Category Archives: Finance (government)

Chesterfield’s $50 Million Fiscal Landmine

Posted on October 17, 2018 by | 21 comments

Virginia and its local governments are constitutionally obligated to balance their budgets ever year. But as I have repeatedly pointed out, there are many ways to duck that obligation. One is to rack up unfunded pension liabilities. Another is to under-fund maintenance.

Today we discover that even a highly reputed county with a AAA bond rating can engage in fiscal sleight-of-hand. From today’s Richmond Times-Dispatch: “Chesterfield County needs $50 million for school maintenance problems that could keep kids out of schools if they are not addressed soon.”

The county issued $300 million in bonds after a voter-approved referendum in 2013 to replace and renovate county schools. Apparently, there’s only $13 million left for fixing facilities — far short of what’s needed.

Dan Champion, a program manager for the firm EMG, said there are schools across the county with serious electrical, air conditioning and roofing problems. If not adequately addressed over the next two decades, the cost of the repairs could rise to nearly $1 billion, he said.

The Times-Dispatch article delves into the riff between the county administration and the school system. There’s a lot of finger-pointing going on. Regardless of who is to blame, it is clear that Chesterfield schools have run $50 million in maintenance deficits over the years. And now the county is on notice that, absent corrective action, the maintenance deficit could reach $1 billion over 20 years.

How many other Virginia school districts have engaged in deficit maintenance spending? How many other agencies and localities have piled up unfunded liabilities for deteriorating roads, highways, bridges, mass transit systems, water and sewer plants and pipelines, libraries, administration buildings, courthouses, jails, prisons, municipal gas systems, IT systems, automotive fleets, and the rest of the state’s vast infrastructure?

Administrators and elected officials have no interest in knowing the truth that might make them look bad. So, nobody tracks this information until it becomes an explosive issue. What’s that noise we hear in Chesterfield? Kaboom!

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Posted in Budgets, Education (K-12), Finance (government), Infrastructure

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Oops, Where Did that $3-4 Million Deficit Come From?

Posted on October 15, 2018 by | 8 comments

The idea behind the Commonwealth Center for Advanced Manufacturing (CCAM) is fantastic: Create a facility where Virginia manufacturers and universities can collaborate on advanced-manufacturing research projects that all participants can share. Research staff for the Prince George County-based facility are expert in everything from “vertical diffusion furnaces” and “robot arm-based automation cells” to “thermal spray coating” and “corrosion crack healing,” and they conduct about $7 million a year in research.

Just one problem: The program is operating at an annual deficit of between $3 million and $4 million a year. Debts include $2 million in unpaid rent to the University of Virginia Foundation and a tapped-out bank credit line, according to the Richmond Times-Dispatch.

Said Secretary of Finance Aubrey Layne: “They’ve got to put together a business plan that makes some sense.”

The Center has procured state and federal funding commitments to build a $12.6 million Advanced Manufacturing Apprentice Academy next door. But state officials, reports the T-D, say they won’t release $9 million in bond money planned for construction of the academy without an answer to the center’s financial questions. Said Layne: “That is not going to happen until this issue is solved.”

Bacon’s bottom line: As I have ranted and raved and inveighed and fulminated, Virginians have no idea how many fiscal land mines are out there. Yes, the Commonwealth has a AAA bond rating (although we have skirted on the edge of a downgrade), but no one has tallied up the long-term commitments, unfunded long-term liabilities, maintenance backlogs, and fiscal tricks of all the local governments and independent authorities set up to serve the interests of the Commonwealth.

After the Petersburg fiscal meltdown, the General Assembly began monitoring the health of local governments, looking for early warning sides of impending financial apocalypse — a big step forward. But no one is tracking dozens of non-governmental entities. Only a couple of months ago, for instance, was the public made aware of a $3.5 billion unfunded pension liability at the Washington Metro mass transit system serving Northern Virginia. Now we learn that CCAM is running a big budget deficit and racking up long-term debt.

