STUMP » Articles » Texas Update: Houston and Dallas Try to Clean Their Pension Messes » 25 October 2016, 17:56

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Texas Update: Houston and Dallas Try to Clean Their Pension Messes  

by

25 October 2016, 17:56

I just banged out a 2K-word article for work and my brain is fried.

So let’s have fun with Spongebob gifs!

(Before anybody from Texas comes hunts me down (love ya, cousins!), all the gifs I’m using come from this Spongebob episode, and the “Dumb Ol Texas” taunts are used to try to rile up a different character on purpose… not really make fun of Texas. Here’s the whole transcript.)

(Are we okay?)

Okay!

HOUSTON: YA WIN SOME, YA LOSE SOME

Houston Firefighters pension fund board OKs mayor’s plan to cut benefits, issue bonds:

Houston Firefighters’ Relief and Retirement Fund’s board voted 7-2 on Monday to accept Houston Mayor Sylvester Turner’s proposal to reduce benefits and issue pension obligation bonds to reduce total liabilities by $3.5 billion, the final city pension fund to do so, said Janice Evans, Mr. Turner’s spokeswoman, in an e-mail.

The Houston City Council will vote Wednesday on the proposal, which adopts a 30-year closed amortization schedule to pay off the $7.7 billion in unfunded liabilities across the pension funds — the $3.8 billion firefighters plan, $4.6 billion Houston Police Officers’ Pension System and $2.5 billion Houston Municipal Employees Pension System.

The mayor’s proposal also includes benefit reductions in the three pension funds that would reduce total liabilities by $2.5 billion, and the city would also issue $1 billion in pension obligation bonds, $750 million of which would be contributed to the police officers’ pension system and $250 million of which would be issued to the municipal employees’ pension plan.

Oh, Houston, Houston, Houston.

Let’s just assume that the $2.5 billion reduction due to benefit cuts really is a $2.5 billion reduction in liability. I don’t want to open that one up right now.

The $1 billion in POBs doesn’t really reduce the liabilities at all. All it does is explicitly make a $1 billion liability for Houston (that it implicitly had to the pension fund anyway). It’s not fixed anything at all.

The thing is, there is still a big liability left in the pension funds, which is still implicitly Houston’s liability. We already discussed how the state of Texas said “Nuh uh, not our liability.”

Maybe Texas ain’t so dumb after all.

I guess I understand why the funds might want the POBs. Not because of the fake arbitrage, but because it really would put Houston on the hook for some of the unfunded liability, which does provide a little more security to the pension funds. But if, after the deal, the POBs are used as an excuse to underpay….

ANALYSIS BEFORE THE DEAL WENT DOWN

Many people have analyzed the proposed deal…. it doesn’t sound that good to me, though perhaps the tinkering makes it less bad.

First, Commentary from Craig Mason at the Houston Chronicle:

Kudos to Mayor Sylvester Turner for stepping up to the plate to address the city’s pension problem. Unfortunately, I think he swung and missed.

His plan has some bright spots – assumed investment returns will be more realistic and the city’s annual contribution to the pension plans will be capped. But, ultimately, the proposal fails to fix the core of the problem, which, quite simply, is this: The city cannot afford the costs of the generous pension benefits for its employees that are embodied in state law.

These generous benefits are epitomized by the benefits received by career firefighters who retired in 2015 and received, on average, an increase in pay upon retirement. Even when considering the risky public-safety work firefighters are called to do, the retirement benefits are extraordinarily lucrative. For instance, the average net annual income of a career firefighter (one with 30-plus years experience) is around $56,000. After retirement, that figure typically rises by a few thousand dollars annually and is supplemented by a very large lump sum payment upon retirement, often approaching $1 million.

Numerous knowledgeable outside objective municipal finance analysts, including The Arnold Foundation and The Greater Houston Partnership, have warned that continuing to support this level of benefits has the city on a path to imminent fiscal disaster.

The city isn’t so far down the hole so as to be hopeless, but any solution must embrace this fiscal truth: Benefits drive the costs of a pension plan. So, any solution to the city’s pension problem must focus primarily on a reduction in future benefits. At a minimum, this must include the provision for automatically increasing benefits after retirement without regard to cost and the costly provision known as DROP (Deferred Retirement Option Plans), which allows retirees to essentially accrue pension benefits while continuing to work. The DROP provision is the source of the lucrative lump sum firefighters typically receive at retirement and has provided long-service police officers with lump sum values at retirement ranging from $1 million to $1.5 million in recent years. These lump sum amounts are in addition to the lifetime annual incomes with guaranteed future annual increases.

