Category Archives: Finance

When Balanced Budgets Aren’t Really Balanced

hide_the_peaby James A. Bacon

The politics of fiscal implosion are ugly. Just look at what’s going on in Petersburg and Richmond.

  • Confronted with a massive budget deficit last year in contravention of the state constitution and the prospect of a deficit in the year ahead, Petersburg City Council bravely agreed to cut the compensation of the city’s 600 employees — but carved out exemptions for senior city officials and themselves.
  • Another trustee has resigned from the board of the city of Richmond’s severely under-funded retirement fund, which has been embroiled in governance issues over who calls the shots over investment decisions.
  • City of Richmond officials say they have nearly completed their comprehensive annual financial report for 2015 — seven months late! The city has not completed the required report on time since 2014. City officials blame IT issues.

That’s just in the Richmond region, which I am familiar with because I read the Richmond Times-Dispatch as my daily newspaper. Who knows what’s happening elsewhere? While Virginians pride themselves for their fiscal rectitude, it is increasingly clear that some jurisdictions don’t hew to standards much higher than Chicago, Cleveland or Detroit.

In theory, the state constitutions requires the state government and each political jurisdiction to balance its budget each year. Virginians should be concerned that Petersburg failed to do so in fiscal 2016, that it shows every sign of failing to do so again in fiscal 2017, and that there appears to be no sanction or penalty in sight. Likewise, we should be concerned of the various tricks the state and its localities can use, if so inclined, to hide long-term structural budget deficits. Here are three:

  • Under-fund employee pensions. The Commonwealth drastically under-funded the Virginia Retirement System in the last recession, although it is now doing penance by accelerating repayments. The City of Richmond has under-funded its government-employees pension, which it operates independently of the VRS.
  • Slow pay creditors. This tactic comes straight out of the Illinois Fiscal Irresponsibility Playbook. Petersburg, it has been revealed, delayed payments of millions of dollars not only to the VRS but schools and the regional jail.
  • Defer maintenance. Rather than properly maintain roads, streets, buses, water systems, sewer systems, school buildings and the like, save money by scrimping on maintenance, even if it means even higher costs down the road.

To what extent do local governments rely upon these and other budgetary sleights of hand to balance their budgets? Nobody knows. Let me rephrase that: The public doesn’t know.

The bottom line here is that citizens cannot take at face value that their local governments are truly balancing their budgets. Some might be. I have faith that my home county of Henrico, whatever its other failings, runs a tight fiscal ship and doesn’t play bookkeeping games. But I don’t know it for a fact. Speaking generally, not specifically about Henrico County, government administrators are subject to the temptation of hiding bad news. And in most cases, local elected officials are either too timid or too untutored to ask tough, probing questions about how money is being spent.

Citizens unite! There are active taxpayer groups in Arlington, Fairfax County and Virginia Beach that I know of. I hope and pray that there are others of which I remain ignorant. Rather than fight lonely fights, they need to pool resources and expertise. I invite like-minded citizens to join Bacon’s Rebellion to create a platform to share knowledge and hold state and local governments more accountable than our elected officials seem able to do on their own. If anyone is interested in such a collaboration, please contact me at jabacon[at]

Detroit on the Appomattox

Downtown Petersburg is rich in historical architecture, not much else.

Downtown Petersburg is rich in historical architecture, not much else.

by James A. Bacon

For its 2016 fiscal year, which closed June 30, the Petersburg City Council enacted a $75 million General Fund budget. Somehow, the city managed to close the year with a $17 million deficit.

Last week, council members knew the situation was dire. Staring at what they thought was a measly, $7.5 million deficit, they unanimously approved a 20% cut in personnel costs. Then, as reported by the Richmond Times-Dispatch, they learned that the deficit was actually $17 million.

Holy moly! In a state that constitutionally requires a balanced budget, how can a government body be 20% off? How can things go so far wrong?

Mayor W. Howard Myers sounded clueless. “I had no idea. I’m like, wow, where is this coming from,” he told the Times-Dispatch. Vice Mayor Samuel Parham only hinted at the problem: “This is a problem that has compounded over many years, so the  balloon has blown up and it has popped here on us.”

