Tag Archives: Boomergeddon

What Do We Do about Petersburg?

by James A. Bacon

More bad news from Petersburg: The Southside city of 32,000 souls and 600 government employees has fallen more than 60 days behind on $2.3 million in pension payments. That development was reported by the Virginia Retirement System in a letter to state legislators, as required under a law that went into force this month.

The city has been forwarding the 5% payments deducted from employee paychecks but still owes employer contributions dating back to November 2015, with the exception of May, when it managed to make a payment, reports the Richmond Times-Dispatch. Petersburg closed the 2015 fiscal year with a $17 million budget deficit, roughly 20% of revenue, and, despite cutting the pay of city employees, has yet to devise a plan for closing the gap in the current fiscal year.

Petersburg is the only locality in Virginia that is delinquent on its pension payments, said VRS spokeswoman Jeanne Chenault. The city, she added, is “committed to paying those [outstanding] contributions and they are working on a plan to do so.”

Bacon’s bottom line: I don’t mean to beat up on Petersburg, which just may be the worst hard-luck case in Virginia. But the city’s travails are unprecedented in modern times. I don’t recall anything comparable in my 40-year journalism career. I wouldn’t be surprised if closing the fiscal year with a massive deficit in defiance of state constitutional requirements for a balanced budget has no parallel since the Great Depression.

The first big question in my mind: Is this an aberration due to one-time factors unlikely ever to be repeated? Or are Petersburg’s woes symptomatic of a deeper malaise throughout Virginia? Have other localities, particularly those with depressed economies, “balanced” their budgets by deferring maintenance, slow-paying creditors or engaging in other accounting tricks? I have written about the small city of Buena Vista, which defaulted on a $9.2 million bond issue to pay for a municipal golf course, as a fiscal canary in the coal mine. (Speaking of coal mines, I’d be amazed if the coal-producing counties of Southwest Virginia, having seen their primary industry go up in soot, weren’t experiencing serious fiscal stress.)

Here’s the next question: What we do about Petersburg? By “we” I mean the citizens and elected officials of Virginia who represent us. Should we let Petersburg figure things out by itself? What if it can’t? What if the politics are so dysfunctional, the underlying economy is so weak, or the choices are so hard that elected officials can’t manage the task of balancing the budget?

Do we just look the other way? Do we pretend that Virginia’s constitution doesn’t required balanced budgets? If so, do we create a moral hazard that encourages other localities to say, what the heck, Petersburg got away with it, maybe we can, too? Or, conversely, do we bail out Petersburg? And if we do, what concessions do we extract in return?

It is no exaggeration to refer to Petersburg as “Detroit on the Appomattox,” because, when there is a 20% gap between revenue and expenses, there is a significant possibility that the city can never climb out of the hole it has dug for itself. If that happens, Virginia will face the same kinds of unpalatable decisions that Michigan did with Detroit and Flint. I don’t know if Virginia even has a legal structure to deal with such a situation. Would we put Petersburg into receivership and, overriding normal democratic institutions, appoint someone to run the place?

So far, there has been no public response from Governor Terry McAuliffe. There hasn’t been much of a response from the General Assembly either, although the law requiring the VRS to report localities that fail to make their pension payments did originate from the legislature. At least someone is paying attention.

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.

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.

Boomergeddon Update: Medicare HI

Image credit: 2016 Medicare Trust Fund Board of Trustees annual report

Image credit: 2016 Medicare Trust Fund Board of Trustees annual report

by James A. Bacon

The Hospital Insurance Trust Fund, one of the four major components of the Medicare program, will run out of money in 2028 — two years earlier than previously projected. That appraisal comes from the Medicare Board of Trustees, which, the last time I checked, is not funded by the Koch Brothers.

The news of the accelerating structural crisis in the nation’s health care safety net stirred only the slightest of ripples in the news media, which buried the story deeper than an Iranian nuclear research facility. One would think the news to be of more than passing interest to the program’s 55.3 million recipients and thus to major media, but the nation’s elite journalists are so obsessed with the latest Tourettes-like tweets by Donald Trump that they cannot bestir themselves to ask the presidential candidates how they intend to preserve the social safety net.

This news comes soon after Congress and the Obama administration avoided the impending depletion of Social Security’s Disability Insurance (DI) trust fund only through the expediency of folding it into the Old Age Survivors Insurance trust fund, thus accelerating by a year the impending breakdown of both by 2034.

Medicare and Social Security will not collapse when the trust funds run out, but the gap between spending and revenues will have to be covered either by a hike in taxes, a cut in benefits or an increase in government borrowing, each of which would be grievous in its own way. The magnitude of this gap, caused by the retirement of the Baby Boomer generation, will precipitate the nation’s greatest economic crisis since the Great Depression — what I call Boomergeddon.

And to what do we owe the accelerating crack-up of Medicare’s hospital insurance program (often referred to as Medicare Part A). Not to accelerating health care costs, ironically enough. “Since 2008, U.S. national health expenditure (NHE) growth has been below historical averages, despite having accelerated in 2014 mainly due to insurance expansions,” state the Medicare trustees.

But having said what the problem is not, the Medicare trustees fail to explain what it was. That is understandable, given the politically sensitive nature of what appears to be going wrong — weak job growth, the low labor participation rates, and less-than-expected payroll revenues. After real-world economic performance has under-performed forecast economic forecast every year for seven years running, the Obama administration appears to be adjusting its long-range forecasts for purposes of long-term budgetary planning.

Nobody wants to admit, least of all in an election year, that economic growth and job creation stink. But that is precisely what underlies the rush to ruin of Medicare, Social Security and the federal budget deficit generally. A weak economy means weak revenue.

Bacon’s bottom line. Boomergeddon is running right on track. The Congressional Budget Office projects a $534 billion deficit this year. (We don’t hear about that number from our journalistic elite either.) Were it not for monetary easing, ultra-low interest rates and multi-billion remittances from the Federal Reserve Bank, the deficit would be far bigger. In any case, CBO projects a cumulative $9.4 trillion in deficits, to be added to the existing $19 trillion national debt. The U.S. is on track to carry World War II levels of borrowing by the mid-2030s, the big difference being that in 1945 the war was over and the nation could demobilize its massive military, while in 2035 the nation will not be in a position to demobilize its social safety net.

Meanwhile, the structural budget deficit of the United States must be viewed in the context of chronic deficits of the European countries and Japan, and the massive over-leveraging of the Chinese economy. As McKinsey & Co. pointed out in a 2015 report, the global economy has added $57 trillion since the Great Recession; rather than de-leveraging, virtually every major nation has doubled down with increased borrowing. Systemic risk has never been greater. All it takes is a black swan event, and financial chaos will rip through the global economy, transmitted by financial linkages that public policy makers don’t even know exist. The Bear Stearns/Lehman Brothers financial panic will be a picnic by comparison.

The question, as always, for Virginians is this: How do we as citizens and taxpayers protect ourselves from the inevitable financial reckoning? Borrowing more is not an answer. (Somebody please tell Richmond Mayor Dwight Jones, who proposes raising the city’s debt limit in order to borrow $580 million more in bonds over the next 10 years.) Building new transportation mega-projects that require subsidies indefinitely into the future is not an answer. Expanding social welfare programs like Medicaid is not an answer. The storm is coming, and we must prepare.

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.