MOORLACH UPDATE — Results-Oriented Government — April 18, 2019

The Reason Foundation had a rather lengthy interview with me about my career in the public sector. The first few questions and the last are provided below. The remainder can be found at https://reason.org/innovators/lone-accountant-in-california-senate-seeks-to-strengthen-states-finances-after-local-successes/.

25th Anniversary Look Back

In the April 19, 1994 edition of the OC Register, a new reporter jumped into the fray. Chris Knap’s piece was titled “Earnings champ takes heat in treasurer race — Government: Orange County Treasurer Bob Citron says he’s being targeted for helping a Democrat.” (At least the incumbent was consistent with his effective partisan defense.) Portions of the piece can be found at MOORLACH UPDATE — April 15th — April 15, 2013.

If you want to get a glimpse of what my life was like during this campaign, I would recommend watching the movie, The Big Short (2015). The credit rating agencies missed the subprime mortgage bundling fiasco, too. And their concerns were used against me by Mr. Citron in his currying media favor (see https://www.latimes.com/archives/la-xpm-1994-04-15-mn-46397-story.html).

Here are the opening two paragraphs and a few selected segments of the OC Register piece:

For more than a decade, Robert L. Citron has been hailed for returning more earnings on Orange County’s government deposits than any other local government treasurer in California – often twice as much.

But Citron now is defending himself against a challenger in the June 7 election. John M. Moorlach suggests that Citron earned these returns by over-extending himself in complicated investments that risk huge losses.

Moorlach said his allies on the [Republican] central committee should not obscure his criticism of Citron’s investment strategies.

Citron and [Assistant Treasurer Matt] Raabe acknowledge that an investment manager can run into trouble with reverse repurchase agreements. If the market value of the bonds used as collateral falls, a dealer will want cash to bring the value of the collateral up to market value. If no cash is available, the investment manager may have to sell bonds at reduced value, creating a loss for the fund.

Diane Brosen, director of short-term debt rating for Standard and Poor’s, said officials from her company met with Citron and Raabe on March 30 and talked at length about the county’s portfolio. “We did not have any cause for concern with regard to the county’s investment strategy,” Brosen said.

For the last 25th Anniversary episode, go to MOORLACH UPDATE — Presenting SB 689 Plus a Dozen More — April 17, 2019.

INNOVATORS IN ACTION

California State Senator John M.W. Moorlach on Results-Oriented Government

Moorlach on how local and state governments can deal with unfunded pension liabilities, spending, debt, outsourcing and more.

By Austill Stuart

https://reason.org/innovators/lone-accountant-in-california-senate-seeks-to-strengthen-states-finances-after-local-successes/

California State Sen. John M.W. Moorlach, a certified public accountant (CPA) by training, started his career in public service in 1994, running for Orange County Treasurer-Tax Collector on the platform that the county’s investment practices would lead to bankruptcy. Although he lost that election, his predictions proved accurate: The county did file for bankruptcy in December that year. After then-Orange County Treasurer Bob Citron resigned, Moorlach served in the post for nearly 12 years, followed by eight years as county supervisor, during which time Orange County was able to emerge from bankruptcy and greatly strengthen its finances.

Since March 2015, Sen. Moorlach has represented the 37th district in Californias’s State Senate, where he has been working to build upon his successes in Orange County to improve the state’s finances.

Reason’s Austill Stuart interviewed Sen. Moorlach on his career in public service, how his accounting background has worked to improve finances in local government, and his plans and challenges for doing the same in California’s state government.

Austill Stuart, Reason Foundation: Looking back to the beginning of your public service, you got involved the 1990s as someone on the outside warning about a possibility of bankruptcy in Orange County that eventually happened, leading you to being appointed as county treasurer. Where did you start trying to right the course on the county’s financial situation? 

California State. Sen. John M.W. Moorlach: Some of the first things we looked at were, should we be outsourcing the investment process? Should we be outsourcing the tax-collection process? And what are we to do with the relationships with outside vendors like the banks, the investment houses and the software underwriters? How do we handle dealing with employees when we needed to downsize?

So one of my first tasks was to reduce my workforce by about 11 percent . You learn quickly that the paradigm in government is not excellence; it’s longevity.  I had to let a lot of wonderful new people go and I was stuck with some of the older people that maybe were not as productive and as innovative, but they were protected by their union. Also, those that had elevated to management did not have union protection, so some really great middle managers had to be laid off. It was really frustrating to deal with the government “last in first out” approach to management.

