MOORLACH UPDATE — Gov. Brown’s End Game — January 26, 2018

Before Hurricane Maria hit the territory of Puerto Rico, it was experiencing a massive out migration and was imploding due to high debts.

For those of you who heard me share my PowerPoint presentation at one of several speaking events last summer, here is a quote from the New York Times I shared:

With its creditors at its heels and its coffers depleted, Puerto Rico sought what is essentially bankruptcy relief in federal court on Wednesday, the first time in history that an American state or territory had taken the extraordinary measure.

The action sent Puerto Rico, whose approximately $123 billion in debt and pension obligations far exceeds the $18 billion bankruptcy filed by Detroit in 2013, to uncharted ground.

While the court proceedings could eventually make the island solvent for the first time in decades, the more immediate repercussions will likely be grim: Government workers will forgo pension money, public health and infrastructure projects will go wanting, and the “brain drain” the island has been suffering as professionals move to the mainland could intensify.

Shortly thereafter, Puerto Rico was able to obtain special legislation from the U.S. Congress to enter a Federal Bankruptcy Court. Amazing. So, the largest U.S. bankruptcies are as follows: Puerto Rico, Detroit, Michigan, Jefferson County, Alabama, and Orange County, California (we have dropped to fourth place, after holding first place for some seventeen years).

California, Puerto Rico is your future. California, take a good look at the end game. Bondholders, be forewarned.

Three major cities in California filed for Chapter 9 bankruptcy protection to address their financial distress: Vallejo, Stockton, and San Bernardino. Not one of these three cities had the will to modify its pension liabilities, although the Federal judges in all three venues informed them that they could. Why didn’t they? Because they were worried about having future hiring efforts jeopardized (and “mother” CalPERS put an immense amount of pressure on them).

Federal Judge Rhodes handled the Detroit bankruptcy and had retirees take a haircut, thus reducing their retirement benefits. There is a way to restructure pension debt, there just isn’t the will. Bloomberg Markets covers this sad chapter in a profound way by stating that municipalities with large unfunded pension liabilities may follow Puerto Rico’s path. It’s the first piece below.

Yesterday, Governor Brown gave his last, theoretically, State of the State Address. I was there and led the applause when he mentioned his minor efforts at pension reform and wanting to address forest fires. But, I also moaned when he insisted that he loved trains, especially electric ones. And, I wanted to vomit when he jested about the Bay Bridge and that it went $6 billion over budget on a $1 billion budget, and that these things happen. What a sad testimony and indictment of the ability of Caltrans and this state’s transportation management team to have a Governor joke about budget overruns (also see MOORLACH UPDATE — Bay Bridge Bloat — October 29, 2015 october 29, 2015 john moorlach).

So, I provide my thoughts on this last, yet historic, speech by the Governor who signed my college diploma on the second day of January, 1978 (Jerry, thanks for the forty year relationship). It’s the second piece below and received the top-of-the-fold placement in the FlashReport.

TONIGHT: I have a District fund raising event at 5:30 p.m. I would love for you to attend and to invite as many of your friends that are concerned about the direction of this state to participate. We’ll provide you with a taco dinner and special surprise guests.

Former Costa Mesa Mayor Steve Mensinger and current Costa Mesa Councilman Jim Righeimer are the hosts. We’re enjoying a great response to visit the Mensinger Lodge and you will be glad that you attended.

For a copy of the invitation and an easy way to RSVP, please go to

Puerto Rico Wants to Stall Creditors. That Went Badly in 1842

By Amanda Albright

  • The plan revives a tactic surpassingly rare in a placid market
  • Municipalities with $1.7 trillion pension burden seek an out

Puerto Rico may pave the way for struggling U.S. cities and states to bite the hands that fed them billions.

The U.S. territory says it can’t pay any of the estimated $17 billion due to bondholders in the next five years. If the gambit is approved by a federal financial control board and kept in place once it emerges from bankruptcy, it would be the first time a major municipal borrower formally suspended debt payments since New York City’s 1975 fiscal crisis.

That could make it easier for some of America’s most troubled cities and states — among them Chicago, Illinois, New Jersey, and Connecticut — to try the same maneuver in the years ahead. Such a step would provide relief for places struggling with pension obligations and moribund urban economies, but could cripple their ability to improve infrastructure and pay for new services. And it would threaten the viability of a $3.8 trillion market generally thought of as the safest investment behind Treasury bonds.

“When you’ve got unfunded liabilities in which there is no way to ever catch up, you wonder what’s the end game,” said Marilyn Cohen, chief executive officer of Envision Capital Management, who has worked in the municipal market since 1979. “The end game won’t be pretty for bondholders, that’s for sure.”

‘Matter of When’

Puerto Rico is idiosyncratic, given that its special territorial tax status made Wall Street eager to fuel a $74 billion debt binge despite a declining economy and population. Indeed, the number of municipal defaults — excluding those made by the island — reached an eight-year low in 2017. No city or town has filed for bankruptcy protection since August 2015, and states don’t have the ability to have their debts dismissed in federal court.