The federal government has accumulated a $21 trillion national debt, and soon will be adding to it at a rate of $1 trillion a year — during an economic boom. The Medicare trust fund is projected to run out in 2026. The Social Security trust fund is expected to run out in 2034. Uncle Sam will never collect a big chunk of the $1.3 trillion in student loan debt outstanding, and taxpayers will have to pick up the tab. Meanwhile, states like Illinois and New Jersey are one sharp recession away from fiscal collapse.

As Boomergeddon looms, Virginia traipses merrily along, most recently creating a new Medicaid-expansion entitlement, with no clear idea of its overall fiscal condition. Our lawmakers look no more than two years ahead — the time horizon dictated by the biennial state budget. Although they are attuned to the necessity of maintaining a AAA state bond rating, the credit-worthiness of state bonds is just one piece of the whole. The credit-worthiness of Virginia’s counties, cities and towns is another piece. The credit-worthiness of our state universities is yet another. The credit-worthiness of a plethora of independent authorities is still another. No one, to my knowledge, has analyzed all the pieces as a whole and stress-tested the system. Until we do, we’re flying blind. It is foolhardy to pretend otherwise.

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Posted in Budgets, Economic development, Finance (government)

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Virginia Ranks 13th Best in Fiscal Condition

News - Posted on October 9, 2018 by | Leave a comment

Ranking of Fiscal Condition, FY 2016. Source: Mercatus Center.

The Commonwealth of Virginia’s fiscal condition ranked 13th among the 50 states in FY 2016, according to data in the Mercatus Center’s “Ranking the States by Fiscal Condition” report released today.

The Mercatus methodology incorporates 13 financial indicators falling in five buckets: cash solvency, budget solvency, long-run solvency, service-level solvency, and trust fund solvency.

Here are the key statistics Mercatus considered:

There is a significant time lag in the reporting and analysis of the data — this is FY 2016 data, and Virginia is now in FY 2019. So, the ranking reflects the state’s fiscal performance during the McAuliffe administration, not the Northam administration.

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Hurricanes, Risk, and Fiscal Collapse

Posted on October 1, 2018 by | 10 comments

Graphic source: Wall Street Journal

John Rubino, publisher of Dollarcollapse.com, and I think a lot alike when it comes to the inevitable fiscal collapse of the United States. The country (indeed the globe) is riding high today on a giant credit bubble right now, but sooner or later the bubble will pop and the economy will crash. If you buy into my Boomergeddon theory — that the U.S. will experience massive social upheaval when federal and state governments are unable to maintain their commitments to core services and the social safety net — you might want to check his website for your daily frisson of fear.

I, like John, have been writing about the dangers lurking in states’ unfunded pension liabilities and the exploding student loan liabilities that are undermining our institutions of higher education. I’d urge John to give more coverage to the issue of hidden deficit spending in the form of growing infrastructure-maintenance backlogs. (Read the Strong Towns blog for a primer on state/local governments’ growth Ponzi schemes.) Meanwhile, in a recent post, John drives home a point to which I have given insufficient attention: the future cost of hurricanes.

Unlike unfunded pensions, student loan defaults and maintenance backlogs, upon which we can put reasonable figures, there is no way for Virginia to budget for hurricanes. The incidence of hurricane hits is relatively infrequent and highly random and the damages are so variable from storm to storm, that budgetary forecasts are a total crap shoot. But I think we can safely say three things about Virginia:

  1. Sooner or later, another large hurricane will hit Virginia;
  2. Subsidence and sea-level rise, which will occur even in the absence of global-warming scare scenarios, will magnify the impact of major storms;
  3. Continued development along the shorelines of the Atlantic Ocean and Chesapeake Bay will lead to more storm-related damage.

John is concerned about the prospect of a monster storm hitting a big city like Miami or New York and giving us “a trillion-dollar summer” that bankrupts major insurance companies, roils insurance markets, depletes federal flood insurance reserves and forces the U.S. government into another massive bail-out “just as federal deficits are exploding, public sector pensions are imploding, and student loans are defaulting en masse.”

I, too, worry that the federal government is headed for disaster. But as I observe the proceedings in Washington, D.C., I have written off the federal government. Our political culture in Washington is so dysfunctional, so toxic, so addicted to short-term political gain, that the federal government is beyond salvation. I don’t waste a lot of intellectual bandwidth wondering what might save Washington. Nothing can. But I would like to ensure that the Commonwealth of Virginia survives the wreckage. Some government entity will have to carry on when the federal government melts down, and state government is the only alternative.