We looked at the idea of outsourcing our investment process but found it was too costly. Not only was it better from a cost standpoint to hire competent money managers internally, they also were more aggressive in getting better bids than the private sector was. For the idea of trying to outsource the tax collection side of it, that didn’t provide the kind of RFP (Request for Proposals) responses that I was looking for.

There was a firm on the East Coast that was assuming responsibility for collecting taxes for a few counties, but it actually went bankrupt, leaving a lot of counties without the infrastructure to do it internally. We looked at a lot of things, but just letting the staff know we were looking at outsourcing certainly forced them to bring up the level of their game and be more serious that, “Hey, if you want to continue here, we’ve got to prove we can do this cost-effectively and appropriately.” So that was one of the components to what I did to restructure and reform the department. I also worked as just one of many of the officers of the county as a whole to structure a strategy to exit from bankruptcy, so I can’t take a lot of credit. I was just a member of the team.  We worked on ideas and then exited bankruptcy within 18 months.

Then we enacted a lot of other reforms for the whole county. One reform concerned results-oriented government, identifying what our metrics were. What was our job and how do we do it and how do we measure it and compare it to other governments? Or internally? That was a real good process which then led to doing annual business plans for every department, eventually leading to each department completing a 10-year strategic financial plan. So then your business plan and your budget for the next 10 years would fold into the 10-year strategic financial plan. We knew where we were going as a county 10 years ahead, but you were making decisions now that we knew what the impacts would be in the future as opposed to doing budgets every year.

We implemented a lot of fun changes about 12 years later when I became a county supervisor in 2007. We initiated a performance audit department, which did a lot more heavy lifting than, say, an internal audit department. It was more of a managerial function of exploring how certain departments are operating and if they are operating as efficiently as they possibly could, which provided a lot of improvements.

When I became treasurer, we were very transparent and very visible right from the get-go. We had better communication. We did a monthly report as opposed to a quarterly report. We established an investment oversight committee, which monitored the market a lot more closely.  Just trying to calm everything down, trying to calm the markets, trying to get a good rate of return, trying to be innovative in investment style.

At that time, Alan Greenspan was the chairman of the Federal Reserve Board. Our game was, “What is Greenspan going to do next? And how can we anticipate it with the duration of our investment holdings?” We were accurate more than 90 percent of the time. So that gave a little bit of added value in the service we were providing. It was a fun opportunity to manage almost $7 billion in funds for the county and its taxpayers.

Stuart: Did the bankruptcy help you get things done that otherwise may have languished as good ideas that sat on the shelf?

Moorlach:  Well, I put a little note on my credenza that said, “Policies, procedures and oversight.” Our focus: How do we run a good shop post-bankruptcy? Having been through a bankruptcy, everybody knew that we were digging out and had to grab the oars and pull. If that didn’t work for them, then other departments or other careers would be their choice. But we were looking for people that could add value.

For instance, I hired a certified cash manager, who came in and started reviewing the banking relationships with the county and we started saving significant amounts of money quickly because the prior administration was sort of sloppy: We had $400,000 a year in banking costs just for our social services agency. We made some dramatic changes in our working relationship with them that they didn’t like at first, but then they realized they were not to be subsidized by every other department in the county. We had a lot of fun getting people to rethink things.

We had a lot of fun getting industry to rethink how they dealt with governmental business. Orange County had 50,000 welfare checks to pay on the first of the month. Most banks didn’t want those people in their banks on the first of the month.

But instead of giving them the checks, why don’t we just give them positive pay cards through the point of sale opportunities and just swipe it through at ATM machines or at grocery stores, etc.? That was a fun exercise, but at the end of the day, we realized the cost savings alone weren’t going to be enough.

But the banking industry knew we were looking because they heard about our efforts with the Federal Reserve Board and the state banking agency. It made them step up to the plate and be a little more cooperative. It provided a little bit of leverage that we weren’t afraid to look outside the box to get something resolved.

We had to really work with industry to rethink what they were going to do in their roll in servicing government work if they wanted the business. We had a lot of fun because of the paradigm. We could force certain companies that maybe didn’t do so well in providing good service before the bankruptcy to step it up. We even encouraged one major national software firm that does investment software to give us a contract. It provided the services for $1 for the first year of the contract just to try to set the relationship right.