The city’s financial woes became apparent early this year when an audit found overspending in the General Fund by $1.8 million and anticipated a budget shortfall of $6 million. City Council fired City Manager William E. Johnson III, and appointed Dironna Moore Belton in his place on an interim basis. With Belton at the helm, a team of state auditors dug deeper into the books and found that about $4.5 million had been depleted from some “internal accounts” without the city’s knowledge.

Petersburg is a case study in how a municipal government can run up deficits without calling them deficits. The Times-Dispatch article refers to $2.5 million in financial obligations to the city school system, the regional jail and the Virginia Retirement System carried over from the 2016 budget to the 2017 budget.

“When you have a deficit, it just keeps rolling forward, Belton said. “We are working very diligently to do long-term finance restructuring, and we’re still trying to break down exactly the causation (of the deficit), but we do know the number of delinquent accounts that we have.”

Bacon’s bottom line: Fiscal negligence of this magnitude is just extraordinary for Virginia, and it raises all sorts of questions.

First, is this incompetence unique to Petersburg, or is it widespread and Petersburg is just the first to “blow up,” as Vice Mayor Parham put it? The situation calls to mind the chronic inability of the city of Richmond to complete its Comprehensive Annual Financial Report, which suggests that at least one other jurisdiction’s finances are in disarray. If I were a resident of the City of Richmond, I would be very concerned.

Second, Petersburg apparently used a number of tricks to hide the deficit, which allowed liabilities to build up unbeknownst to elected officials. Stretching out payments to vendors is a classic — Illinois is notorious for the late payment of its bills, incurring more than $900 million in late payment interest over six years. Petersburg apparently did the same thing on a smaller scale. How many other Virginia jurisdictions are slow-paying their vendors?

Third, what can be done when a deficit this large has built up? Petersburg, a jurisdiction of about 32,500 people, is already down on its luck. The city has a hollowed out economy, a large population of poor minorities, and one of the worst-performing school systems in the state. Its challenges are immense. Going into drastic budget-cutting mode can only make matters worse. For now, city officials seem determined to take drastic action to get their fiscal affairs in order. But the task will be painful. Which brings us to the fourth question…

Fourth, what happens from a constitutional perspective if a jurisdiction runs a deficit? Are there any sanctions? Or is the requirement to balance budgets every year merely aspirational — desirable but not mandated? What provisions are there for the state to step in? Who initiates the process — the governor or the General Assembly? We’d better get answers because my guess is that the problem is not going to go away.

The Hidden Risk in Money Market Funds, and What It Means for Virginia

Cranky old man... or seer of the future?

Cranky old man… or seer of the future?

by James A. Bacon

I’m sure many readers are tired of hearing my jeremiads about excess debt, fiscal unsustainability, and the necessity of re-engineering Virginia institutions to survive the inevitable reckoning. Well, too bad. The global economy is severely out of balance, Virginia is part of that economy, and we will suffer the consequences when the world’s 21st century experiment with fiscal and monetary perpetual motion machines collapses. State and local polities that prepare for the inevitable storm will be in a better position to ride it out.

Bacon’s Rebellion has explored the unintended consequences of the Federal Reserve Bank’s policy of monetary easing, which has been magnified by comparable policies of monetary easing and reckless credit creation in the European Union, China and Japan. While near-zero interest rates benefit the world’s largest debtor, the United States federal government, it punishes savers and the institutions that serve them. Thus, the Social Security and Medicare trust funds are generating lower income from their surpluses, leading to premature depletion. Insurance companies are earning less on their capital, causing them to increase premiums. The rate of return for pension funds are earning less money, compelling corporations and governments to bolster their contributions.

Even money market fund are affected. A new study published by the National Bureau of Economic Research, “The Unintended Consequences of the Zero Lower Bound Policy,” has found that zero-interest rate policies create problems for savers who park their cash in seemingly safe money market funds. In an effort to deliver non-negative net returns to their investors, portfolio managers have not only reduced expenses charged to investors but chased higher yields by taking bigger risks.