But I worry about Virginia, too. As I blogged recently, we have no idea what governments and quasi-state agencies — from the Washington Metro to local economic development authorities — have piled up in long-term debt, unfunded pension liabilities, and maintenance backlogs, much less how vulnerable they are to the next economic downturn. Now, add the risk of damage from hurricanes to roads, bridges, railroads, water and sewer facilities, coal ash ponds, the electric grid, pipelines, and other infrastructure. How prepared are our state agencies and utilities to cope with a major disaster? What would the impact be on taxpayers and rate payers, what have we set aside in reserves?

In a word: How fiscally resilient is Virginia in the face of natural disaster? Puerto Rico showed how a hurricane can push a corrupt and mismanaged polity over the edge. Surely we’d hold up much better. But that assumes Uncle Sam can continue handing out billions of dollars in disaster relief and that insurance markets are functioning. No one knows. We live in ignorance at our peril.

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Posted in Budgets, Disaster planning, Federal, Finance (government)

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Has NoVa Finally Woken Up?

Commentary - Posted on September 28, 2018 by | 24 comments

VA-10.  State Senator Jennifer Wexton (D) hopes to unseat Congresswoman Barbara Comstock (R) in Virginia’s 10th Congressional District.  A typically gerrymandered Virginia district, the 10th stretches from inside the Capital Beltway to well west of Winchester.  As a resident of the 10th I watch the elections in that district closely.  This one is shaping up to be a doozy.  Far left Jennifer Wexton is running on an anti-Trump platform while trying to avoid taking a position on any issue relevant to the constituents she hopes to represent.  Meanwhile, Barbara Comstock is running as an embarrassed Republican who tries to avoid gazing east at the current occupant of the Oval Office.  Think Nelson Rockafeller in drag.  All in all I think Barbara Comstock has done a better job of explaining herself and focusing on issues that are relevant to her district.  One issue in particular stands out for me – the allegation that Wexton has sold out Northern Virginia during her time in the General Assembly.

Don’t get Wexton’ed.  Recent negative ads run by the National Republican Congressional Committee (presumably) on behalf of Barbara Comstock hit a point that hasn’t been hit before.  The ads call out Jennifer Wexton for her role in the General Assembly’s massive rip off of Northern Virginia.  The 30 second ads are punchy and direct.  One ad has a graphic that shows money raining out of NoVa into Richmond.  It cites high tolls and NoVa – only taxes.  Needless to say, Jennifer Wexton is the highlighted villain.  Another ad shows traffic jams and tolls in NoVa then cuts to a single car effortlessly driving down an otherwise empty road claiming, “The rest of the state rides for free.”  As far as I’m concerned, the ads are completely on target and finally call out the gutless NoVa politicians we have elected for selling out their constituents.

I wish I could drive I295.  For many people from Northern Virginia there certainly seems to be a vast sucking sound coming from the General Assembly in Richmond.  There also seems to be a two class system when it comes to a lot of things including transportation.  Take Richmond for example … the city, not the state government.  The OMB defines the greater Richmond area as comprising thirteen counties, including the principal cities of Richmond, Petersburg, Hopewell, and Colonial Heights. As of 2016, it had a population of 1,263,617.  Somehow, this qualifies the area for a 4 lane “beltway” called I295.  Meanwhile, the greater Washington area has a population of 6.1m as of 2016.  It also has a 4 lane beltway in NoVa.  An area with 4.7 times the population of Richmond somehow ends up with the same sized highway encircling it as Richmond gets?  And Jennifer Wexton thinks that’s all fine and dandy?  Comstock’s right – let’s not get Wexton’ed.

