Tag Archives: Boomergeddon

What Do We Do about Petersburg?

Posted on July 28, 2016 by | 26 comments

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.

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Posted in Government Finance

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The Seven Percent Assumption

Posted on July 12, 2016 by | 9 comments
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.

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Posted in Government Finance, Government workers and pensions

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Detroit on the Appomattox

Posted on July 12, 2016 by | 36 comments
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.

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Posted in Government Finance, Government workers and pensions

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

Posted on July 8, 2016 by | 28 comments
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.

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Posted in Business and Economy, Federal issues, Government Finance

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Chicago on the James?

Posted on July 1, 2016 by | 7 comments

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.

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Posted in Government Finance, Government workers and pensions

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Boomergeddon Update: Medicare HI

Posted on June 28, 2016 by | 15 comments
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.

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Posted in Federal issues, Government Finance, Health Care

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Virginia Ranks 19th for Fiscal Condition

Posted on June 1, 2016 by | 2 comments
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.

— JAB

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Posted in Government Finance

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Reader Alert: Another Jeremiad about Debt and Risk

Posted on April 20, 2016 by | 1 comment
Richmond Fed "Bailout Barometer" -- federal backing of total U.S. debt increased another 0.7% in 2015 to reach almost 61%.

Richmond Fed “Bailout Barometer” — federal backing of total U.S. debt increased another 0.7% in 2015 to reach almost 61%.

Holman W. Jenkins, Jr., at the Wall Street Journal reminds us how countries around the world, including the United States, are doubling down on debt to stave off recession:

The Richmond Fed’s “bailout barometer” shows that, since the 2008 crisis, 61% of all liabilities in the U.S. financial system are now implicitly or explicitly guaranteed by government, up from 45% in 1999.

Citigroup estimates that the top 20 advanced industrial economies, in addition to their enormous, recognized public debts, also face unrecorded additional debts of $78 trillion for their unfunded pension systems.

Six years after a crisis caused by excessive borrowing, McKinsey estimates that even visible global debt has increased by $57 trillion, while in the U.S., Europe, Japan and China growth to pay back these liabilities has been slowing or absent.

No one likes recessions but they serve a useful purpose — they wring bad investments out of the economy and reallocate resources to more productive uses. But that’s not much consolation to a laid off Intel employee in the U.S. or a laid off cement-plant worker in China. So, politicians and central bankers around the world are doubling down on variations of the same strategy of spending, borrowing and financial repression (driving down interest rates to transfer wealth from savers to debtors) to perpetuate economic growth. When countries start experimenting with negative interest rates, the consequences of which no one can predict, you know that policy makers are desperate.

The global economy is entering a new phase: the end game in which democratic welfare states struggle to maintain massive entitlements in the face of aging populations and slowing economic growth. The United States is not as far down this road as some other countries, but absent major policy changes, deficits and the national debt are heading inexorably higher. Don’t believe me — believe the Congressional Budget Office.

Meanwhile, the four leading contenders for U.S. president are advancing platforms totally disconnected from reality. The cost of Bernie Sanders’ programs, if implemented, would cost $18 trillion over ten years, estimates the Wall Street Journal. Donald Trump’s tax-cut plan would cost $9.5 trillion over 10 years, says the Urban-Brookings Tax Policy Center, while the Ted Cruz tax plan would cost $8.5 trillion, according to the same group. The least fiscally irresponsible candidate, Hillary Clinton, would expand government spending by a mere $1 trillion over ten years, according to the McClatchy news organization

We can argue about the biases of the groups crunching these numbers, but that would miss the point. The odds are overwhelming that the next president of the United State will not be remotely serious about balancing the budget. Liberals argue that bigger spending can be paid for with taxes on the rich with little or no adverse impact on the economy, and conservatives can argue that the “dynamic” effects of tax cuts will stimulate economic growth and bring in more revenue than static models would indicate. Yeah, right.

Hither Virginia? There is little that Virginia can do to buffer its economy from these national and international trends, nor can state and local governments insulate themselves from collapsing tax revenue in the next recession. But they can protect themselves by maintaining AAA bond ratings and putting their public pensions on a sound footing so that when the crunch does come, they will be better positioned to meet long-term obligations without debilitating tax increases.

I am particularly worried about two categories of state-local debt. The first category is university debt backed by revenue from students. The higher ed bubble is unsustainable even during a period of modest economic growth. A recession will leave many institutions destitute, and a Boomergeddon-scale calamity could leave the entire industry in a shambles. A second category is debt taken on for “economic development” projects like sports stadiums, convention centers, golf courses, and other glittering objects that are best paid for by private investors trained in analyzing risk.