That money market fund you think is a safe and stable repository for your cash? It may not be as safe and stable as you think. Not only is the yield approaching zero, but you may be shouldering risks you didn’t know existed. What’s worse:

Although our empirical results speak mostly to one part of financial markets, we want to emphasize that the effects we document are not necessarily limited to [the] money fund industry only. The reaching-for-yield phenomenon has been observed in other markets: for example, an average insurance company has shifted its assets toward riskier equity holdings, reaching the level of equity exposure of almost 20% in 2014. Similarly, pension funds expanded their holdings into more than 60% equity, away from typically held bonds. More work is needed to better understand the transmission mechanisms underlying the effects of the zero lower bound monetary policy on the stability of financial markets.

Just as generals are said to fight the last war, economic policy makers fight the last recession. Just as the masters of the universe in Washington, D.C. pursue policies to prevent a repeat of what they failed to foresee in 2007, they are blind to the extraordinary leverage built into the global economy, the linkages between sectors, and the mechanisms by which defaults in one corner of the globe will spread panic and chaos to other parts of the globe.

The best way for state and local lawmakers to insulate Virginia and its communities is (a) to curtail borrowing and (b) stop creating new long-term obligations that cannot be readily pared back. That’s not to say that we should cease borrowing altogether or refuse to launch any new programs, but it is to say that we live in times of great volatility and unpredictability and we should set higher standards for incurring any new liability.

Chicago on the James?

richmond_skylineby James A. Bacon

As if the City of Richmond didn’t have enough problems, now tensions are erupting between the executive director, board of trustees, and members of the city pension fund’s investment advisory committee. Based on the account by Michael Martz at the Richmond Times-Dispatch, the rancorous relations between pension director Leo F. Griffin and members of the investment advisory committee might have originated over policy but have now gotten personal.

The underlying issue appears to be over who should control the pension’s investment decisions. For years the investment advisory committee set policy in lieu of hiring a high-priced chief investment officer. But Griffin, who took on his post three years ago, allegedly has been working behind the committee’s back to assume control of rebalancing the system’s investment portfolio and making other investment decisions, while blocking the flow of information to committee members. In effect, Griffin is alleged to be changing the governance model of the pension fund without a serious discussion by the board.

Like most Richmonders, I had never heard of the Richmond Retirement System. I assumed that the Virginia Retirement System ran the city’s pensions. But, no, the city’s $540 million fund is responsible for paying the retirement benefits of nearly 10,000 retired and current city employees.

funding_progressThis fracas follows on the heels of a proposal by Richmond Mayor Dwight Jones earlier this week to raise taxes and borrow $580 million over the next ten years to fix the city’s derelict public school buildings and meet other capital needs approaching $1.5 billion. The two sets of issues are linked because, it turns out, city pensions are only 63.5% funded, and the unfunded liability amounts to $310 million. As seen in the “Schedule of Funding Progress,” the city has made only marginal progress during the past seven years of economic expansion to restore the pension to the fully funded position it had in 2000.

In reading the pension fund’s 2015 Comprehensive Annual Financial Report, I see that the pension fund could be even more fragile than it appears from those numbers. When calculating its unfunded liabilities, pension managers assume that the fund’s assets will generate an annualized rate of return of 7.5% over the long run. By contrast, the Virginia Retirement System assumes a “discount rate” of only 7.0%. Some pension observers say that, in an era of persistent, near-zero interest rates, the discount rate should be even lower.

The discount rate used by municipal pension funds has political ramifications. A higher rate assumes greater investment returns, which reduces the funds the City of Richmond has to contribute each year to support the pension. But if actual performance falls short, the city will have to increase its annual payout, much as the General Assembly has done in recent years to shore up state pensions.

Fiscally speaking, we live in perilous times. We fantasize that we’ll always be able to muddle along. Then along comes Puerto Rico, which shows how dysfunctional our political system can get when managing long-term debt. Closer to home we can observe the political turmoil created when Illinois and Chicago, a state and city with massive unfunded pension obligations, struggle to avoid becoming the next Puerto Rico.

