Category Archives: Government workers and pensions

Petersburg’s Other Fiasco

petersburg_city_hall

Petersburg City Hall

by James A. Bacon

Poor Petersburg. The economically depressed Southside city of 32,000 serves as a vivid warning of just about everything that can go wrong for a local government in Virginia. Not only is the city running a massive General Fund budget deficit, it is falling millions of dollars behind in the collection of revenues for its water system.

The heart of the problem is a botched rollout of a meter-reading system that was pitched as a low-risk way for the city to overhaul its aging infrastructure without a tax increase. The city contracted with systems-controls giant Johnson Controls to install meters that would transmit usage figures electronically, obviating the need to send employees door to door to collect the numbers. Supposedly, the overhaul would pay for itself through more accurate readings and personnel reductions.

But something went wrong. First, the $3.9 million project experienced overruns of $1.4 million, bringing the final cost to $5.3 million. Second, it didn’t work properly. A year and a half later, surely enough time to work out the kinks, some people are reporting that they haven’t received water bills for months, while others say they have been billed too often, sometimes to the tune of thousands of dollars.

City officials blame the vendor, Johnson Controls. Yesterday City Council voted to hire an outside attorney to pursue litigation against the company to seek remedy, and has asked for assistance from the Virginia State Police.

While it is possible that Johnson Controls bungled the installation of the meters (Full disclosure: I own 400 shares of Johnson Controls stock), the City of Petersburg’s track record and evidence in the Richmond Times-Dispatch’s reporting of the story suggest that the city itself might have contributed to the problem.

First, the article mentions that more than a fifth of the cost overrun came from a $300,000 change order the year after the contract signed. No mention of whether there might have been other change orders.

Second, the contract was negotiated by then-City Manager William E. Johnson III, under whose watch the city’s General Fund plunged into such chaos that City Council fired him. If his oversight of city books was dismal, the same might well have been true for his oversight of the contract.

Third, it’s not clear from published accounts that the billing problem can even be traced to the meters. Meters report water usage; they do not send out billing statements. Perhaps the billing problem arose from the integration of the meters with the billing process. If so, responsibility gets murky. A successful launch of the system would have required collaboration between Johnson Controls and the city administration.

Fourth, Mayor W. Howard Myers admitted that he and other council members were unaware that the project had experienced cost overruns, or that city administrators had approved Johnson Controls’ work months after the system went live and residents had began complaining about faulty billing. This is the same mayor who declared, after being informed that the city had closed the year with a 20% deficit, “I had no idea. I’m like, wow, where is this coming from?” This is not a mayor who is on top of things, and if he blames the vendor for the mayhem, there is no reason to take his appraisal very seriously.

Fifth, in February, Myers hired Paul Goldman, law partner of former state Del. Joseph Morrissey, to investigate the matter at the rate of $330 per hour. But the city terminated the contract before Goldman could complete his job — more money down the drain. (I would conjecture that Goldman couldn’t finish the job because he found the matter to be an indecipherable morass that would take far more time than anyone had initially imagined.)

The business of government is complicated — and getting ever more so. I admire the everyday citizens who dedicate their time to running for office, helping constituents and overseeing government. They don’t get paid enough for what they do. But many of them, especially in smaller jurisdictions, are ill equipped to master the complexities of the job. Frankly, it’s a wonder we don’t see more fiascos like Petersburg’s.

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]baconsrebellion.com.

The Seven Percent Assumption

U.S. Fed Funds Rate. Source: Trading Economics

U.S. Fed Funds Rate. Source: Trading Economics

by James A. Bacon

The Virginia Retirement System earned an estimated 1.5% return on its $68 billion portfolio of investments last year, spurring discussion over whether state and local governments are contributing enough to maintain the long-term financial integrity of the retirement plan for Virginia school teachers and government employees.

For purposes of calculating the system’s financial integrity, VRS officials assume that the return on investment will average 7% annually over the long term — an assumption that is more conservative than many government pension plans. But is it conservative enough? After earning 1.5% the past year and only 4.7% the year before, is the 7% assumption still defensible?

VRS Chief Investment Officer Ronald D. Schmitz assured lawmakers that it is. “Over a 20-year horizon, we’re comfortable with a 7 percent return,” he said at the first meeting of the Virginia Commission on Employee Retirement Security and Pension Reform created at the urging of House Speaker William J. Howell, R-Stafford.

Getting that assumption right is no easy task. Investment returns fluctuate widely from year to year, losing money one year and then making spectacular gains the next. Investment performance varies considerably, depending on the time frame used. According to the VRS 2015 report issued a year ago (the 2016 report is not yet available), annualized investment returns averaged 10.6% over three years, 10.3% over five years, but only 6.7% over ten years.

The question is whether the past twenty or thirty years is a useful yardstick for predicting the next twenty or thirty years. The United States has benefited from a 35-year bond market boom, over which time interest rates have trended consistently lower to the near-zero rate that it has held steady for the past seven years (as seen in the graph above). All other things being equal, lower interest rates push stock and bond prices higher. Consequently, U.S. pension funds have enjoyed 35 years of rising prices for stocks and bonds (with short interludes of falling prices) in their portfolios. But as interest rates approach zero, it is impossible under conventional economic theory for them to drop any lower. Perhaps, as we are seeing in some places around the world, it is possible for central banks to engineer below-zero interest rates, but we have no historical experience by which to judge how economies, bond markets and stock markets will perform under such circumstances.