You can add a third category of long-term obligation: maintaining transportation services such as Washington-area metro, Virginia Beach light rail, Richmond bus rapid transit, and the like, which will require government subsidies in perpetuity. Could local governments support those services in a severe revenue downturn? Doubtful. Likewise, I am suspicious of toll-backed highway bonds assuming long-term traffic growth even as the evolution to more dense, mixed-use communities scrambles traditional commuting patterns, and as Uber, Lyft, Bridj, transportation-as-a-service enterprises, and self-driving cars seem destined to radically alter Americans’ driving habits.

Nassim Nicholas Taleb writes about building “anti-fragile” enterprises and institutions — entities that are not merely resilient in the face of massive adversity but can thrive in adversity. Virginia can become anti-fragile if state and local governments, in the face of a global economic meltdown, can maintain the ability to provide core government services while other states and metros are falling apart. Talent and capital will migrate to the oases of stability. A handful of states will prosper. Will ours be one of them?

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Posted in Education (higher ed), Government Finance, Transportation

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Mala Suerte, Puerto Rico

Posted on April 15, 2016 by | 3 comments

potential_derelictsby James A. Bacon

The U.S. territory of Puerto Rico, like several American states, has forged a facsimile of prosperity by borrowing and spending beyond its means. Earlier this year, independent bond-issuing authorities began defaulting on their debt. Investors fear the territory will fail to make payments on General Obligation bonds coming due in May and June.

Not surprisingly, Senate Democrats called for bankruptcy protection for Puerto Rico. Every Democrat in the Senate signed a letter in January, calling for “appropriate restructuring tools” available under bankruptcy law that would allow the territory “to respond to [its] economic and humanitarian crisis.” Virginia Senators John Warner and Tim Kaine signed the letter.

longer_range_risks2Congressional Republicans have been trying to devise some other means of devising default. One proposal has been to create a “control board,” which, though lacking the broad bankruptcy authority that territorial officials had sought, would facilitate some debt restructuring. (Bearing Drift has an excellent article describing the thinking of Rep. Rob Wittman, R-1st, who serves on the House Committee of Natural Resources, which has oversight of this issue.) Democrats maintain that tough measures usurping local control smack of colonialism.

All sides agree that there is no easy remedy. Either bond holders get stiffed, rattling municipal markets and creating fallout for the 50 states, or Puerto Rico must adopt draconian policies that will cripple the economy and hurt the poor. There is no happy ending here.

Why should Puerto Rico’s financial woes concern a Virginia-centric blog? Because whatever solution is devised for the territory will set a precedent for future bail-outs and, indeed, could accelerate the coming reckoning with reality of states in terrible fiscal shape like Illinois. Inevitably, there will be calls for more forgiveness in which fiscally disciplined states like Virginia will bail out improvident states.

safe_for_nowMichael Thompson, president of the Thomas Jefferson Institute for Public Policy, makes the following observation in his latest column:

Allowing Puerto Rico the unprecedented power of abridging [municipal] debt will come at a direct cost to Virginia and all the other states that rely on the bond market for financing. Once the market sees that ‘full faith and credit’ protections are faulty, borrowing costs will go up for states in accordance with the increase risk. … Likewise, the value of funds holding this debt, which are found in 401ks and other retirement nest eggs across Virginia and the rest of the country, will be severely shaken.

The importance of Thompson’s insight cannot be overstated: Once bond investors realize that the assurances they thought they were guaranteed are rendered null and void by political expediency, they will demand a risk premium on all other municipal debt. That will hurt Virginia, although probably to a lesser degree than states lacking our AAA rating. What the Senate Democrats overlook is that investors will demand the highest risk premium for precisely those states whose finances are in greatest disarray — the blue states of Illinois, New Jersey and California. A higher cost of debt would make Illinois’ currently perilous predicament even worse.

Now, it’s one thing for Congress to take a hard line toward Puerto Rico, a territory that no one quite considers a part of the United States, and a very different thing to take a hard line on Illinois, which has senators and representatives with voting rights in Congress. Should the unimaginable occur and Illinois default on its bonds, bailing out Puerto Rico will create a precedent that will make it harder to deny Illinois, and any other states that might follow it, similar consideration.

