations, liabilities and debts.

One of the underlying causes of the current structural budget imbalance is the underfunding of the City’s pension obligation by previous City administrations.

Ok, we know this.  This is true among states and municipalities across the country.  But what to do?  In some (not all) places the pitch of the problem has reached a scream – CONTINUING GOVERNMENT OPERATIONS ARE UNSUSTAINABLE.  Amazingly, the choice to cut critical services has become the lesser of two evils – the other being pension and benefit reform.  Elected officials, charged with managing cities like San Diego would rather have fewer cops, less trash pick-up, deteriorating infrastructure and higher taxes, than deal with runaway benefit spending.  Even if you believe that the benefits are deserved, earned and righteous, the city simply does not have the resources to pay these costs and also maintain a livable city.  So what’s the decision?  Give up the livable city?  The City’s Independent Budget Analyst stated:

Structural deficits require structural solutions.

The report suggests using the federal bankruptcy courts to determine what can and cannot be restructured.  Investors, along with public employee unions (strange bedfellows) hate this solution and prefer to stay in one-shot-land, or stand by while the deterioration mounts (see stories on Vallejo’s increasing crime.)  The courts could also decide to trim back debt obligations in the same restructuring process.  This has happened in Vallejo, where there is a moratorium on debt service payments (at least with the current intent of re-paying in full at the end of the moratorium period).  Vallejo’s bankruptcy tackled the city’s ability to reject union contracts, a key step, but they did not touch the pension issue.  The San Diego Grand Jury suggests a bankruptcy court could help sort out this benefits conundrum.

Finding 26: A proactive dialogue as to the efficacy of a Chapter 9 reorganization cannot be removed from any discourse as to the City’s financial health

Finding 27:  A Chapter 9 filing would result in a federal determination of which fringe benefits and collective bargaining agreements could be restructured.  The fringe benefit total is $423.7 million, according to the FY 2011 Proposed Budget.

RECOMMENDATION

The 2009/2010 San Diego County Grand Jury recommends that the Mayor of the City of San Diego and the San Diego City Council:Convene a panel of bankruptcy experts to discuss the legal and financial ramifications of a Chapter 9 declaration of bankruptcy, in the context of a publicly noticed City Council or Council Committee meeting. 

In this context, the municipal credit analyst, the investor and the taxpayer, need a new tack on fiscal review.  Unfunded pension liabilities must be included as a long term debt in debt ratios.  The rating agencies discuss these burdens but they are not included in the numbers. Medians that include all long term and contractually obligated costs should be developed to correctly compare cities and identify outliers like San Diego Vallejo.  The long term cost of these obligations should clearly be disclosed so that ratios may be calculated.  For example, red flags of fiscal trouble are waving fervently in San Diego’s case and the Grand Jury mentions Vallejo as well:

In 1994, the city’s budget for pension expense was 6% of payroll cost.  Today, sixteen years later, the cost is 28% of payroll, and growing.

For FY2009, the City’s fringe benefits rate was 52.5% of budgeted salaries of $728 million (IBA Report #09-10 issued February 24, 2009, p.2).  On average, privately operated companies spend 35% of budgeted salaries on fringe benefits. 

Some 76% of Vallejo’s operating budget went to salaries and benefits.  The norm is 50%.  Pensions were not an immediate issue since Vallejo had funded its pension obligation.  Vallejo’s most significant liability was $135 million of unfunded health care.  Vallejo officials brought the unions back to the bargaining table after the federal bankruptcy judge ruled collective bargaining agreements can be voided. 

A few other red flags that can be identified with a bit of extra work:

Is the municipality/state postponing annually required benefit contributions?  Is the government making its “annually required contribution” or ARC?  If not, this will catch up quickly as evidenced in San Diego (see separate post on the state of Illinois)

Are judgments and claims high and increasing?  This points to the government’s poor risk management practices and sloppiness.  This is a low-hanging fruit that cities should tackle with gusto.  The Grand Jury found in San Diego’s case:

Funding of the City’s (self-insured) public liability fund against lawsuits that could drain the General Fund for years to come.  As of June 30, 2009, the City faces $129 million in claims.