Thanks, Barbara.  Jennifer Wexton is hardly alone in selling out her constituents.  All 140 seats in the Virginia General Assembly are up for election in 2019 including every state politician claiming to represent Northern Virginia.  It’s high time that all of NoVa’s politicians are taken to task for selling out their constituents.  Hopefully these ads and others like them will continue to haunt the comfy re-election dreams of our political class in Northern Virginia.  If our politicians want to argue about their role in grifting NoVa the approach is easy … clearly and quantitatively document the amount of money taken by state and local government in NoVa and compare it to the amount of money spent by state and local government in NoVa.  Then … defend the difference.  I happen to know that a number of General Assembly members from NoVa read this blog (at least occasionally).  Any of you who read this – are you up for the challenge of demonstrating the fairness of your actions vis-a-vis inflows and outflows of money from NoVa?  I won’t hold my breath.

— Don Rippert

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Posted in Budgets, Commentary, Demographics, Elections, Finance (government), General Assembly, Politics, Taxes

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Virginia and the Next Global Debt Crisis

Posted on September 15, 2018 by | 12 comments

Ten years ago the Lehman Brothers debacle precipitated the financial meltdown we associate with the Great Recession, and the financial media are full of retrospectives. A key question is what lessons we learned from the epic failure. The main conclusion drawn, according to Daniel J. Arbess in the Wall Street Journal today, appears to be that the way to dig out of a debt-fueled financial crisis is to pile on more debt. But that doubles down on the original problem, he warns:

In the past decade, total global debt (sovereign, corporate and household) has spiked nearly 75%. This includes a doubling of sovereign debt, from $29 trillion to $60 trillion, according to a recent McKinsey report. Total corporate debt increased by 78% over the same decade, to $66 trillion. Bank loan volumes have been stable, although low-quality “covenant lite” loans have dominated. Bond markets have filled in, with nonfinancial bonds outstanding up 172%, from $4.3 trillion to $11.7 trillion. McKinsey says 40% of U.S. companies are rated one notch above “junk” or lower, and the Bank for International Settlements estimates 10% of legacy companies in the developed world are “zombies,” meaning earnings before interest and taxes don’t cover interest expenses.

This is what zero interest rates and quantitative easing have wrought — more debt and lower credit quality. … Higher rates are coming, possibly heralding a tsunami of credit defaults.

As the Federal Reserve and the European Central Bank slowly dial back quantitative easing, interest rates will rise, stressing debt-laden governments, corporations and households. We are already seeing the effects in Turkey, Venezuela, Argentina and other developing nations as higher U.S. interest rates push the value of the dollar higher. Defaults in developing countries will be transmitted to the developed world in ways foreseeable and unforeseeable. The financial media have remarked upon the massive exposure of Spanish banks to the Turkish economy, for instance, which could prove problematic for the larger Spanish economy, the 13th largest in the world. But global markets are so complex and intertwined that defaults can spread as unpredictably and explosively as the sub-prime mortgage loan crisis in the U.S. did ten years ago via financial innovations that have so far eluded the notice of media and regulators.

What’s it to us? That’s all fine and good for bond traders and hedge fund managers, you say, but what difference does it make to Virginia? It matters because Virginia is part of the global economy and global financial system, and what happens elsewhere will impact us. The policies we pursue at the level of state/local government can make us more vulnerable to, or more resilient in the face of, the next financial crisis.

To be sure, the Commonwealth is nowhere as vulnerable as, say, Puerto Rico was before it declared bankruptcy, or as Illinois and Chicago now are. We have a AAA credit rating, we balance our budget with only a modicum of chiseling, and we pay our bills on time. But the bond rating of the Commonwealth does not tell us anything about the indebtedness of our local governments, our universities, our hospitals, our quasi-government organizations, our economic development authorities, our housing authorities and all the other bond-issuing entities in the state. No one has toted up all those numbers.

We continually discover things we didn’t know before. While Virginia’s $20 billion or so in unfunded pension liabilities are well known, only recently has our attention been drawn to the $3.5 billion in pension liabilities at the Washington Metropolitan Area Transit Authority (WMATA), which operates Northern Virginia’s heavy rail mass transit system and much of its bus system. As the Government Accountability Organization concluded, “Due to their relative size, proportion of retirees compared to active members, and investment decisions, these pension plans pose significant risk to WMATA’s financial operations, yet WMATA has not fully assessed the risks.”

How many other WMATAs are out there?