The City of Richmond is an awesome place and, economically speaking, has more going for it than any time in 30 or 40 years. But weak finances may be its Achilles heel.

Virginia Procurement Process Needs Reform

Complex projects from transportation to IT need risk management.

Complex projects from transportation to IT need risk management.

by James A. Bacon

The Commonwealth of Virginia needs to reform its procedures for contracting and administering billions of dollars of contracts, the Joint Legislative Audit and Review Commission (JLARC) has found in a new study.

In 2015 Virginia spent more than $6 billion through contracts, including for transportation projects, information technology, and building construction, noted JLARC. The process for managing the contracts is decentralized, with each agency handling its own work. State procurement staff are insufficiently schooled in risk management, and the state pays insufficient attention to monitoring and enforcing the contracts.

Even though contracts account for a significant portion of state spending, the state does not maintain comprehensive information on how contracts are performing. This prevents individual agencies and state-level decision makers from assessing whether their investments in individual contracts have provided value to the state. It also prevents agency staff from avoiding problematic vendors and developing and administering contracts in a way that takes into account previous “lessons learned” at their own agency or other agencies.

JLARC embarked upon the study in 2014 after the maladministration of the U.S. 460 superhighway project resulted in a $250 million loss to the state without any ground being cleared or asphalt laid. The state has been embroiled in other high–profile contractual disputes involving the provision of IT services and the explosion of a rocket at the Wallop’s Island space port.

“Risk management isn’t on the radar,” said Tracey Smith, study project leader, in a presentation to lawmakers Monday. Writes Michael Martz in the Richmond Times-Dispatch:

Legislators on the commission, particularly the lawyers, expressed shock that state agencies routinely enter into big, often risky contracts without legal advice from the Attorney General’s Office.

Del. David B. Albo, R-Fairfax, chairman of the House Courts of Justice Committee, called it “ludicrous” that agencies would draft major contracts without lawyers.

Bacon’s bottom line: State procurement laws reformed corrupt practices of an era in which politicians routinely gave contracts to their friends and supporters. The laws emphasized putting contracts out for competitive bids, procuring the lowest price and making the process transparent. The nature of business has changed over the decades, but with one important exception, the state procurement process has not kept pace.

Unless you’re procuring commodity products like office supplies or janitorial services, the lowest price is almost meaningless. The quality of work is often a critical but hard-to-define variable. Another is the allocation of risk — who pays when something goes wrong? Identifying and allocating risk is why we have lawyers. Sometimes the lawyers get carried away, picking at nits, but they perform a critical business function because things often do go wrong. Accidents occur. Disagreement arise. Unanticipated events throw everyone for a loop.

Government employees are not trained to think about risk. Politicians aren’t inclined to worry about risks that might explode on someone else’s watch.But as contracts grow increasingly complex with the trends to outsourcing and public-private partnerships, the allocation of risk can be as important as the price.

There is one outfit in state government that has been acquiring the competencies to engage in sophisticated risk management — the Office of Public-Private Partnerships (OP3), which oversees contracts for some of the state’s most complex transportation projects. As I recall, OP3 raised red flags relating to the infamous U.S. 460 project but its warnings were overruled for political reasons. The office has developed a network of contacts it can call upon to supplement the skills of its in-house staff. Virginia’s Secretary of Technology and the head of the Department of General Services should have comparable capabilities.

Good management doesn’t excite the electorate like, say, banning guns or restricting bathroom options for transexuals. But billions of taxpayer dollars are at stake. And that makes it a sexy topic for me.

War on the Poor Update: the Attack on Payday Lending


Debra Grant. Photo credit: Virginian-Pilot

by James A. Bacon

Once again the war drums are pounding as do-gooders unleash a wave of publicity against payday lending. A local case in point is a guest column in the Virginian-Pilot under the name of Debra Grant, who told her personal story. This is how it started:

I had a relative who needed to borrow $150, so I took out a payday loan to help. Every month, I would have to roll the loan over until the next month, for a $37 fee.