The market is sensitive to any possibility that Puerto Rico’s suggestion of a moratorium might spread. In 2010, banking analyst Meredith Whitney incorrectly predicted “hundreds of billions” of municipal-bond defaults, causing one of the steepest selloffs in the municipal market in the past decade.

State and local governments face a $1.7 trillion debt to their pensions, a debt that is difficult for politicians to rein in if they don’t deeply cut spending or hike taxes. In 2015, the Illinois Supreme Court struck down a 2013 pension overhaul, saying it violated the state constitution’s ban on reducing retirement benefits. Other states have similar protections.

States can’t file for bankruptcy protection, and when the idea of giving them that option was raised after the last recession it was roundly dismissed by U.S. lawmakers and governors of both parties. But some governments need a way out, said John Moorlach, who was treasurer of Orange County, California, which filed its own record-setting case in 1994.

“There are ways to get out of the situation,” he said. “It’s just the will.”

Breathing Room

Puerto Rico isn’t the first to try a debt-payment moratorium. New York lawmakers in 1975 allowed the near-bankrupt city to stop making payments on short-term notes for three years. An appeals court declared the measure unconstitutional the next year.

But the respite allowed the city to fix its finances, said James Spiotto, managing director at Chicago-based Chapman Strategic Advisors LLC, whose firm advises on municipal restructurings. The state created a vehicle that allowed the city to tap the capital markets again and it operated under a control board similar to Puerto Rico’s.

In the 1840s, eight states and one territory defaulted on their debts. Florida, then a mere territory, repudiated $4 million in bonds in 1842, according to the National Bureau of Economic Research.

It took Florida over 10 years to borrow again, Spiotto said. For that reason, he said he doesn’t think municipalities will follow Puerto Rico’s suit because having the ability to borrow cheaply is essential.

“It’s been greeted by the market harshly,” he said.

Paying Paul

States and cities are already taking at least one page out of Puerto Rico’s playbook. The island built up its crushing debt by borrowing to pay off older debts, like using one credit card to pay off another.

After a political standoff left Illinois without a budget for two years, the near junk-rated state borrowed $6 billion in October to pay off the $16 billion in unpaid bills it accrued from that time without a spending plan. Pennsylvania, which has seen its credit rating slide over the years due to high debt and pension costs, will borrow more than $1 billion next week to help close its deficit. Houston took on a $1 billion obligation in December to close the debt it owes to retirees, a practice widely frowned upon.

Puerto Rico gives a “big warning sign” for states and cities with large debts, poor financial management, and unfavorable demographic trends, said Jeff Timlin, managing director and portfolio manager at Sage Advisory Services, which oversees about $1 billion of municipal bonds.

“This isn’t a widespread problem, but there were no problems a decade ago in the muni market,” he said. “We’re starting to see municipalities trending in a direction leading to their own demise.”

The Real State of the State: Gov. Jerry Brown leaving California bankrupt and homeless

Posted by John Moorlach

Gov. Jerry Brown’s State of the State address yesterday, his last of 16, was rather melancholy and underwhelming. Some aspects of the state seem in great shape, such as low unemployment.

But when I look around the state I see something I have never seen before since my family immigrated here from Holland in 1960: a vast homeless population for which there seems no solution. Even the deep recessions of 1974, 1980-81 and 2008-9 never produced that.

Brown has to bear much of the blame, beginning when he first entered the governor’s office in 1975. In that year, according to data from the California Association of Realtors, the median home price in California was $41,600. That was 15 percent above the national median of $35,300.

That small premium certainly was worth it given not just the incredible weather we still enjoy, but great K-12 schools, from which I graduated in 1973; a low-cost state university system, from which I earned my accounting degree at Cal State Long Beach in 1977; and an interstate highway system the world envied.

Contrast that with a median home price in the United States of $207,000 today, according to Zillow, but $504,000 in California – 2.4 times as much. The state’s schools now rank among the worst in the nation. Its roads shatter shock absorbers faster than in any other state, according to TRIP, a transportation research group.

In 1975, Brown insisted, “There is no free lunch…. This is an era of limits and we all had better get used to it…. Small is beautiful.” The latter was a phrase made popular by the 1973 book “Small is Beautiful: Economics as If People Mattered,” by economist E.F. Schumacher and promoted among environmentalists and hippies.

Well, certainly we need to watch spending and balance budgets. But California’s population of 24.5 million in 1975 has soared to 39.4 million today – a 61 percent increase. There was no “era of limits.”

Then, after the great building programs during the 1959-1967 governorship of Pat Brown, Jerry’s father, and Ronald Reagan’s governorship, 1967-75, priorities and power shifted – to the detriment of the everyday people of the state and to the benefit of the political class and environmental activists.

Brown’s flippant, “small is beautiful” attitude also resulted in the cancellation of hundreds of road and highway projects meant to deal with a growing statewide population. There were opportunities to ease the congestion, but his inaction since has led to a state paralyzed by a failing infrastructure. Taxpayers are now assuming the costs of his folly starting 43 years ago as they are taxed over $5 billion a year through gas purchases and vehicle license fee increases. In today’s speech, he boasted about the taxing and spending, and vowed to oppose any repeal attempts.