The country will immediately polarize between citizens of states that have acted prudently, made hard choices, and husbanded their resources and states that ducked fiscal reforms and borrowed more. Congress will face a terrible decision: whether to bail out the improvident, thus creating a moral hazard for the very behavior that got those states into the fix in the first place, or to hold the line, at the risk of having state governments failing to perform essential responsibilities, as we have seen, for instance, in the Flint, Mich., lead-poisoning crisis.

This is a litmus test issue for me. Having railed against fiscal recklessness for years only to be told by many that I am an alarmist if not an outright right-wing whackjob, I have zero sympathy — no, in this brave new world of negative interest rates, I have negative sympathy — for any Virginia politician who caves on this issue. I will wage relentless blogfare against anyone who buckles. The spenders and borrowers need to get a strong, in-your-face message that states must mend their fiscal their ways because there will be no succor for them in the future. Tough luck, Puerto Rico. But better you than Illinois.

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Fed Theft Update: $749 Billion from Bank Depositors

Posted on March 21, 2016 by | 23 comments

silent_theftFederal Reserve Bank suppression of interest rates has cost bank depositors $749 billion in interest income on savings accounts, CDs, and money market accounts over the past six years, according to Richard Barrington with MoneyRates.com.

Quantitative Easing has made possible one of the greatest redistributions of wealth in United States history. Unlike with taxes, which tend to be highly visible, most people don’t understand how interest rate suppression affects them. Low interest rates have devastated not only bank account savings but public and private pension funds and savings vehicles such as insurance policies. Beneficiaries are borrowers, including house buyers, car owners, college students, credit card owners, corporations leveraging their balance sheets, and, of course, the U.S. government. Every percentage point in interest rate suppression across the yield curve benefits Uncle Sam to the tune of $180 billion a year.

So, how did Barrington calculate the cost to bank depositors?

MoneyRates.com starts with the total amount on deposit at U.S. banks as of March 31, per the FDIC. That total is then increased by average money market rates over the subsequent year … and then adjusted for the inflation rate over the same period. The difference between the resulting figure and the original amount on deposit at U.S. banks represents the hidden cost of the Federal Reserve’s low-rate policy.

The little guy knows the system is stacked against him. He just doesn’t know how. Pass this blog post around.

— JAB

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Posted in Federal issues, Poverty & income gap

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Buena Vista: the Canary in Virginia’s Fiscal Coal Mine

Posted on March 18, 2016 by | 7 comments

dead_canaryby James A. Bacon

The City of Buena Vista, which defaulted in 2014 on a $9.2 million bond issue to pay for a golf course that was supposed to spur growth in the city, has received some good news. It will be allowed to keep its city hall. For now. The office building, along with the police station and the golf course itself, stands as collateral on the debt.

Although ACA Financial Guaranty Corp., the bond insurer, still could take possession of city buildings, reports the Roanoke Times, it will not do so any time soon. “ACA is not currently interested in pursuing the option of foreclosing on the deeds of trust securing the bonds,” an attorney for the insurer wrote to the Buena Vista city manager.

The long-running controversy has harmed the ability of Buena Vista, a city of 6,500 in the Shenandoah Valley, to access credit markets. The Virginia Resources Authority recently rejected a request by the city for a loan to upgrade its public water system.

Maybe someone needs to call in Marc Edwards, the Virginia Tech professor who documented the lead poisoning in the water system of Flint, Mich., to make sure Buena Vista’s water is OK. I say that only partly tongue in cheek. The overlooked part of the Flint tragedy is the decades of fiscal mismanagement preceding the city’s takeover by state authorities that allowed the water system to deteriorate.

In Virginia, there is very much the idea that “it could never happen here.” But, in fact, it could, and Buena Vista is a case study. There are many other fiscally challenged cities, towns and counties in Virginia, where the old tobacco-textiles-furniture-and-coal economy has suffered comparable devastation to the Michigan automobile economy. Who knows what kind of hail-mary “investments” other local governments have pursued in desperate bids to revitalize local economies? Who knows the extent to which localities have deferred maintenance on their municipal water systems?

Buena Vista is so small that its plight has escaped the notice of the usual hand wringers, and I haven’t heard of any requests for bail-outs (although that’s not to say Buena Vista hasn’t been quietly looking for help.) At the national level, Puerto Rico is bordering on insolvency, and the entire state of Illinois is close behind. You can be assured that both will ask for help at some point to relieve them from the consequences of their bad decisions and dysfunctional political cultures.