The Metropolitan Washington Airports Authority (MWAA) comprehensive annual financial report indicates that the authority’s two pension plans were fully funded as of Dec. 21, 2017. The General Employees Retirement Plan was seemingly in great shape with assets amounting to 105% of pension liabilities. Great news! But dig into the assumptions, and we see that the pension plan projects a 7.5% annualized investment rate of return. Many actuaries are saying now that a 7% or 6.5% rate is more realistic.

Similarly, the Ports of Virginia reported an unfunded pension liability of only $8.9 million as of June 30, 2016, an improvement over the previous year. The pension was about 91% funded. The ports assumed a 7% investment rate of return, somewhat more conservative than MWAA’s assumption.

MWAA and the Ports of Virginia are two of the largest quasi-governmental business entities in Virginia, and it is reassuring to see that they have their pensions under reasonably good control. But there are dozens if not hundreds of other bond-issuing entities in the Commonwealth. After the Petersburg fiscal meltdown, the General Assembly began watching for early warning signs in Virginia’s local governments, but there are dozens if not hundreds of other entities that issue bonds and borrow money. The federal government conducts “stress” tests on too-big-to-fail banks to see how they would hold up under adverse economic circumstances. Is anyone conducting stress tests for Virginia’s public and quasi-public entities? Not very likely.

The bottom line: Another global debt crisis is inevitable, the only questions are when it happens and how the damage ricochets throughout the global economy. How vulnerable is Virginia? We really don’t know. To be forewarned, as the saying goes, is to be forearmed. We are neither.

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Dominion Offers New Investment Option

Posted on June 26, 2018 by | 8 comments

Dominion Energy has launched a new financing program, Dominion Energy Reliability Investment, that will allow investors to purchase debt issued directly by the company.

The offering bears similarities to money market funds in that investors can put in and withdraw money freely. The big advantage is that they earn significantly higher interest rates — 1.75% for accounts with balances less than $10,000, $2.0% for balances over $50,000, and $1.8% for balances in between. But in contrast to money market funds, which invest in a diversified portfolio of notes, investors enjoy no diversification and do not benefit from federal regulations protecting money market funds, so they do take on a modicum of additional risk.

The program is administered by the Northern Trust Company, so Dominion presumably does pay an administrative fee. Otherwise, middleman are cut out of the transactions to the benefit of both Dominion and its investors.

The idea is not unique to Dominion. Duke Energy, and the financial arms of Ford, GM, Caterpillar and others all have comparable programs, says Dominion spokesman C. Ryan Frazier. The initiative provides “diversified and cost-competitive funding for capital investment programs,” he says.

The company prospectus states that the company can float up to $1 billion in notes outstanding.

Bacon’s bottom line: There is a fringe benefit to this initiative that may or may not have factored into Dominion’s thinking: Expanding the number of investors in the company enlarges its political constituency. Virginians who own Dominion stock often attend public hearings and speak on the company’s behalf. This new program creates a new investment vehicle that should appeal to a new class of investor. If those investors believe they are getting a better deal from Dominion than they can from bank CDs or money market funds, it is not a stretch to think they might be more favorably inclined to Dominion’s public policy positions.

Some observers might find this insidious. I’m perfectly OK with it. I think large companies should do more to expand the investor class and build support for America’s market-based economic system, and if they cut out big bank/big finance intermediaries in the process, all the better. Anything that helps Main Street over Wall Street is a good thing.

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Posted in Finance (government)

The Virginia529 Board Should Be Lauded, Not Criticized

Posted on June 12, 2018 by | 3 comments

Participation in Virginia 29 pre-paid tuition plan has declined in recent years as measured by the number of accounts and semester-units sold. Graphic credit: Joint Legislative Audit and Review Commission.

State government, local government, universities and independent authorities in Virginia are larded with debt and unfunded liabilities. No one, to my knowledge, has compiled a total inventory of public institutions’ exposure to pension obligations, leases, maintenance backlogs, infrastructure debt, economic development loans, and other long-term obligations. Institutions’ exposure to the vagaries of the economy and fluctuations of interest rates is largely hidden from public view.