Stuart:  What kind of challenges did you run into during the dozen years or so that you served as treasurer before moving to the county board of supervisors? 

Moorlach: You certainly run into the public employee union paradigm, meaning you can’t lay off employees that might have been lagging in their ability to provide a good work product. You just had to learn to live with that. You also learn that it would take a pretty thick file of documentation to remove employees that were not producing to the standards that were expected—a little different than the private sector. Other than that, I didn’t have too much trouble improving things.

The California Legislature was really nervous about us making unique kinds of changes. It was coming from me and out of Orange County. They knew we were trying to make appropriate and necessary decisions and not invest in anything scary or risky because we were now the most conservative portfolio in the state. We had fun trying to be innovative.

One idea we pursued was trying to start our own bank because most of the major banks did not want to have welfare recipients in their branches. How could we issue 50,000 checks on the first of the month?

Stuart: Was there a limit as to how far you could push reform serving as treasurer or treasurer-tax collector?

Moorlach:  There was. When you saw your Board of Supervisors making certain decisions, it was frustrating to say, “Hey, what you’re doing may put future boards in jeopardy because of the financial impact of the policies you’re approving.”

One example was granting retroactive pension benefits, effective 2002, to the date of hire with an improvement of the benefit just because there was a dot-com boom. It was distressing to me and it was one of the few major reasons for me to leave the treasurer position and run for supervisor to see if I could at least do some damage control after the votes were already cast. Because once you give a pension benefit enhancement, you can’t take it back. And, at the time, I was screaming, “This is a lobster trap that you’re walking into. You can walk into it, but you can’t walk out, so don’t do it!”

Three of the five supervisors, all Republicans, voted for another pension increase for the rank-and-file. That’s when I announced I was going to run for supervisor in 2006 because I’d rather be on the dais and at least lose 4-1 than to watch a 5-0 vote on some of these inappropriate fiscal decisions because a lot of elected officials are not business majors or defined-benefit pension plan students. But I had the privilege of serving on the retirement board for the county for close to a dozen years. Certainty, I had my share of actuary presentations to understand how a defined­-benefit plan works. That was a reaction to a dilemma that most of California and the nation face.

Stuart: You’ve said that pensions were a major issue for you in deciding to make the leap over to the county board. Can you maybe explain a little bit more about that issue and what motivates you?

Moorlach: What I decided to do was leave a position that paid a lot more than the county supervisors earned and it was not subject to term limits, which was one of the things a supervisor is subjected to. They are only allowed two terms, so we had to jump in and start swinging right away with a long list of ideas we wanted to implement.

One of the first things we did was address retiree medical care. The county had an unfunded liability of $1.4 billion. We were able to negotiate with the bargaining units. They agreed to make a number of significant changes, which resulted in a 71 percent reduction in the unfunded liability: from $1.4 billion to $412 million, about $1 billion dollars. If we could do the same at the state level, we could reduce an unfunded liability by about $50 billion dollars. It was a great opportunity to attack at that level. Then we had to deal with all the legal onslaughts of “hey, you can’t do this,” because it’s treated as a vested right. We had to go through all the expense and time to have judges rule that the changes were allowable.

Another area we took on: was that, The California Constitution states, in two sections, you have to retire debts in the year they are created. If you can’t pay it off in that year, then you have to get two–thirds voter approval. So we sued the deputy sheriffs, who received the 50 percent increase in their pension benefits. Their pension formula went from 2 percent at 50 to 3 percent at 50. That means 3 percent of their final salary times the number of years on the job. The deal was made retroactive to the date of hire, so their benefits went up dramatically. If they were going to retire before the change with $100,000 salary after 25 years, they were going to get $50,000 a year if they retired. But if they waited a few days for the new formula to kick in, they would have received a pension of $75,000 a year.

The plan had not been actuarially funded for that massive increase, so we said that’s a debt. When you take a fully funded pension plan and you improve the benefits by 50 percent overnight, your plan becomes 2/3 funded. We said the whole one-third is a new debt, liabilities that have to be paid by future boards.

