Moody’s New Pension Rules Would Bankrupt Six Cal Counties Including Marin

Under the enactment of Moody's Pension Rules Marin County would become technically bankrupt because its investment return assumptions are much too high.

This is a posting of an article written by Wayne Lusvardi in Fox & Hounds on Wednesday, January 16th, 2013

Read the post on Fox & Hounds site:


Unedited text of Wayne Lusvardi's article:

To meet new public pension financing rules, six counties in California would have to dedicate all of their existing property taxes to pay for pensions or pursue municipal bankruptcy through the courts. That is the conclusion of an independent pension analyst of the new pension rules established last year by Moody’s municipal credit rating agency. The only alternatives would be to get voters to approve immense property tax increases or undergo deep cutbacks to essential public services.

The six counties listed below affected by Moody’s new pension financing rules all have independent pension plans that are outside the California Public Employees Retirement System (Cal-PERS):

Alameda County

Contra Costa County

Marin County

Mendocino County

San Mateo County

Sonoma County

Back on July 2, 2012, Moody’s announced proposed adjustments on how it evaluates public sector pension data.  Independent public sector pension analyst John Dickerson in Mendocino County recently released his analysis of Moody’s proposed pension fund rating changes for the above six counties. Dickerson has a website –- YourPublicMoney.com –- for public oversight into public pension plan solvency in 21 California counties. The California Public Policy Center website recently posted a summary of Dickerson’s full 10,000 word analysis of Moody’s pension fund changes.

Moody’s proposed changes in evaluating pension funds are:

The assumed rate of return on pension fund investments will be lowered from 7.75 percent to 5.5 percent. The lower the interest rate on pension fund investments, the larger the cash contribution required by employees or counties. Public pension funds have assumed unrealistically high investment return rates based on inflation during the Mortgage Bubble.

Municipalities will be required to catch up on its unfunded pension liabilities in 17-years, not the 20 to 30 year period now used.

Full payment of borrowed principal and interest – called full amortization — will be required in making pension payments. This means that level payments will be required, not graduated payments that start low and rise over time.

Pensions Would Consume All Property Taxes

Dickerson calculated the affects the above changes will have on the above-listed six counties. Pension payments will have to double according to Dickerson.

Catch-up pension payments will have to increase in the six counties by 192 percent. And existing aggregate pension bond payments will have to be increased by a total of $177 million total in the six affected counties to avoid insolvency. As Dickerson states, this will result in consuming 98 percent of all the property taxes in the six counties for pensions only as shown in the table below.

The percentage that each county depends on property taxes for their operating budget is shown in the table below. Alameda County –- with a seaport related economy — relies on property taxes for a low 12 percent of its General Fund. Agricultural-based Sonoma County has 43.6 percent of its General Fund dependent on property taxes.  Contra Costa County relies on property taxes for 21.9 percent of its operating costs; Marin County 25 percent; Mendocino County 14.4 percent; and San Mateo County 22 percent.

Doubling the amount of property taxes dedicated to pensions wouldn’t be enough to meet increased pension payments in two of the counties. Mendocino County would have to raise property taxes by 9 percent and Contra Costa County by 54 percent to meet their pension payments. This would require voter approval unless other funding sources –- such as the county share of sales taxes or income taxes –- could be shifted away from essential services such as police, fire protection, road maintenance, social services and medical care.

Failure for each county to double pension fund payments could result in: a) bad credit ratings; b) much higher interest rates on municipal bond borrowings that would crowd out pension payments in county budgets; or c) even failure of bond investors to buy county bonds for public works projects or for refinancing of existing pension bonds.

Large property tax increases to cover the unmet portion of public pensions is not much of an option in an economic recession. That is because real estate markets will adjust property values downward resulting in lower property values and, thus, a lower property tax base.