Also in those years, Brown sharply shifted the state’s political power from its balance among many factions – industry, finance, unions, the public sector – to the public-employee unions. Some collective bargaining rights had been given to city and county unions in 1968 with the Meyers-Milias-Brown Act, signed by Reagan.

But Brown signed the Educational Employment Relations Act of 1976, which gave collective bargaining rights to teachers, turning the California Teachers Association into the most powerful force in the state. In 1977, he signed the Dills Act, which “<href=”#.WmkR066nGUk”>formalized collective bargaining rights for state employees.” And in 1979, he signed the Higher Education Employer-Employee Relations Act, which advanced collective bargaining for University of California and Cal State employees.

These new powers given to public-employee unions meant they sat on both sides of the bargaining table: on one side, representing labor; and on the other side, union-friendly politicians put in office by union campaign contributions. Union power has been busting budgets ever since.

The worst way the unions abused their new powers was to get the Legislature to pass pension spiking in 1999-2000, under Gov. Gray Davis, who earlier had been Brown’s chief of staff. For example, SB 400 of 1999 spiked pensions by 50 percent.

Yesterday the governor thumped his pride in minimal pension reforms. I was hoping to hear something about attempting one more college try to address our failing pension systems in a substantial way. I was hoping to hear more about additional reforms to PEPRA, the California Rule and cost of living adjustments as he has intimated through recent amicus briefs to the Supreme Court.

Instead, we’re left with Brown’s new budget proposal for next year, where he includes $9.3 billion to pay to keep CalPERS and CalSTRS solvent. And that’s just a start of future payments that will chew up the state budget, as similar pension spiking chews up city budgets and grinds their services to a halt. Expect to hear more cities utter the “B” word soon.

Brown persists in wasting billions on the bullet train that just this last week has been shown, again, to be dramatically over budget. The great train boondoggle also just sparked a bipartisan request in the Senate for a new audit. And he invoked the Bay Bridge and its $6 billion cost, which should only have cost $1 billion, by stating “budget overruns happen.” That may have sounded cute, but it was not funny.

The California Environmental Quality Act was passed in 1970 under Reagan with the expectation that narrow environmental review would be limited to major private projects. It has grown into a beast that prevents hardly any construction at all.

During these past seven years as governor, Brown has expended almost no political capital to reform what has become an immense regulatory burden on constructing new homes. Exceptions have been, not to ease the construction of housing for the middle class, the poor and the homeless, but to build the new NFL stadium in Los Angeles and Sacramento’s new arena for the Kings basketball team – playgrounds for millionaires.

Kerry Jackson of the Pacific Research Institute wrote January 14 in the Los Angeles Times, “By some estimates, California energy costs are as much as 50 percent higher than the national average.” All that “green” energy – duplicative power and transmissions for solar and wind for when the sun doesn’t shine and the wind doesn’t blow – aren’t free.

In the meantime, our state burns and the powers that be would rather you pay more in food, transportation and housing costs for their vanity projects, whether it means paying climate taxes or funding out-of-control costs for a train that is stuck on the tracks.

Jerry preached electrifying our cars and bragged about cap-and-trade. But the fires caused by electric power lines and transformers wiped out all of his greenhouse gas reductions. He expressed a realization and offered up the formation of a fire advisory committee. This is scores of lives too late. He should have offered up cap-and-trade revenues to focus on mitigating the causes of wild fires and mudslides.

Brown recalled that, when he again sat in the governor’s chair in 2011, our state was branded with such epithets as “Coast of Dystopia” and “the Ungovernable State.” And he touted the state’s economic comeback, with low employment, 2.8 million jobs created and record profits, stock values and revenues for the state treasury.

But surely he knows the main cause of the state’s prosperity is the national economic boom, which has intensified under President Trump, who enacted the tax cuts Brown and state Democrats, especially House Minority Leader Nancy Pelosi, have criticized. In the 2016 election, by 4 million votes California voters preferred Hillary Clinton, whose planks included massive tax increases that by now would have sparked the Great Recession II.

The sad thing is Brown’s missed chance may be the last opportunity California has to righten its fiscal Titanic. His mastery of the budget, immense institutional knowledge, family heritage and well-honed political skills could have been used to enact real reforms. All that will be gone in a little over 11 months.

Under the failed governorships of Gray Davis and Arnold Schwarzenegger, each signed a budget spiking spending 15 percent for just one year (fiscal 1999-00 and 2005-06), leading to $20 billion-plus deficits in recessions. That showed just how powerful the forces of overspending are – even before pensions become a part of the picture. The Democratic frontrunners, Gavin Newsom of San Francisco and Antonio Villaraigosa of Los Angeles, both ran their cities into the ground financially, as new studies are showing. So the future will be bleak.

As the governor takes a victory tour of the state these next 11 months, the cheers he heard today in the Capitol will fade as the realization sets in of the fiscal disaster barreling at us as fast as a Japanese high-speed train.

Sen. John Moorlach, R-Costa Mesa, represents the 37th District in the California Senate.

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