Inevitably, Americans will face cruel choices — either bail out reckless and improvident governments or let their innocent citizens face more Flint-like calamities — and most likely Virginia will, too. To be sure, the Old Dominion’s finances are sounder than those of most states, but they aren’t as sound as we think, and not every jurisdiction has a AAA bond rating like Fairfax County, Henrico County of the City of Virginia Beach.

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Posted in Economic development, Government Finance, Infrastructure

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Are the End of Times Upon Us?

Posted on March 4, 2016 by | 74 comments
Big hands... Rest easy, America

Big hands… Gog (left), Trump, and Magog

by James A. Bacon

Surely we have reached the end of times of apocalyptic lore when the leading Republican candidate for president flapped his arms during a national debate and assured the American people that not only are his hands of respectable size but so is another part of his anatomy. “I guarantee you, there’s no problem,” said the inimitable Donald Trump last night.

Such is the state of the nation that rather than explicate how he proposed to “make America great again” — beyond building a big wall, bringing in “really great” people, and hammering China, Japan and Mexico on trade — Trump felt compelled to assure the public that the size of his genitalia is something the nation can be proud of.

While Trump is grotesque, he taps into a very real malaise across a broad swath of the electorate. The American people know that something is very wrong, and that the elites have rigged the rules of the game to their favor, although they’re really not sure how. Americans are appalled by political correctness, they’re appalled by Wall Street bailouts, and they’re appalled by big money in politics. They are enraged by the loss of jobs, many of them to competitors overseas, and they are demoralized by the increasingly difficult struggle to maintain a middle-class standard of living.

My argument in Bacon’s Rebellion is that much of this malaise can be traced to the failure of core economic institutions. The health care sector, which comprises close to one-fifth of the economy, is plagued by the poorest record of productivity and quality of any economic sector, making the cost of health care increasingly unaffordable for all. Meanwhile, college tuitions have become even more burdensome, blocking a traditional path to a middle-class occupation. Both sectors have become captured by the leading players — hospitals, insurance companies, institutions of higher education — and are run to protect their interests, not the interests of the public. And don’t get me started on dysfunctional land use patterns, also the playground of special interests, which drive up the cost of housing and transportation.

How these complex systems work is poorly understood, so Trump personifies the enemy as illegal immigrants and Chinese factory workers stealing American jobs, while both Democratic candidates personify the enemy as cops killing innocent black men and deploring the United States as institutionally racist.

There is another contributor to this malaise, also poorly understood: monetary policy. I have addressed it periodically in Bacon’s Rebellion, although I only dimly comprehend the dynamics myself and assuredly speak with no authority on the subject. But Bill Gross, head of Janus Capital Group and one of the leading bond investors in the world, does understand it. And I will let him do my talking for me.

In the current issue of his monthly newsletter, Gross writes the following:

Our global, credit based economic system appears to be in the process of devolving from a production oriented model to one which recycles finance for the benefit of financiers. Making money on money seems to be the system’s flickering objective. Our global financed-based economy is becoming increasingly dormant, not because people don’t want to work or technology isn’t producing better things, but because finance itself is burning out like our future Sun.

What readers should know is that the global economy has been powered by credit – its expansion in the U.S. alone since the early 1970’s has been 58 fold – that is, we now have $58 trillion of official credit outstanding whereas in 1970 we only had $1 trillion. Staggering, is it not? But now, this expansion appears to be reaching an ending of sorts, at least in its current form. Private sector savers are growing leery of debt piled upon debt and government regulators have begun to build fences against further rampant creation. In addition, the return offered on savings/investment whether it be on deposit at a bank, in Treasuries/ Bunds, or at extremely low equity risk premiums, is inadequate relative to historical as well as mathematically defined durational risk. The negative interest rates dominating 40% of the Euroland bond market and now migrating to Japan like a Zika like contagion, are an enigma to almost all global investors. Why would someone lend money to a borrower with the certainty of getting less money back at a future date? …

Negative yields threaten bank profit margins as yield curves flatten worldwide and bank NIM’s (net interest rate margins) narrow. The recent collapse in worldwide bank stock prices can be explained not so much by potential defaults in the energy/commodity complex, as by investor recognition that banks are now not only being more tightly regulated, but that future ROE’s will be much akin to a utility stock. …

In addition to banks, business models with long term liabilities that depend on 7-8% future returns from risk assets are themselves at risk – not necessarily of bankruptcy but future profitability. … Same goes for pension funds. Puerto Rico follows Detroit not just because of overpromised benefits but because they cannot earn enough on their investment portfolios to cover the promises. Low/negative interest rates do that. And the damage extends to all savers; households worldwide that saved/invested money for college, retirement or for medical bills. They have been damaged, and only now are becoming aware of it. Negative interest rates do that. …