Cal-PERS and Cal-STRS: Not Too Big to Fail

As the editor of the website UnionWatch.org sums up the situation:

“The arithmetic, fact-based reality is this: We are on track to spend more money each year to pay public sector pensions than we will spend on social security for five times as many citizens. The average government employee retires with benefits that are five times more lucrative than the average social security recipient… the counties he (Dickerson) evaluated, Alameda, Contra Costa, Marin, Mendocino, San Mateo, and Sonoma, are not unique…“And what they (the six counties) are going to face is unlikely to differ significantly from any of California’s other local government pension funds, or CalPERS or Cal-STRS for that matter.”

The bond markets, not the courts, are starting to push counties into fully funding their pensions that could make many cities and counties in California fall into municipal bankruptcy. Gov. Jerry Brown, the Democratic supermajority in the State legislature, Cal-PERS, and public sector unions are hoping for a favorable court ruling in the pending municipal bankruptcy case of the City of San Bernardino. But the bond market is beginning to overrule whatever decision comes out of the courts.

Fearing an uncontrollable statewide wave of municipal bankruptcies, the California legislature passed a municipal bankruptcy reform law in 2011 –- Assembly Bill 506 – requiring cities and counties to first obtain a neutral bankruptcy analysis except in the case of a financial emergency. But it is difficult to be neutral between unsustainable pensions and essential protective public services when the governor has released criminals back into communities under prison realignment.