One fund operating in the shadows is Virginia529’s tax-advantaged, pre-paid college tuition program. In contrast to the many entities that take on unwarranted risk, however, Virginia529 is a rare instance of sterling governance. The $2.7 billion fund for the prepaid tuition plan is defensively invested to guard against market downturns. It makes a conservative assumption about future returns on its investment portfolio — only 6.25% annually rather than 7.0% for the Virginia Retirement System. And rather than being chronically underfunded as the General Assembly has allowed the VRS to be, Virginia529 is 138% funded. Indeed, the plan is in such solid shape that actuaries judge that it has a 98% likelihood of meeting future obligations to the parents who are trusting that it will deliver on promises to pay for their children’s educations.

Apparently, that’s a problem.

In a review of the 529 plan, the Joint Legislative Audit and Review Commission (JLARC) suggested that the plan is too conservatively run. Its intolerance of risk means that has built up unnecessarily large reserves that make the program unnecessarily expensive. By reducing the size of the pricing reserve on future contract sales from 10% to 7%, JLARC says, Virginia529 could lower the price of an eight-semester contract by $1,851.

Key lawmakers strongly favor the JLARC recommendations, reports the Richmond Times-Dispatch, and they have pressured Virginia529 CEO Mary Morris to adopt the recommendations. Said Senate Majority Leader Tommy Norment, R-James City ominously: “Sometimes there’s a very thin line between defiance and supreme independent confidence.”

True enough, the cost of participating in the Virginia529 plan has surged as the cost of college tuition has consistently outpaced inflation and income growth — a fact that can be attributed (a) to the General Assembly’s cutbacks in support for higher education, and (b) administrative bloat, mission creep and other policies pursued by colleges and universities themselves. Rather than price its plans over-optimistically as, say, long-term care insurers did a decade or two ago only to increase their premiums in order to maintain plan solvency, Virginia529’s governing board prices its product based on the conservative — one might say, cynical — assumption that tuition and fees at Virginia four-year institutions will increase by 5% in the 2018-19 academic year and by 6.5% each year thereafter.

Also true, participation in the plan has declined in the past 10 years as the price has risen, as seen in the chart above. Since fiscal 2009, the number of plan participants has declined from 71,800 to 63,900. Meanwhile, participating families are buying less coverage. The number of annual “semester units sold” has tanked 43% from 18,800 to 10,700 over the same period. Admittedly, that is a disappointing trend.

Virginia529’s investment performance has lagged industry benchmarks over one-, three- and five-year time horizons, says the JLARC report, although it has met or outperformed benchmarks for the 10-year period. “Virginia529 staff, the investment advisory committee, and the program’s investment consultant indicate that the fund is defensively positioned with the intention of protecting assets in down markets and periods of market instability.”

The JLARC report seems to accept that explanation. Staff has a bigger problem with Virginia529’s large pricing reserve. The pricing reserve is a portion of the contract price in excess of the amount needed to pay future contract benefits; the reserve generates surplus revenue to protect the fund against risk. JLARC recommends a guideline that would reduce the pricing reserve as long as the Virginia529 fund has assets in excess of 130% of liabilities. “Reducing the pricing reserve from 10 percent to seven percent would improve affordability of Prepaid529 contracts but would have only a minor impact to the fund.”

Virginia529 staff disagrees. First, reducing the pricing reserve on future contracts creates equitability concerns for those who already purchased contracts. In effect, risk would be shifted to people who paid higher premiums so newcomers could enjoy lower premiums. Second, future dips in portfolio performance could affect actuarial soundness and necessitate returning the reserve to a higher percentage, creating contract pricing volatility. And third, reducing the pricing reserve would have only a modest impact on contract prices. Slashing the reserve to 7% would reduce the price of an 8-semester contract of $67,880 by only $$1,851.

Bacon’s bottom line. Here’s what JLARC and Virginia legislators seem to miss: Virginia529 signs a contract with Virginia families locking in college tuition at a certain price. Virginia529 doesn’t promise to “try real hard” to fulfill the terms of the contract. It will fulfill the contract. It doesn’t have the luxury of raising taxes, or diverting revenue from other programs, or literally borrowing from its investment portfolio and promising to pay it back later, as the General Assembly has done with the VRS. The program should be applauded for adopting an actuarial gold standard.