In addition, government policymakers seem to be setting up future roadblocks for savers. There is a somewhat suspicious uniform attack on high denomination bills of global currencies. Noted economists such as Larry Summers; respected journalists such as the FT’s Gillian Tett, central bankers such as Mario Draghi – all seem suddenly concerned that 500 Euro or 10,000 Yen Notes are facilitating drug dealers and terrorists (which they are). But what’s an economist/central banker doing opining on law enforcement? It appears that the one remaining escape hatch for ordinary citizens is being closed. Money in a mattress will heretofore be associated with drugs/terror.

Continue reading →

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Posted in Poverty & income gap

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Your Federal Tax Dollars at Work

Posted on February 29, 2016 by | 2 comments
The fog of government

The fog of government

And I thought the City of Richmond was incompetent for its inability to close out its financial books in a timely manner!

Heed this opinion from the federal Government Accountability Organization (GAO) on Uncle Sam’s financial statements for 2014 and 2015: “Certain material weaknesses in internal control over financial reporting and other limitations on the scope of … work resulted in conditions that prevented GAO from expressing an opinion on the accrual-based consolidated financial statements.”

Three major departments — Defense, Agriculture and Housing & Urban Development, controlling 34% of assets and 19% of spending — accounted for the most questionable financials, according to Government Executive Magazine. But accounting issues pertaining to Medicare cost control also prevented GAO from expressing an opinion on sustainability financial statements on HHS’ Statement of Social Insurance on accounts worth about $27.9 trillion.

Bacon’s bottom line: The federal government will run a $544 billion budget deficit this year…. we think. It could be more, it could be less. What’s a few billion dollars?

(Hat tip: Tim Wise.)

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Posted in Federal issues, Government Finance

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Boomergeddon Update: Deficits Rising Again

Posted on January 28, 2016 by | 10 comments
Source: Congressional Budget Office

Source: Congressional Budget Office

by  James A. Bacon

Blame who you want for this sad state of affairs — it’s always the other guy’s fault, right? — but after six years of shrinking federal government deficits, red ink is on the rise again. And unless Congress enacts significant budget reforms, deficits will get worse every year pretty much forever until the wheels fall off the bus.

The chart above comes from a new report from the Congressional Budget Office (CBO), which, to my knowledge, is not funded by the Koch Brothers. What should be really scary is that the forecast is based upon the assumption of slow-but-steady economic growth (about 2% annually) over the next 10 years — without a recession, a totally improbable supposition. The current business cycle, though anemic, is seven years old, and the global economic situation is a mess. When a recession does occur, revenues will decline, spending will climb and deficits will shoot higher.

Some will comfort themselves from the chart above by observing that CBO’s projected deficits for the next 10 years are no worse than the deficits of the Reagan/Bush I era. That’s true, assuming we don’t have a recession, in which case it won’t be true. But such thumb-sucking ignores the fact that we have a $19 trillion national debt, which, as a percentage of the economy, is higher than at any time since the Korean War. It ignores the fact that the percentage of the budget on auto-pilot (entitlements and interest) will be far higher, which will give Congress far less latitude to cut spending should it need to. It ignores the fact that the Federal Reserve Board today is pursuing a highly stimulative, near-zero interest policy today, in contrast to the slam-on-the-brakes interest policy of the early 1980s. And it ignores the fact that the 1980s-era economy had greater growth potential than our economy today with its aging workforce, debilitating tax code, over-regulation and seriously impaired global economy.

What does this imply for us mere mortals residing south of the Potomac? President Obama and Congress made a pact with the devil to jack up discretionary spending in the latest budget, thus easing the pain of sequestration. But long-term, the prognosis for Virginia’s federally dependent economy is grim.

discretionary_spending

Expressed as a percentage of the economy, federal discretionary spending (which includes defense spending) will continue to shrink as mandated spending and interest payments hog new revenue dollars. That bodes ill for the military-intelligence-homeland security complex in Northern Virginia and Hampton Roads.

Bacon’s bottom line. First the uncontroversial: Virginia needs to ramp up its efforts to diversify its economy away from federal spending. Next, the controversial: Put state and local finances (including pension obligations) on a tighter leash. And then, the super-controversial: Don’t trust federal funding promises for anything. What Uncle Sam giveth, Uncle Sam can taketh away. And that includes federal dollars for Medicaid expansion.