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Bob Silvestri January 19, 2013 at 06:32 PM
The cost of public sector services, salaries and benefits has exploded. On average public sector employee total compensation packages exceed their private sector counterpart by almost 100%. That's right. That's if you count their entire salary, benefits, healthcare and early retirement compensation (government employees get to retire at 50 years old whereas private sector retirement age is 65 years old but people all live the same average lifespan so public employees collect "benefits" for 15 more years). We cannot afford this nonsense. And to add insult to injury many government employees "retire" and then get another government paid job and then get two pensions! The whole thing stinks and it needs to be taken apart and put right. But to even mention what I've just said is considered so untouchable that everyone sweeps it under the rug. But this won't change the math. And so what Moodys has correctly assessed is that if and when this system collapses under its own weight the "greater fool" left holding the bag will be the taxpayers.
RD January 19, 2013 at 09:20 PM
- Some good news is rate of return was 23.5% for past 2 years 2010-2011 - does not solve problem of course, but is good news. http://digital.marinmagazine.com/article/POV/1047226/109540/article.html - Inflation will return at some point, I recall interest rate on savings account being 5% no so long ago. - Moddy's we all recall were those folks that rated AAA (very safe investment grade) all those mortgage backed securities etc. which were in the end not AAA but junk, so I take what they say with a grain of salt. I do not disagree, we do have a problem, but being aware of it now will hopefully insure it is addressed before it is too late.
Bob Silvestri January 20, 2013 at 01:27 AM
Agreed. And that's the reason to bring it up now, loudly, and it's why Moodys is bringing it up. And that's why the Grand Jury has brought it up. Better to be safe than sorry in this instance.
L. J. Butterfield January 20, 2013 at 02:41 AM
Okay, I get it. We have a serious problem. The unions won't bend and the employees have an agreement with the county and they want their pensions. So, is the answer to go BK OR sit down with the unions and say, we need to revisit these employee contracts regarding pensions OR the county will go BK? What about the health benefits too? Does the 350 Million- 2billion unfunded liability include that too or is that seperate? What specifically should the Board of Supervisors be doing to stop kicking the can farther and farther down the road? Solution?
John Parnell January 20, 2013 at 02:48 AM
Bob - Thanks for another excellent article. You are brilliant, and I hope that you will consider running for office. We need people like you, who are smarter than the rest of us, and actually understand these nuts and bolts.
Al Dugan January 20, 2013 at 04:38 AM
The fist step in problem solving is recognizing the true nature and extent of the problem. The supervisors should be using a conservative estimate for return for the pension fund and quite frankly 5.5% is very optimistic for the next two years. The supervisors are using 7.5%'that is off the charts unrealistic. Once they use a realistic return, and right now I would agree to 5.5% as if the economy goes well for the next 5 years, that may be the average and then the supervisors need to work out the numbers and how it will be paid. Let's see this from the supervisors. Peter, kicking the can down the road is using 7.5% return for the pension fund, and yes I do get excited when I hear the county could go bankrupt.
Al Dugan January 20, 2013 at 04:45 AM
What was the return 2008 and 2009? I know what my return was. Remember these numbers go up and down and the real measure is 5 year periods.
Roger January 20, 2013 at 04:26 PM
I am only going to vote for future candidates that promise pension reform. But are there any such candidates?
Bob Silvestri January 20, 2013 at 04:48 PM
So portfolio "risk" analysis would be an important first step is to understand how performance is being achieved. This would indicate the real extent of the problem, and perhaps might suggest some solutions. But either way there are no magic bullets. As it is now, the public sector and the private sector have been living in parallel universes for almost 20 years. Private sector job security, pension benefits and healthcare have been disappearing while the public sector has seen the reverse. And when I say "public sector" I mean government jobs and government related jobs: city, county and state employees, and union workers whose livelihood is directly tied to government. This parallel universe phenomena is not, however, true of union workers in all other sectors since they've suffered pretty much the same as the rest of us. What people are failing to realize is that the unfunded pension and healthcare liabilities of government at all levels is a much more dangerous problem that either social security (which is not, contrary to media, a national debt issue) or Medicare (which provides benefits at 10% of the administrative cost of private insurance companies). The pension problems sit directly on the shoulders of every taxpayer in Marin. For more information see: http://www.marincountypensions.com/
Bob Silvestri January 20, 2013 at 04:49 PM
