MOORLACH UPDATE — State Debt — October 17, 2013

In October of 2011, Gov. Brown signed a bill that moved all ballot propositions, except two that had already qualified, to the November 2012 General Election, thereby removing them from the June Primary Election cycle. This was done to move Proposition 32 to November, when there is a higher voter turnout. A higher voter turnout would see more liberal-leaning voters participating, thus giving an advantage to those opposed to this measure that would have impacted public employee union dues. The strategy worked, as Prop. 32 was defeated. And, it also aided the Governors Prop. 30, which raised income and sales taxes in the state. Between the improving economy and the tax rate increases, the Governor was able to construct a bigger budget. As the projected revenues for the budget grows, then the percentage attributed to fixed costs decreases. In the bill-signing window that just recently concluded, in which the Governor has a limited time to sign or veto bills, Gov. Brown did sign a bill allowing one proposition to appear on next Junes ballot. Ironically, it is a ballot measure that will allow the state of California to issue more debt. The OC Register provides its perspective on state debt in one of todays editorials.

Debt takes smaller bite

State bond payments shrink as budget share.

The debt picture for California state bonds has improved slightly this year, according to a new Debt Affordability Report by state Treasurer Bill Lockyer. This is important because the debt is paid from the general fund, meaning money spent on debt service reduces funds available for other purposes. And lower debt generally brings lower interest rates, also lowering debt payments.

The good news is that the debt as a percentage of the state general-fund budget revenue has dropped. Its pegged at 7.7 percent in fiscal 2013-14, which began July 1, down from 8.8 percent in fiscal 2012-13. Its also well below the 8.9 percent projected in last years report, and much lower than the 9.8 percent projected for this year in the 2009 report, during the Great Recession. So, the recovery has helped in this area.

Almost all these bonds were authorized by voter-approved ballot measures, i.e., school and water bonds.

But there are problems. This years 7.7 percent number still is above the 6 percent long considered prudent by bond advisers. For example, when then-Gov. Arnold Schwarzenegger campaigned for his package of bond measures in November 2006, he promised, I think it is something I am more comfortable with if we stay around 6 percent or below that ceiling.

It turned out that, because of the Great Recession, the bond debt percentage number for 2010-11 rose to 7.1 percent; and in 2011-12 to 7.9 percent.

The dollar numbers also are telling. Bond debt was $82.6 billion in 2010-11, then rose to $98.2 billion in 2011-12. How can a 19 percent increase in debt not have brought an equivalent increase in the debt ratio? Orange County Supervisor John Moorlach pointed to the $7 billion Proposition 30 tax increase from a year ago. He told us, Why is the ratio going down? Because the revenues are going up. So your percentage goes down.

While this may seem like a good thing, we often have pointed out that tax increases dampen overall economic activity. And Californias revenues, because they are based so heavily on income and capital-gains taxes, notoriously fluctuate wildly. When the next recession strikes, that debt ratio figures to rise greatly.

Meanwhile, prudent policy dictates delaying new debt of any kind. First on the list to be postponed: more bonds for the controversial High-Speed Rail project. Of the $9.9 billion that can be spent, so far only $703.5 million is outstanding, Mr. Lockyers office told us. The rest should wait at least until the debt ratio drops to no more than 6 percent.

FIVE-YEAR LOOK BACKS

October 17

2003

Rich Saskal of The Bond Buyer covered a debt issuance topic in Orange County Pension-Bond Plan Sparks a Bad Case of Dj Vu. A couple of observations. The first is that youll observe that I have been consistent on my concerns about the pension system for quite some time. I believed then, and do now, that long-term pension obligation bonds (POBs) are a gamble. If the County had issued POBs at that time, 20 percent of the proceeds would have been wiped out in the liquidity crisis of 2008. This would have fulfilled my stated concern about watching the funds disappear inside of the pension system, yet still having the fixed debt outside of the system that is due to the bondholders. Sometimes in life, the decision not to do something is the much better one.

A proposal to issue pension obligation bonds has come under fire in Orange County, Calif., where memories of the county’s 1994 bankruptcy remain strong.

Thomas Beckett, the county’s public finance manager, reportedly has proposed issuing more than $300 million in pension obligation bonds to shore up the Orange County Employees Retirement System.

The county’s auditor-controller David Sundstrom and Treasurer John M.W. Moorlach both criticized the proposal.

"The volatility of the market at this time makes it a very, very uneasy bet," Sundstrom said. "If Orange County were flush it might be a better bet, but right now I’m not sure it’s the time for the county to be entering into these transactions to solve a short-term budgetary problem with a long-term liability.

Moorlach and Sundstrom are nonvoting members of the countys Public Finance Advisory Committee, which must approve debt proposals before they to the county board of supervisors.

That committee has discussed the pension bond plan but hasnt taken any action, said Diane Thomas, spokeswoman for the county chief executives office. She declined to provide any further details about the proposal.

According to a county report, the pension plans unfunded actuarially accrued liability was $734 million at the end of 2002.

Moorlach said the market timing is poor for a pension bond issue. Under the proposed plan, Orange County would borrow money by issuing taxable bonds in hopes of getting a sufficient rate of return on the invested proceeds to cover debt service and make a profit for the pension fund.

Even though the pension plan has reduced its expected rate of return to 7.5% from 8%, for the pension bond arbitrage to work the county has to gamble on sustained high returns from the stock market, Moorlach said.

If we put another $370 million into the plan now, its just not going to meet the reduced interest rate earning expectation, he said.

Moorlach came to prominence as a critic of former Orange County Treasurer Robert Citrons investment strategy before it went awry in the early 1990s, provoking the countys historic bankruptcy filing in 1994.

The filing, the nations largest municipal bankruptcy, came after Citrons highly leveraged county investment pool suffered a $1.8 billion loss because of rising interest rates.

Moorlach says pension bonds, like Citrons investments, involve risk.

Weve seen cities and states issue pension-obligation bonds and watched money disappear inside the plan, Moorlach said. And you still have the debt.

Sundstrom makes a similar analogy.

I kind of equate it to my own financial situation and whether or not Id mortgage my own house at 90% loan-to-value just to go out and dump all that money into the stock market. Obviously, I wouldnt, and most people wouldnt, he said. I do not think its a good idea necessarily to borrow money to make money.

Like many pension plans, Orange Countys was hurt when the stock market started falling in 2000.

The county also gave public safety employees substantial retirement boosts when the market was riding high. Those benefit enhancements were responsible for 47% of the unfunded liability, according to the countys report.

As a result, the countys retirement costs more than tripled from fiscal 2002 to 2004, from $39 million to $150 million, with another $45 million increase expected next year.

Moorlach believes biting the budgetary bullet is a more appropriate response than issuing bonds.

Start making the cuts, he said. Deal with life as it is instead of pushing it off.

A spokesperson for Beckett declined to comment for this story.

Disclaimer: You have been added to my MOORLACH UPDATE communication e-mail tree. In lieu of a weekly newsletter, you will receive occasional media updates, some with commentary to explain the situation, whenever I appear in the media (unless it is a duplication of a previous story).

I have two thoughts for you to consider: (1) my office does not usually issue press releases to get into the newspapers (only in rare cases); and (2) I do not write the articles, opinions or letters to the editor.

This message should appear at the bottom of every e-mail you receive. If these e-mails should stop arriving in your mail box, it will be because your address has changed and you did not provide a new one. If you do not wish to receive these e-mails, then please e-mail back and request to unsubscribe.