Funding the city (self-insured) worker’s compensation fund against outstanding claims, currently estimated at $161 million.

As the press and blogosphere keep telling us, there will be more municipal defaults and bankruptcies.  But there is a difference between painting all securities with the same brush and rigorous analysis.  We believe the flags are identifiable. 

We are coming out of a period when investors bought municipal bonds with their eyes closed.  The mantra that municipals don’t default and the once widespread presence of bond insurance convinced the investing community that analysis was irrelevant.  No more.  On the other hand, Congress has pressured newly contrite rating agencies to upgrade municipals at perhaps the worst time in history. 

San Diego’s GO ratings?  Moody’s: Aa3; Fitch: AA- and Standard and Poor’s: A 

There is a table at the end of the Grand Jury report with a September 6, 2010 deadline for city officials to respond to the specific recommendations.  The Mayor, the City Council, the Retirement System’s administration, the Audit Committee and Independent Auditor are required under the state of California Penal Code to do so. Looks like a busy summer.

See this post on Reuters for discussion about Antioch, latest city in California to talk bankruptcy.  There is a bill, sponsored by state senator Mendoza, AB155, that would require cities to go through the state (via the California Debt and Investment Advisory Commission, CDIAC).  The bill was referred last week by the Senate appropriations committee — but now appears there will be some further review.  The pros and cons line up as follows;  cities strongly against state involvement in order to preserve local autonomy; unions and bondholders in favor in order to prevent reduction of obligations, whether they are union contracts or debt obligations.  Interesting line-up.  Many states have had oversight programs for their distressed communities for years.  Distressed designation may trigger  grants or aid to distressed municipalities that would not be present in a federal bankruptcy.  Some states map out a “receivership” process that gives the state certain intervention rights to reorganize the municipal government and bring finances back into balance.  Cities oppose any additional intervention by the state that encroaches on their powers.  Pro-union forces in the legislature want to prevent the cities from filing bankruptcy since it may result in reduction of  contract provisions (which was determined to be possible in the Vallejo case).  So far the pension albatross has yet to be tested.  According to Antioch’s 2009 audit the city is obligor on about $27 million certificates of participation, paid through lease agreements, current underlying ratings are Standard and Poor’s “A” and there is MBIA insurance on at least some (maybe all, we didn’t check each series) of the certificates.

Tight financial margins are not kind to political squabbles.  In the last few weeks the city of Los Angeles has been engaged in a squabble with the city council and its utility, the Los Angeles Department of Water and Power (LADWP).  The city’s mayor wants the utility to implement green power, the utility asked for a rate increase to cover additional expenses, the council refused and the utility held hostage a transfer to the city of funds.

Each of these events has its own logic, but when the “b”-word (as in “bankruptcy”) got thrown around, the city’s rating was downgraded and put on negative watch. 

Looked at from a different perspective, when one body of government promotes green power or makes a regulatory change, utilities either get some kind of financial incentive or are simply required to comply.  They could file a rate increase request with their state Public Utilities Commission.  Or at the municipal level the utility would pass along the extra costs to the consumer – assuming the local council goes along.  The PUC could grant the increase (or not) and the utility would charge higher rates or alternatively eat the loss through lower profits (or maybe find savings!).

Transfers from municipally owned utilities are also common practice.  Think of them as “payments in lieu of taxes” (PILOT).  Most investor owned utilities (IOU’s) pay taxes to the local government.  The PILOT or tax covers the cost of the usual stuff – police, fire, sanitation, roads that benefit the utility, as well as an economic environment that allows the utility to grow or maintain its customer base.  In some parts of the country, where municipally owned utilities are more common, these transfers are made below the line – after all other expenses have been paid – so that the security covering utility bonds is not compromised.  For IOU’s, not paying the corporate taxes – is out of the question.  Non-payment could result in penalties or shut-off of power.