It took great sacrifice, but I was eventually able to pay off the loan. Soon after, another relative needed my help again, and I took out a loan of $300, plus an $87 fee every time I rolled that one over.

I was finally able to pay that one off — and then another family member needed help. Seeing no other alternatives, some of my relatives took out a car title loan, missed a payment and lost their car. Without a car, our whole family suffered. As a single mother and breadwinner for my family, I thought I had no other choice.

Any person of limited means who extends so much help to her relatives deserves kudos for her caring and generosity, and nothing I say here is meant to disparage Ms. Grant personally. But I have to question her logic.

Drawing upon her personal experience and her association with Virginia Organizing and the Virginia Poverty Law Center, Grant advocates two things: (1) support for the Bank On program, which teaches financial responsibility and runs a matched savings incentive program, and (2) support for a Consumer Financial Protection Bureau initiative to institute new underwriting rules that would reduce payday lending. The first expands options available to poor people, and is to be lauded. The second narrows the options available to the poor, and should be condemned.

Let’s parse what happened to Grant. She took out a payday loan on behalf of a relative. No one held a gun to her head and made her take out the loan. She could have availed herself of any number of available alternatives.

Er, she did have alternatives, didn’t she? What are you telling me — she didn’t? She couldn’t take out a bank loan? Perhaps that has something to do with the fact that over-regulated banks operating in a near-zero interest rate environment can’t make money on small personal loans and have largely gotten out of the business. How about credit cards? Grant doesn’t tell us, but it seems likely that she either didn’t have any credit cards or had maxed out her credit.

How about taking out a car title loan? Grant’s relatives did take out a car loan, and look what happened — they missed a payment and had the car repossessed. That didn’t turn out so well.

The fact is, there are no attractive borrowing alternatives for poor people (and people with bad credit). That dismal reality reflects the country’s super low interest rate environment, the high cost of government regulation, the high cost of administering small uncollateralized loans, and the high risk of default by people with poor credit. Rather than address the underlying causes, do-gooders respond by blaming one of the few groups willing to extend credit to the poor by excoriating them and removing one of the few options, as bad as it is, available to the poor.

According to Grant, research by the Pew Charitable Trust shows that if payday loans weren’t available, 81% of borrowers would cut expenses. Insofar as cutting expenses is possible for poor people, that sounds like something they should do whether they have access to payday lenders or not!

Grant also cites the work of the Matched Savings Incentive Program, in which consumers deposit money in a savings account and community-funded grants match the deposit to double the savings. “This helps create a cushion for low-income people to use instead of payday loans in an emergency,” she writes. “Instead of trying to pay off-high interest loans, Bank On customers can save money and even earn a little interest of their own.”

Ah, teaching personal thrift and responsibility. What a great idea. Instead of spending time and energy shutting down payday lenders, maybe consumer advocates should focus less on putting payday lenders out of business by regulatory fiat and more on out-competing them by providing better terms and superior service. That’s a revolutionary idea!

Virginia Ranks 19th for Fiscal Condition

Graphic credit: Mercatus Center

Graphic credit: Mercatus Center

Virginia’s state finances are nothing to brag about, according to data contained in the Mercatus Center’s 2016 edition of “Ranking the States by Fiscal Condition.” The Old Dominion gets below average scores for cash solvency (cash on hand to pay short-term bills), and middle-of-the-road scores for budget solvency and long-run solvency. The state scores above average in trust fund solvency (pension funds and long-term debt), and 5th best in service-level solvency (the ability to raise taxes and increase spending without damaging the economy). Summarizes the Virginia state profile:

Total liabilities are 30 percent of total assets. Total debt is $6.86 billion. Unfunded pension liabilities are $87.66 billion, and other postemployment benefits (OPEB) are $5.19 billion. These three liabilities are equal to 24 percent of total state personal income.

Virginians tend to think that the state’s fiscal condition is fine as long as the Commonwealth maintains a AAA bond rating. Mercatus, which admittedly is funded by the Koch brothers but has no particular ax to grind against Virginia, suggests otherwise.