Wednesday, June 27, 2012

Let's All Follow the Example of Providence, Rhode Island and Not that of Stockton

Down and Out in Stockton is subtitled 'The latest city to confront bankruptcy and how it got there.' The real lessons worth learning are coming from places like Providence, Rhode Island.

While Stockton is taking the cowardly way out and asking the courts to deal with its pain sharing responsibilities, Providence officials have chosen to do the right thing and manage their own affairs.

Stockton city and union officials are simply abdicating their fiduciary responsibilities, whereas Providence leaders, in contrast to Stockton's leaderless intransigence, adopted a painful but necessary problem solving approach to their problems. The citizens, employees and taxpayers of Providence will be better served for their having done so.

We'll quote from the editorial:

"Great summer investors are having. Greece is in default. Italy and Spain are slouching toward insolvency. And now Stockton, California may become the largest U.S. city to declare bankruptcy....

Even so, bankruptcy wasn't inevitable. A new state law mandates that municipalities engage in a three-month confidential mediation with creditors and unions before declaring bankruptcy. But Stockton's unions haven't acceded to the significant benefit changes needed to rationalize the city's fisc. And creditors have resisted a reprise of the Chrysler bankruptcy in which investors got scalped while the unions walked.
Unions are blaming Wall Street and the foreclosure crisis for the city's woes. Like many other cities in California's inland regions, Stockton suffers from a high foreclosure rate, which has depressed property tax revenues and helped push the city's unemployment rate to 15%. The city of 290,000 also borrowed millions for projects that urban planners hoped would goose the economy and tax revenues—such as a $129 million waterfront development, a $68 million arena for minor league hockey, and a $35 million city hall that has since been repossessed.

Still, debt financing is not the city's main cost driver. That would be labor costs, specifically retirement benefits. The city has a little over $300 million in general-fund backed debt, but an $800 million unfunded liability for pensions and retiree health benefits.

The latter, which are not pre-funded, are expected to grow by 7.5% annually for the foreseeable future. Pension costs are about 40% of what the city pays on worker salaries and are also growing. The average firefighter costs the city about $157,000 a year in pay and benefits and can retire at age 50 with a pension equal to 90% of his highest year's salary plus nearly free lifetime health benefits.

The city has laid off a quarter of its police officers, 30% of its firefighters and 43% of general city staff to pay for these generous benefits. Yet the city still faces a $26 million deficit on a $180 million budget. Soaring retirement costs mean that the gap will grow even if the city's housing crisis ebbs and revenues begin to recover. You can't build a city on debt and retirement checks.

Unions have made few concessions save agreeing to give up sick leave payouts and scale back pensions for new hires—when there are any. City officials could freeze worker pensions and reduce benefits going forward, as San Jose did via ballot initiative earlier this month. However, such a move would set off an expensive and protracted legal battle with the unions, which a city on the edge of bankruptcy can hardly afford.

Mr. Deis, the city manager, has said he won't try to modify pensions even in bankruptcy because of the cost of litigation. The California Public Employees' Retirement System pushed back hard when some on Vallejo's city council suggested restructuring current worker pensions in bankruptcy court a few years ago. That California city instead cut payments to bondholders, modified pensions for new hires, and scaled back retiree health benefits. Stockton is likely to do something similar.

But perhaps a better model for Stockton and other insolvent cities is Providence. Rhode Island's capital city earlier this year faced a roughly $30 million structural deficit, $900 million unfunded pension liability and a shrinking tax base. Its city council—all Democrats—averted bankruptcy by voting to cap pension benefits at 150% of the median household income and suspending retiree cost-of-living increases. City workers and retirees overwhelmingly backed the deal.

Providence heeded the canary in nearby Central Falls, which declared bankruptcy last year after workers and retirees refused to renegotiate their retirement benefits. Their pensions were cut by half in bankruptcy. Central Falls provided an instructive lesson in the high costs of delaying reform for Rhode Island's government workers and lawmakers.

Stockton likewise offers a rebuke to those who don't believe that union entitlements can drive governments to insolvency. Its lesson ought to teach Sacramento, if that capital's politicians were capable of learning."

My Take

For many years, Stockton (1) spent money on normal city government operations, (2) borrowed money or guaranteed loans to fund non-self sustaining projects and (3) made promises about future retiree benefits which it didn't pre-fund.

That's pretty much the 1-2-3 of what lots of governments, including the U.S. government, have been doing for many decades. Eventually, the bills pile up in 2-3 and the required payments must be paid.

That's when debt servicing costs (required interest and principal payments) and retiree benefit payments (as government workers retire and are replaced) overwhelm the government and in effect ambush the unknowing and too trusting taxpayers.

In other words, what was one affordable cash outlay later becomes three unaffordable cash outlays.

So while the city's tax and fee base can continue to pay for (1) normal operations, its (2) debt payments and (3) retiree entitlement expenditures were not accounted for properly and therefore can't be paid as promised.

In other words, if the projects predicted to be self sustaining in fact prove not to be self sustaining, the taxpayers get the bill. That's an example of the known unknown or unknown unknown case we discussed yesterday.

And if sufficient money wasn't set aside to fund the retirement benefit promises to city workers, which it hardly ever is, the taxpayers get the bill. At the federal level, Social Security and Medicare are good examples, as are pension and health care promises for retirees at the state and local levels.

Then the fit hits the shan, and all hell breaks loose.

At that point, politicians are reluctant to approach the taxpayers and ask them to make up the shortfall and agree to have their taxes increased dramatically. At the same time, union representatives are reluctant to approach their members and ask them to make up the difference and see their benefits cut dramatically. Meanwhile, creditors want their money repaid as scheduled or as much thereof as possible.

This becomes the point when the rubber meets the road. In the auto bailouts, the national government in effect committed all U.S. taxpayers to make up the difference. They did this by borrowing additional money from the Chinese.

At a later time, the Chinese will want to be repaid as scheduled and properly so. Of course, we won't have the money to do so, so that's a future problem we'll have to face as a nation. But it won't disappear so face it we will, at least at some point down the line.

Although some people may actually believe that government can in fact "save the 98% of the population belonging to the voting -- er-- middle class," that's simply impossible.

Only a strong and vibrant productive private sector, along with a living within its means limited government, can do that.

Thanks. Bob.

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