MOORLACH UPDATE — Looking Back, Looking Ahead — December 9, 2019

25th Anniversary Look Back

The media interviews 25 years ago kept coming.  Two of the more special visits are provided at MOORLACH UPDATES — OC Register — December 9, 2009.   

20th Anniversary Look Back

In the 1994 Look Back links, you’ll also see references to December 1999, when I assisted in halting a proposed awkward sale of the 91 Express Lanes.  It’s a great success story for a 20th Anniversary Look Back series. But, I’ll spare you.

15th Anniversary Look Back

Speaking of toll roads, if my May 2009 UPDATEs were on my blog, you would also have seen grist for a 15th Anniversary series.  One where I assisted in halting the merger of the Transportation Corridor Agencies (TCA) and its potential $4 billion refunding (refinancing) proposal.  It included a significant amount of interest rate swaps that would have enriched the underwriters significantly (see MOORLACH UPDATE — OC Register — November 21, 2011) .

Had this sales pitch been consummated, many market experts believe the TCA would have found itself as a Chapter 9 bankruptcy filing candidate as a result of the 2008 liquidity crisis, just like Jefferson County, Alabama.  So you can see, I’ve had some fun over the years. Stopping the TCA merger was another big success.

As you can see, greed still runs rampant in government and with those who are compensated for advising it.  Elected leaders have to watch out for the slick salesmen who will profit handsomely from their “fail-safe schemes.” 

Defined Benefit Pension Plans

Defined Benefit Pension Plans work well if the employer is in existence in perpetuity, the formulas are not changed midstream and realistic investment returns are assumed.

In California, formula changes have been abused through enhancements that have created massive new debts.  Consequently, investment return assumptions have had a difficult time being reduced, as they create larger employer contribution requirements.

The entire globe is now seeing how low-interest-rate returns are impacting overall pension fund returns and it’s not pretty.   As a cautionary tale, these past few days there have been riots in the streets of Paris, France over proposed pension reforms.  

Government employees and taxpayers face a problem with one systemic root cause: an over reliance on what the economy will generate through the yield curve and the equity markets.

Such is the joy of a slick salesman convincing financially naive and, most likely, employee-union dependent elected officials, to modify pension formulas midstream.

The OC Register was kind enough to run my editorial submission on these concerns in Sunday’s Opinion section.

my editorial submission on these concerns in Sunday’s Opinion section.

OPINION

Lessons from Orange County’s 1994 bankruptcy

By JOHN MOORLACH

https://www.dailynews.com/2019/12/08/lessons-from-orange-countys-1994-bankruptcy-john-moorlach/

What lessons have we learned 25 years after Orange County’s 1994 bankruptcy?

The economy controls what the government can do. When local government bureaucrats and elected officials believe they can rely on rosy economic trends, that’s when a fiscal calamity is just around the corner. It’s a classic case of the tail wagging the dog.

It takes a few stumbles by some municipalities before others conclude that trying to be a hero by pursuing higher investment yields in the bond market usually results in a disaster. Investing short-term cash balances should not be a difficult assignment. It’s as simple as keeping funds in a bank or money market fund.

But, when large balances are involved, there’s always a salesperson to entice unsophisticated bureaucrats with the lure of higher yields with a fail-safe gimmick. One technique is known as the carry trade, where one borrows at a low-interest rate and invests in higher-yielding longer-term bonds. However, one should never underestimate the power of the yield curve and the direct economic forces impacting its direction. And, don’t forget, when interest rates rise, the bonds’ value declines.

As a result of Orange County’s embarrassing and costly implosion in 1994, the Government Accounting Standards Board issued pronouncement Number 31 in 1997. It required that municipalities report their cash and other investments at market values in their audited financial statements. This approach, known as marking to market, was something I vociferously advocated during my 1994 campaign to replace Bob Citron, the Orange County treasurer-tax collector whose disastrous investment strategy caused the infamous bankruptcy protection filing.

The investment of surplus cash would also change dramatically around the nation. Portfolio managers would keep their investments short-term, with a weighted average maturity closer to 30 days. Citron’s average durations were measured in years, not days.

Although the nation has not seen a similar investment faux pas matching Orange County’s, it has seen the power of interest rates and the fixed income market. The liquidity crisis of 2008 had a major impact on short-term interest rates and would make well known a new gimmick provided by slick salespeople, “interest rate swaps,” which led to imploding municipalities.

A famous example is Jefferson County in Alabama. It filed for Chapter 9 bankruptcy protection in 2011 as a result of high rates at the short end of the yield curve that increased borrowing costs to the point of making it unsustainable on a $4 billion blended bond issuance. This county, which includes the city of Birmingham, would push Orange County out of first place for the size of a municipal bankruptcy filing.

Three California cities sought relief in a Federal bankruptcy courtroom for old-fashioned reasons: Vallejo in 2010 and Stockton and San Bernardino in 2012 found that pension costs were consuming a massive portion of their annual budgets.

Then there was Detroit, which became the largest Chapter 9 bankruptcy filing in 2013, addressing $18.5 billion in debts, mostly for pensions. That pushed Orange County into third place.

Today we are feeling low interest rates over a historically lengthy period in other investment areas. The biggest casualties are the defined benefit pension plans that have assumed high annual rates of return to provide benefits to retirees. It is difficult to achieve an annual rate of return of 7 percent when, as with most public pensions today, a major component of the portfolio is invested in the bond market. It forces a heavier demand on the equities in pension portfolios to achieve higher returns.

Twenty-five years after the Orange County bankruptcy and the yield curve’s direction is still wreaking havoc on municipalities with unsophisticated and greedy elected officials and union leaders who believed a salesperson who provided a fail-safe gimmick to enhance retirement benefits.

Unfortunately, this time nationally we’re not talking about billions of dollars at risk, we’re talking trillions. So much for assuming you can rely on the economy and the direction of interest rates.

Get ready for more bankruptcy protection filings in the years to come, as the tail does not wag the dog.

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

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