We took that to the local Orange County Superior Court. The forces against us had it moved to an L.A.-area court. Superior Court judges must go up for election every six years. The decision had very poor citations. And when asked how she came to this conclusion, her response was, “Well I’m looking forward to your brief when you file it at the appellate level.” We fought it in the Appellate Court in L.A. on constitutional grounds.

The unions put up a lawyer by the name of Miriam A. Vogel, who had just retired from the appellate court, and who greeted her former colleagues at the court, “How ya doing, how’s it going?” Her position was simple: “They’re going after my pension and they’re going after yours” – and she sat down. In less than two weeks, the Appellate Court ruled the liability was not a liability, but an estimate, though we’ve got an amicus brief from accounting professors from around the nation saying it was a liability.

Then we took it to the California Supreme court, only to have new Chief Justice Cantil-Sakauye, whose husband was a police sergeant soon to retire. They decided not to hear our case, so we lost that battle. Very unfortunate, as we could have saved the state and local municipalities a boatload of grief, burden and money. Gov. Jerry Brown and I had a conversation about the case, and he realized that granting retroactive benefits was crazy. And so, in his Public Employee Pension Reform Act of 2013 (PEPRA), he put a specific provision that they could not grant retroactive benefit increases, so at least we got a little consolation prize.

Another thing we did in 2009, not too long after I got on the board, was address new tiers for new hires. We were probably the first county in the state to do that, which is now common practice with PEPRA. We also set up a new plan, a hybrid, that was partially defined-contribution and partially defined-benefit, but at a much lower formula than what was being offered. This would be available to new and existing employees. However, for current employees, we found ourselves fighting an Internal Revenue Service ruling. If there’s ambiguity in the tax code, the IRS will issue a Revenue Ruling to clarify their position.

Ours was Revenue Ruling 2006-43. The U.S. Treasury was unwilling to change its position, which was basically that you only have one choice—whether or not to make the pension plan selection. Providing a new lower tier was a second choice, and that would disrupt the deductibility of the contributions and the taxability of the pension benefits, by jeopardizing the tax-exempt status of the retirement trust.  So it would be taxable, as pension payments were being contributed; as opposed to when the pension benefits were being received later on in retirement.

We tried to convince the U.S. Treasury and the IRS to change, but we found the national public employee unions were pretty strong and were lobbying the IRS and the U.S. Treasury just as aggressively, if not more than we were. When you deal with the AFL-CIO, the American Federation of State, County and Municipal Employees and the SEIU at the national level, it gets even more interesting. But at least we had a solution for allowing current employees to opt out to a lower pension formula, which would have been a lot of assistance in lowering unfunded liabilities for the county. That’s still being lobbied and addressed even as we speak.

We took on a lot of things that are now kind of normal. But we were very innovative in Orange County in my two terms as a supervisor in starting the conversation and moving the ball forward and encouraging others to do the same.

Stuart: You’ve now had 20-odd years or so in public service pushing for reform. What are some lessons learned and what advice would you offer to those who might be following in your footsteps getting into government today, especially with respect to how to push reform and the limits of doing so?

Moorlach: I would love to challenge individuals with MBA’s and CPAs and CFPs and other professional designations. To think about running for elected office, which means they have to make significant sacrifices in family time and earning capacity to help their fellow citizens. We need a lot more fiscal brains in elected office. People that really understand how balance sheets and income statements work and can analyze a budget. I’d love to encourage people with fiscal backgrounds to get involved.

A lot of accountants tend to be kind of quiet and introverted individuals. They’re not really accustomed to a public limelight. I would say, if you have that skill set, you are desperately needed to be the adult in the room when it comes to a lot of the financial silliness that’s occurred because of pensions and other promises being put in the shadows and now finally coming out to the light of day.

I would add that it’s a big chore to step up and disagree with public employee unions—be prepared for an unpleasant campaign. Take heart in spite of all the negative mail, TV commercials and all the other things you might have to endure, you’re a part of the solution for resolving and reforming government so that we don’t give a massive debt to our kids, our grandkids and our great-grandkids. Because, by doing nothing, this nonsense just continues.

We must educate critics to help them understand that they’re not going to be able to pursue their programs if they don’t pay attention to the nickels and dimes as they’re putting their budgets together. There are trends. You need to watch the trends and what they’re doing to push other programs out. That’s the job—trying to message and communicate so they understand the ramifications of their decisions.

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