Well, I would guess that like any other problem the first thing to do is stop denying there's a problem, or as in this case, multiple problems. Marin isn't the first county that has lost sight of what is realistic. However, what the Moody’s study does tell us, regardless of what you think of Moodys, is that we're among the worst in the state (and I would argue, in the country). As you correctly point out, there's no question that employee compensation and benefits need to be on the table. It's just ridiculous that a person can work in a city job for only ten years and get to retire at 50 with full pension and healthcare benefits for life (as happened recently in Mill Valley). Where else in the "real world" does that happen? Nowhere. Solutions? One that's been suggested is that government employee total compensation should be pegged to the average compensation of the same job in the private sector (the people government employees "serve"). Another first step is to dig into the track record and management of the pension fund. Fiscal solvency and future earnings projections are not just a matter of numbers like 7.75% or 5.5%. There are questions to ask about asset quality as it compares to performance. In other words, many pension asset managers have been moving farther and farther out on the "risk curve" (buying more risky assets like emerging markets corporate debt) to "chase yields" to keep up with their projections.
Bob Silvestri January 20, 2013 at 05:06 PM
Important to note that the "23.5% in 2010-2011" ROI, stated by Jeff Wickman in the Marin Magazine article you referenced, is already included in the Grand Jury and Moody's analysis but the unfunded pension liability is still over $2 billion. And as any reasonable person would admit, the historical investment return of the markets is around 10%, and 90% of all asset managers fail to do as well as the market average. So there's little comfort in one good year. Even a broken clock is right twice a day.
Al Dugan January 20, 2013 at 05:12 PM
Bob, your are spot on. Portfolio review and risk analysis should be performed to indentify the problem and it size and scope. This Amy be the first time I would agree to an outside expert to perform this work as first of all I do not think the supervisors or qualified to task this work and/or complete a review of the financial implication of the review after it is completed. I think a group of county residents with true financial expertise should form a panel to review and make recommendations to the supervisors. The only down side is the supervisors never listen, not to Grand Juries or anyone else.
John Parnell January 20, 2013 at 05:14 PM
Roger - Toni Shroyer in Novato is running for Supe against Judy Arnold. She's the only one I know of who takes our pension problem seriously. Bob's, Al et al - do you think that perhaps having the Supervisors be removed from the county pension system might be a way to go? It seems like an obvious conflict to me, and may be one reason they won't act. If they're feeding from the same trough, then why would they want to put themselves on a diet? After all, nobody wants to bite the feeding hand. Go Niners!
Bob Silvestri January 20, 2013 at 05:58 PM
A very interesting idea, John
Bob Silvestri January 20, 2013 at 06:59 PM
Thanks for saying that, John, but I'm just calling it like I see it. I've been asked to run for office many times but I'm not a very good politician. I've been an activist and working in Mill Valley and the County on planning and housing issues for 20 years. I've worked for Environmental Media Fund, a nonprofit I founded, without pay for 10 years, only concerned with educating the public about how enormous our environmental, human health and social justice issues are. We all do what we can.
Bob Silvestri January 20, 2013 at 07:03 PM
Another obvious solution is to peg retirement benefits to annual income the way we do with Social Security. If someone is getting a government pension and has an annual income of over $250,000+ per year, their benefits should begin to be scaled back. The savings from this would be significant. Does anyone really believe they can't live, "retired," on $250,000+ per year?
Al Dugan January 20, 2013 at 07:26 PM
Peter is a blogger that regularly submits to the Novato Patch under numerous monikers as a troll. He always say the same things but with different adverse tone and message. We call him Bud Light, but he also is my way or the highway and grouchy old man plus numerous others. He has mentioned his voter group many times on the Novato Patch but never post the link. No, I have not been drinking, sorry for it not being clear. May have a beer later though....go Niners.
Al Dugan January 21, 2013 at 02:22 AM
John, I didn't know the supervisors are part of the same pension system they manage. In the corporate world the executives are not part of the compensation committee to prevent any conflict of interest. That is a very interesting idea, to remove the supervisors from the pension plan, and certainly makes sense to prevent obvious conflict.
cathy January 21, 2013 at 02:44 PM
Hear hear! Thanks for coming out and stating this so clearly. I have hated the 'double pension' ever since I became aware of it.
John Parnell January 21, 2013 at 07:15 PM
Al - I'm the first to admit that my naïveté on the intricacies of this issue matches my outrage. I was under the impression that the Supes are members of the same pension plan, but I could be wrong. Does anyone know for sure?
Al Dugan January 22, 2013 at 02:06 AM
John, I have sent an email to the Marin Supervisors to answer the question, are they part of the pension fund they manage.
Kevin Moore January 22, 2013 at 02:28 AM
Are there any funds that guarantee a return of 7.75% year after year? I mean other than Bernie Madoff. If Wall Street won't offer that guarantee, our public officials shouldn't either. I remember reading Susan Adams saying that she made over 10% and didn't see why retirement funds can't make 10%, so 7.75% is reasonable. The problem is individual funds are like running a speed boat. In and out, it is easy to maneuver. Sell everything you have, the market won't notice unless your portfolio is in the millions or you trade penny stocks. Large funds are like oil supertankers. Managers can't pull out millions without affecting the stock price. The Janus 20 fund got into trouble this way. They only invested in the top 20 stocks. It worked well until they have billions in the fund. Then they were like a ship with a stuck rudder. CalPers is like running a convoy of oil supertankers. Good luck turning that group of ships when the housing market icebergs come into view. I fear we are nearing the end of the Fed easing. Things may change when that happens.