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Agreed, We Can’t Risk Expanding Medicaid. But What’s the Alternative?

Posted on December 18, 2015 by | 81 comments

innovationby James A. Bacon

Republican leadership in the House of Delegates once again has slammed the door on Governor Terry McAuliffe’s proposal to expand Virginia’s Medicaid program. There are good reasons both for and against extending the entitlement but the decisive and most compelling argument is the likely inability of the federal government to honor its commitment to pay 90% of the cost of the expanded program far into the future.

If you need a sobering reminder of how dismal the long-term fiscal condition of the federal government is, just read this recent Senate Budget Committee testimony by Boston University economist Laurence Kotlikoff. As everyone knows, the national debt now exceeds $18 trillion. But that’s just the tip of the fiscal iceberg. The fiscal gap, the difference between revenues and obligations projected 75 years into the future, is $210 trillion — more than 10% of GDP. The gap between revenues and promises in the U.S. is worse than that of any other developed country, Kotlikoff said, worse even than Greece. (Hat tip: Tim Wise.)

If something can’t go on forever, eventually it won’t. At some point, whether ten years from now, twenty years, or thirty, the federal government will reach a crisis. There is a high likelihood that a future Congress will decide either to radically curtail Medicaid or to dump a significant share of the funding burden on the states. Either event would be traumatic for Virginians. This is not scare-mongering, it is arithmetic.

While rejection of Medicaid expansion may be fiscally justified, it leaves hundreds of thousands of poor and struggling Virginians without access to health care, except in emergency room settings. If Republicans and conservatives are going to reject the fiscally improvident expansion of Medicaid, they are obligated to present a different vision for Virginia’s healthcare future. We have seen bits and pieces of such a future — repeal the Certificate of Public Need (COPN) process that protects established companies from competition, and make patient-level data more widely accessible — but no one has articulated a coherent vision. Let me advance three propositions that may lead us to such a vision:

  • The main reason that medical insurance has become so unaffordable for so many Virginians is that the underlying cost of providing that care has increased relentlessly over the decades faster than inflation and faster than the increase in wages and salaries.
  • The primary thrust of public policy in the United States and Virginia has not been to stimulate productivity and innovation, making medical care more affordable for all, but to restrain cost increases by regulatory means and to redistribute wealth from the affluent to the poor in a zero-sum game. The resulting system, marked by rampant regulation, red tape, cross subsidies and an total lack of transparency, is a colossal failure.
  • To make health care affordable and accessible, Republicans and conservatives need to champion market-driven competition and innovation that drive down costs and improve medical outcomes.

That’s the vision, but a vision is nothing more than words and generalities. Where do we go from here? There are three things we can do in the short term that will move us in the right direction:

  • Eliminate COPN, which protects established hospitals from competition, not only from other hospitals and outpatient-care facilities but from entrepreneurs who might have novel ways to organize and deliver care. In so doing, we must recognize that COPN represents a back-door means of compensating hospitals for the significant sums they spend on indigent care, and acknowledge that some kind of political settlement will be necessary.
  • Eliminate mandated health benefits, which limit the ability of health insurance companies to create innovate products for niche markets.
  • Create market transparency. Patients have little consumer power in the medical marketplace because they cannot compare the price of different medical procedures or the quality of work performed by different hospitals and doctors. The methodological issues of comparing price and quality are formidable but not insurmountable. For market-driven health care to work, we must have price transparency.

That’s just the beginning. Thinking more long-term, we need to acknowledge that the concept of hospitals — centralized medical facilities that provide a bundle of unrelated medical procedures — may be outdated. The future belongs to the factory model in which specialized medical teams (doctors, nurses and others) work in specialized facilities with specialized equipment, and stay up to speed with the latest scientific knowledge about particular procedures or diseases. This specialization and knowledge allows them to treat patients at lower cost with better outcomes.

In parallel, insurance companies need to pioneer new reimbursement strategies that cover not just individual procedures but entire courses of treatment, rewarding medical “factories” described above for superior outcomes and lower costs.

Republicans and conservatives don’t have to come up with every answer. They’re politicians, not medical practitioners. But they do need to paint a picture of the future, eliminate legal and regulatory obstacles and push the health care industry in the right direction. If they fail to do so, the end result will be fiscal insolvency, hundreds of thousands of Virginians people dispossessed of health care, or a chronic health care crisis for all.

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Posted in Health Care

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