Not so in Los Angeles where all of this is up for negotiation.  In tight economic times, when reserves are thin and maintaining monthly cash flow is essential to the government function, a hold-up could spell disaster.  The LA city council opted to play a high stakes game and in the current environment, the mayor’s counter-offer of bankruptcy or shutting down city government added fuel to the fire.  Factors that are not up for negotiation elsewhere got caught in the political crossfire in Los Angeles.

I am posting Municipal Utility Transfers , an article I wrote  some time ago on this topic – covering Los Angeles under Mayor Riordan – that still has merit today. For municipal history buffs (a small and nerdy group), today bears a strong resemblance to the 1992 period: a run-up in asset values followed by a bubble-burst; taxpayer protests; downgrades and economic recession, particularly in southern California not to mention the Clinton mid-term elections.  Keep in mind that the city of Los Angeles and its utility are large, diverse and wealthy and will be able to manage through the storm.

Just thought I would post a really useful link for documents and explanations of the financial regulatory reform legislation as it moves through Congress.  As you know, the Senate Banking Committee approved the “manager’s amendment” and the discussion will likely go to the floor for debate, maybe after the Easter recess.  Like everything else in Congress these days, the vote was along party lines.

Governor Christie signed off on pension reform in the state of New Jersey.

I am adding a link to this article that updates Toledo’s fiscal situation.  (See prior post.)  The city is wrestling with a budget gap and trying to negotiate with unions over compensation.  Ohio is a state that has a fiscal emergency program and municipalities may not file for bankruptcy without going through the state.  The state’s oversight of fiscal emergencies is useful but does not give the oversight panel the right to cancel contracts or replace management.  The biggest clout is the panel’s ability to prevent borrowing — a severe but important hammer for any city in fiscal emergency that may be facing a cash flow shortfall.

Here is an interesting clip from MLive about the debate over Flint’s dire finances.   Michigan has a receivership program that has been used a number of times so municipalities cannot just file bankruptcy in federal court without going through the state.  The article poses the sensible, if painful and difficult, questions of concessions on salaries and benefits compared with outright layoffs (in a city with 25% private sector unemployment) as well as collaboration with other municipalities on providing services (we applaud that approach).   We also note the exaggeration of county Commissioner Curtis, who said “cities across the country are going into Chapter 9 and getting relief from the contracts…”  Of the 89,000 municipalities in the U.S. there’s Vallejo, California and Prichard, Alabama.  Las Vegas monorail mentioned in the Wall Street Journal article last week  (you may need a subscription to access this) is in Chapter 11 which is the part of the bankruptcy code for corporate filings.  There have been a number of Chapter 9 filings by hospital districts, as well as numerous, small land-development-based special districts.  Then there’s Connector 2000 in South Carolina.  Harrisburg, PA has been discussed and of course, Jefferson County, Alabama sewer system,  but there has been more chatter on the wires since the Journal.  Connector 2000, the Harrisburg incinerator and the monorail have each been problem credits for some time, apart from the recession and credit market meltdown.

Looks like the city is making its best effort to try to resolve budget imbalance.  Ohio is one of the states that has a strong oversight/receivership program and municipalities may not file bankruptcy without approval of the state.  Local governments there do rely on income taxes, which is tough in the current economy, especially in auto and manufacturing which dominates the landscape.

Here’s a good, local clip about the Harrisburg bond/incinerator problem:

See attached item from Reuters: http://www.reuters.com/article/idUSTRE61D27C20100214

Click on article title to get the link (sorry for the clunkiness)  Hat tip to Mayraj Fahim.

A blogsite, “Mish’s Global Economic Trend Analysis” recently aggregated a selection of news stories covering state and local government budget deficits and proposed layoffs.  Click here  to link to the post.  There are a few differences between private sector layoff announcements and the public sector that are worth pointing out.   The private sector typically announces layoff actions that are already decided.  There is little incentive to inflate the numbers.  On the other hand, public sector layoff announcements are typically proposals, made in the context of budget negotiations and ultimately subject to the influence of many constituencies: unions, elected officials, civil servants, and service beneficiaries.  I don’t believe it’s common practice for the private sector to lists vacant job positions in their layoff numbers.  Governments typically count the position that has been budgeted for and maybe even funds were appropriated but the position was not filled.