While JLARC raises reasonable points worthy of discussion by the Virginia529 board, legislators need to butt out. They have no skin in the game. They don’t pay a price if Virginia529 fails to fulfill its promises. If lawmakers want to make college tuition more affordable, they should either (a) increase state funding for public institutions, or (b) do the really hard work of driving costs out of the higher-ed system. Otherwise, brow-beating the Virginia529 board is cheap grandstanding.

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Posted in Education (higher ed), Finance (government), Governance

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A World Awash in Capital

Posted on June 8, 2018 by | 9 comments

Lawrence H. Summers

Shifts in the global supply and demand for capital are depressing interest rates over the long term, with momentous implications for investors and borrowers, argues Lawrence H. Summer, former Treasury Secretary under President Clinton and former president of Harvard University.

For many years, it has been the conventional wisdom among managers of pension funds, foundation endowments, and other large investment portfolios that it is prudent to operate on a payout ratio of 5%. That wisdom was predicated on the assumption that funds could earn at least 5% annually on a long-term basis after accounting for year-to-year fluctuations in performance. But Summers contends that the payout ratio should be “somewhere under 3%.”

“Payout ratios should be far less, or expected return assumptions should be far lower, than has been the case historically,” he said at a conference sponsored by the National Bureau of Economic Research, “New Developments in Long-Term Asset Management.”

If global finance is in fact experiencing a capital glut, it is excellent news for the United States government, which is the world’s largest debtor. Interest payments on the $21 trillion national debt are a huge driver of budget deficits, and an increase in interest rates could prove calamitous. If Summers is correct, my Boomergeddon scenario could take considerably longer materialize than I suggested in my recent post, “Moody’s Reaffirms AAA Rating. Don’t Get Cocky, Virginia.”

On the other hand, if Summers is correct, chronic low interest rates could depress returns for the Virginia Retirement System and universities like the University of Virginia. The VRS assumes that its assets will average returns of 7% annually over the long term.

Summers argues that the global economy is undergoing a “de-massification” in which technology substitutes for capital-intensive in investment in equipment and real estate. The trend, which is driven by the declining cost of computing power and the rise of Artificial Intelligence, means that businesses need to invest less capital to achieve economic growth. Thus, law firms have shrunk the office space per attorney from 1,200 square feet to 600. And Apple, the world’s most valuable company, decided recently to funnel $100 billion into dividends and share buybacks instead of investing in new capital projects. “Something very important and structural is happening,” he said, when a global innovation leader is deploying its capital that way.

The average yield on U.S. 10-year Treasury bonds and comparable debt for Japan and European nations arguably has shrunk by 250 to 350 basis points (2.5 to 3.5 percentage points) over the past 10 to 15 years, Summers said. In addition to de-massification, he suggested, slower rates of population growth around the world are dampening economic growth and reducing the demand for investment capital.

Writing in my book, “Boomergeddon,” eight years ago, I argued that aging populations, the draw-downs of pension funds, and the rising cost of government entitlements would lead to higher interest rates over the next two or three decades. I failed to consider that de-massification, slower population growth, and slower economic growth would simultaneously depress the global demand for capital.

I’m open to the possibility that an interest rate-led meltdown of U.S. government finances is less likely in a world awash in capital. Let’s just hope that the politicians never get the message, though: Otherwise, they are likely to ramp up deficit spending and the national debt higher than ever. Meanwhile, state governments, elite universities, insurance companies and people saving for their retirement need to adjust to the reality of lower returns on their investment portfolios.

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Moody’s Reaffirms AAA Rating. Don’t Get Cocky, Virginia.

Posted on June 7, 2018 by | 6 comments

Storm clouds off the Virginia coast, circa February 2017. Photo credit: Strange Sounds.

Moody’s Investors Service, one of the nation’s three bond rating agencies, has reaffirmed Virginia’s AAA bond rating and stable financial outlook, the Richmond Times-Dispatch reports.

Moody’s had issued warnings that Virginia’s hallowed AAA status was looking fragile, due mainly to a sharp draw down in previous years of the Commonwealth’s budget reserves. The Revenue Stabilization Fund had shrunk to 1.5% of state general funds.