Al Dugan January 22, 2013 at 02:35 AM
Kevin, well articulated and your financial knowledge is very apparent. The super tanker analogy is perfect. Thanks for the post.
Scott January 22, 2013 at 06:55 PM
While I agree we have a serious pension problem, theres lots of misinformation and poor conclusions in this article. The problem lies much more in the ever increasing benefits rather than the assumed rate of return. The 7.5% return assumption is a bit on the high end, but not fanciful nor outrageous. 5.5% on the other hand is very conservative and likely not warranted. Determining the appropriate assumption requires much more information than discussed. It requires knowing the makeup of the beneficiaries, how long they have until they begin drawing as well as how much they will be drawing. If payments are weighted to the longer term, greater risk and greater returns are called for. The converse is true of shorter term withdrawals. Moreover, I didn't see anywhere a discussion of long term average returns for various asset classes. Here are the LT rates of some of those classes: 25yrs 80yrs Large cap stocks 13.4% 10.4% Small cap stocks 14.0% 12.9% T-bond 11.1% 5.4% T-bill 5.3% 3.7% CPI 3.1% 3.1% Source: Ibbotson, MSCI One can easily see a weighted average return assumption of 5.5% is very conservative and expensive especially for younger beneficiary pools.
Scott January 22, 2013 at 07:12 PM
Also, Moody's doesn't set the rules on pension funds as this article states. It is stating how it will evaluate them to determine the county's creditworthiness on its outstanding, and to be issued, debt. The better way to manage this is to remove pension liabilities from the balance sheet, as most corporates have done, or are doing. This means a switch from a defined benefit (DB) plan, where the county guarantees the benefits, to a defined contribution (DC) plan, where the county contributes an agreed amount every year. DC plans in the private sector are commonly called 401k plans. The government should not be responsible for guaranteeing individuals' retirement. That's not why, as the citizen taxpayers, we hire them. We hire them to provide police/fire/ambulance coverage, pave the roads and etc. The county's employees, as with nearly every other citizen in the country, should bear the responsibility for ensuring they're saving enough so as not to be a burdon on society in their senior years. Employers can, and do, encourage that with DC/401k plans where they often match some, or all, of the employees' contributions. That's the rational solution that limits the ability of the county to load up its balance sheet with excessive liabilities. Why doesn't this happen? Unions. Public employee unions are an anathema that should be outlawed. Unions exist to protect employees from their bosses. Public employees already have such a redress - the polls.
Bob Silvestri January 22, 2013 at 10:23 PM
Thanks, Scott. But the process you suggest is what the Grand Jury did in evaluating the unfunded liability and that is what produced a $2 billion plus shortfall. Also, pension funding obligations don't use 80 year market averages (which I would have to say are more like 11% for the S&P, and not realistic buying govt. bonds in recent years or the next five years at 11% or bills at 5%). 5.5% is being called the Buffet Rule since it's Warren Buffet (nobody's fool) who is advising pensions to use that rate.
Bob Silvestri January 22, 2013 at 10:25 PM
Again, that's what the Grand Jury and all the rest of us have been saying for years: make this your own problem or cut benefits to more realistic levels. The County decided to create their own private retirement plan system. So I'm sure we all agree public employees should live in the same "risk" environment as the rest of us..
Al Dugan January 22, 2013 at 11:40 PM
While I will debate the return issue, just look at 2008 and 2009, I agree 100% with you recommended switch from a defined benefit (DB) plan, where the county guarantees the benefits, to a defined contribution (DC) plan, where the county contributes an agreed amount every year. DC plans in the private sector are commonly called 401k plans. This began in the 1990's in the private sector as companies were running into the exact problem the public pension funds are in now. You are right Moody does not set the rules for pensions but it they can rate the county with a "junk" rating.
Vox Publius January 24, 2013 at 07:19 AM
Ya'll are just 'rearranging the deck chairs on the Titanic'. Actually, worse than that: Ya'll are just TALKING ABOUT 'rearranging the deck chairs on the Titanic'. Actually, even worse than that: Ya'll are JUST BEGINNING to talk about 'rearranging the deck chairs on the Titanic'. And watch out from such non-nonsense you speak. They tried to crucify Scott Walker in Wisconsin actually dealing with this very same obamanation: public pensions!
Kevin Moore January 24, 2013 at 06:26 PM
For 5 years, about break even, plus dividends if you look at the S&P 500. At 7.75% compounded over 5 years, the market should be up 45%. http://finance.yahoo.com/echarts?s=%5EGSPC+Interactive#symbol=%5EGSPC;range=5y Here is the S&P500 over the history. Notice the sharp rise in 1990. You can thank the "digital age" and "easy credit policy". We are heading for a triple peak after two bust cycles. http://finance.yahoo.com/echarts?s=%5EGSPC+Interactive#symbol=%5Egspc;range=my;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined; The "Rule of 72". Take the return rate and divide it into 72. That is how many years it should take for the principle to double. This works for bank loans and investments. 7.75% projects the principle to double every 9.30 years.


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