While no one knows with any certainty where interest rates, bond prices and stock prices are headed — perhaps changes in the global economy have repealed the laws of classical economics, and below-zero interest rates will do no harm — it is safe to say that a reversion of interest rates to historical norms would be disastrous for stock and bond prices, indeed asset prices of all kinds. And it is reasonable to say that there is at least a risk that such a reversion could take place. Whether such a reversion to historical norms takes places or not, is indisputable say that central banks cannot replicate the past 35 years of falling interest rates, and that the primary driving force behind the bull market era of the past 35 years has run out of steam.

It is almost inconceivable that the future 35 years of investment returns will match that of the previous 35 years, one of the great bull market eras of U.S. financial history. Therefore, the VRS (and other all pension funds) are reckless to assume that recent history will be any guide at all to future performance. Stretch out the frame of analysis for 50 years, 100 years, or longer, and the case for equities and bonds may be as favorable as ever. But the VRS cannot look out 100 years. Baby Boomers in the state workforce are retiring in large numbers now: One quarter of the state workforce will be eligible to retire within five years. Virginia will need the money in the next 20 to 30 years.

At least one state official in a position of responsibility, House Appropriations Chairman S. Chris Jones, R-Suffolk, is worried. As the Times-Dispatch quoted him: “I’m thinking that 7 percent might be aggressive at the end of the day.”

Jones is absolutely right. The VRS needs to lower its assumption, and the General Assembly needs to allocate more money to the VRS than in the past. Such an action surely will be painful, given all of Virginia’s other budgetary constraints. But Virginians will be grateful that the legislature acted with foresight when investment returns tank. It won’t get easier to do later what we should be doing now.

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.

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.

Questions about Bidding War for FBI HQ

Rendering of proposed new FBI headquarters

Rendering of proposed new FBI headquarters

There’s a bidding war between Virginia and Maryland to snag a planned, 2.1 million-square-foot Federal Bureau of Investigation headquarters campus. Maryland Governor Larry Hogan is in for $317 million in state and local funds, according to the Washington Business Journal. Governor Terry McAuliffe is in for $120 million. In both cases most of the money would be applied to make transportation improvements near the proposed sites.

The Virginia location would be in the Springfield area, and the funds would be used to mitigate the transportation impact of relocating thousands of employees from Washington, D.C., to Northern Virginia. There are many interesting angles to this story:

  • Would the $120 million McAuliffe proposes spending benefit mainly the FBI and its employees, or would the contemplated improvements benefit others in the Springfield area as well?
  • Where would the money come from, and what alternate uses are there for that money? What other projects would be deferred?
  • How would the move alter commuting patterns? Would a significant number of employees be “reverse commuting” from Washington, D.C., to Virginia? Will the relocation ease or stress Northern Virginia’s transportation problems?
  • What would be the economic benefits of bringing the FBI to Virginia? Presumably, as a federal facility, the headquarters would generate no real estate tax revenues. Would a Virginia location inspire many FBI employees to move to Virginia — and, given the lack of property tax revenue, would they represent a net gain to the state and local governments and their taxpayers?
  • Who owns the Springfield site for the new headquarters? How much would the property owner stand to benefit from this deal and resulting investment in transportation improvements?

— JAB

How Not to Run a City

Will somebody please help this city?

Will somebody please help this city?

The bad news just keeps getting worse for the City of Richmond: An audit released yesterday of 98,000 transactions valued at $2 billion found significant delays to vendors, insufficient and inconsistent documentation and unrecorded wire transfers, the Richmond Times-Dispatch reports. That report was presented alongside a second report, an assessment of Richmond’s fiscal sustainability that found that the city collects and spends 1 1/2 times the revenue per capita of benchmark localities.

“I look at it and say, ‘My gosh, we have a lot of inefficiencies here,’” said Ramon Brinkman, a member of the audit committee. “What could you save by reducing some of the expenses and give a little money back to the taxpayer?”

Richmond is an awesome city. It has wonderful people, great neighborhoods, historical architecture, vibrant businesses, a rich history, a multitude of museums, theaters, art galleries and cultural institutions, and one of the most beautiful rivers in the country. But it has a wasteful and inefficient city government that taxes too much and delivers too little in the way of municipal services.

Part of the city’s financial woes can be attributed to a flawed implementation of an $18  million RAPIDS financial system in 2013, which, according to the city’s deputy chief administrative officer, still suffers from “severe system limitations.” Another problem is the extensive staff turnover, insufficient training and heavy reliance upon inexperienced temps in the accounts receivable office. Those maladies, it would seem, are a reflection of poor management. Of course, there has been high turnover in senior staff positions as well, prompted no doubt by the frustrations encountered with the dismal organizational culture. Thus, the serpent swallows its tail in a never-ending loop of dysfunction.

Richmond has so much potential, but it will never live up to that potential until the city administration gets its act together. What will it take to make that happen? A mayor who makes organizational reform the unremitting focus of his or her attention over all other priorities.

— JAB