But the new budget, which awaits Governor Ralph Northam’s signature, appropriates an additional $90 million for the cash reserve, writes the T-D‘s Michael Martz, on top of the $156.4 million already pledged from excess revenues carried over from the fiscal year that ended June 30. The budget also will carry forward an expected $60 million in additional revenues from the current year into each year of the new biennium.

Moreover, said Secretary of Finance Aubrey Layne, a surge in income tax payments after the December tax cuts could produce $500 million in additional one-time payments of income taxes.

Bacon’s bottom line: Governor Northam has pulled off quite the trick, expanding Virginia’s Medicaid entitlement while shoring up state finances. While I am happy to see that Virginia remains one of the 14 states with the coveted bond rating, I regard AAA status as a minimal standard, not a mark of great fiscal probity.

Senate Majority Leader Tommy Norment, R-James City told Martz that the Moody’s report came as “no surprise.” He had characterized the warning about losing the AAA rating as “demogoguery and false assertion to try to scare legislators into voting for [Medicaid] expansion. Complete poppycock.”

I sympathize with Norment’s frustration over his inability to thwart the entitlement expansion, which will be paid for in part by a new tax on hospital revenue, which in turn, to an unknowable degree, will be passed on Virginians in the form of higher private health insurance premiums. I also resent that the public was not informed during the Medicaid-expansion debate of the full cost of the expansion, which will require additional revenues, as yet not identified, to increase reimbursement rates for physicians.

However, I also believe that numerous states and the U.S. government are building unsustainable mountains of debt that eventually will collapse during my lifetime with horrific consequences. The Medicare HI trust fund (for hospital payments) will run out in seven years, requiring Congress to come up with $52 billion (and more in future years) to maintain benefits. Social Security is dipping this year into its own trust fund for the first time since 1982; the trust fund will run out in 16 years, precipitating a 22% cuts to the program. Despite a tax-reform boost to revenues and a surge in economic growth, federal budget deficits are approaching $1 trillion a year. And an increasing number of states are one recession away from fiscal meltdown.

Incredibly, as the nation hurdles toward its rendezvous with Boomergeddon, national political leaders have abandoned any pretense of fiscal sanity. The Democratic Party is moving to the left, entertaining dreams of even greater entitlements. Trump-led Republicans fight increased deficit increases only fitfully, trading off increased domestic spending to pump up the military.

Yes, America is enjoying greater economic growth right now, but the jury is out whether the latest rounds of tax cuts will “pay for themselves.” (I remain dubious.) Global growth has been fueled since 2008 by unprecedented credit creation and debt accumulation, and massive structural vulnerabilities lie beneath the relatively placid surface of international finance. Sooner or later, a gasket will blow — Argentinian bonds, Italian banks, the Venezuelan economy, Chinese real estate markets, war in the Middle East, a cyber attack on the electric grid, or a black swan that no one can even imagine — and the shock will cascade in unpredictable ways through the global economy as one debt domino topples another. Sooner or later, the U.S. will experience a recession, and it will be a doozey.

So, yes, there is every reason to question the ability of the federal government to stick to its Medicaid-funding promises. There is every reason to fear that fiscally crippled states like Illinois, New Jersey, Connecticut and Kentucky will slide down the path to Puerto Rico-style insolvency and throw themselves upon the mercy of an already-overextended federal government, even while the threat of massive defaults roils financial markets and drives up the cost of government borrowing. And there is every reason to think that Virginia will experience a repeat of 2008-style fiscal stress, if not worse — even as it is forced to confront multibillion-dollar shortfalls in public-employee pensions that can no longer be deferred. 

Virginia needs to bullet-proof its budget, not with any old army-surplus vest but ceramic-plated Kevlar-backed body armor. We need a AAA+ bond rating. We need to restructure our economy, our land-use patterns, our transportation system, our health care system, our K-12 and higher-ed systems, our criminal justice system, and every other sphere of state and local government to be more fiscally sustainable during bitter times.

I know this gloom-and-doom talk sounds bizarrely unreal in a growing economy with a 3.4% unemployment rate. But the time to prepare for the storm is when it is far offshore, not when it is upon us.

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