…..
The mayor’s plan also includes the issuance of $1.8 billion in pension obligation bonds as a means to reduce the actuarial unfunded accrued liability of the pension funds. This is a very risky transaction as it converts $1.8 billion of the city’s pension liability from a “soft” debt payable to the pension funds to a “hard” debt payable to the bondholders without an appreciable reduction in the city’s overall pension liability burden. It’s somewhat of a shell game, and city taxpayers stand to lose.

Acutely absent from Turner’s plan is any attempt to increase city authority of the pension plans. Currently, the ultimate authority to determine the pension benefits payable to the city’s employees rests with the state Legislature. This is a significant structural flaw, and it’s easy to see why: Most of these lawmakers are not accountable in Houston, even as their action (or inaction) on this issue directly affects Houston taxpayers, and they are unduly influenced by a small group of self-interested plan beneficiaries with an inherent incentive to seek maximum reward for themselves while shifting maximum financial risk to the city.

Okay, sounds like the $1.8 billion was reduced to $1 billion.

The bolded sentence is something that has caused problems in other states, such as Illinois.

From a Rice University blog, an overview of some analysis:

Experts Weigh in on Houston Mayor’s Pension Proposal

Experts organized by the Kinder Institute for Urban Research weighed in Houston Mayor Sylvester Turner’s newly-unveiled pension reform proposal at a panel discussion Tuesday — the same say ratings agency Fitch concluded that Turner’s proposal “could improve the sustainability of the city’s pensions.”

Several measures in the proposal will produce significant cost-savings, according to Turner, but without buy-in from all three pension boards, warned the panelists, challenges to any reforms could be hard to avoid down the road. Notably, while the city’s police and municipal workers have backed Turner’s plan, the city’s firefighters plan has not.

Each of the city’s three pension funds are underfunded, to some degree, and their funding levels have worsened since 2000, in large part due to lower-than-expected investment returns and underfunding by the city, according to a report from the Kinder Institute for Urban Research.

The mayor’s proposal includes both cuts to some retiree benefits and a lower assumed rate of return, as well as a set 30-year schedule to pay off the unfunded liability, which today is around $7.7 billion, according to the mayor’s estimates.

The city would also commit to paying the full contribution amount each year — something it hasn’t done for all three funds in over a decade. It includes $1 billion in pension obligation bonds, and a system of thresholds — right now, not publicly defined — that would trigger further negotiations between the city and the pension boards in the future, depending on changing financial conditions. Notably, the plan does not include a switch to the type of defined contribution plan that is offered to many private-sector employees.

See the bolded piece? They passed something like that in New Jersey. What happened? They didn’t pay the full contribution when it was deemed too expensive. Just like all the other years.

Unions sued. The courts said “tough, ain’t got the money of.” and the undercontributions just add to the liability.

Any way to enforce this promise?

Jon Cassidy: Houston mayor offers half-serious pension plan:

The pension plan that Houston Mayor Sylvester Turner announced last week is about as realistic as Houston can handle right now.

In other words, it’s far from straightforward, but still horrifying enough to scare both the left and the right, neither of which is ready to face the abyss, known technically as the city’s unfunded pension liability.

The truth is that there are still massive property tax hikes to come, along with vicious benefit-slashing for retirees; the alternative is bankruptcy.

Just a year ago, under former Mayor Annise Parker, the city was still claiming that its pension debt was $1.2 billion. Now Turner says it’s really $7.7 billion (hey! That’s just what we said back in January!), so long as the city’s pension funds earn 7 percent returns forever.

Even that’s leaving out $600 million in outstanding pension obligation bonds and $1.5 billion in retiree health care obligations. And Turner’s solution to balance the books involves putting another $1 billion in pension obligation bonds in the leave-it-out category.

Turner’s plan could get the city out of debt if it’s followed scrupulously for 30 years, according to the number crunchers at the Kinder Institute for Urban Research at Rice University. That is, aside from that aforementioned $1 billion in new pension obligation bonds that the Kinder Institute was generous enough to leave out of its calculations, if the city actually comes through with all the heavily backloaded funding the Turner plan requires, it’ll be pretty square in three decades.

That is of course a dubious assumption, given that the city has failed for 15 years in a row to come up with the minimum pension payments required to keep the system sound.

……
On the negative side, Turner is calling for $1 billion in pension obligation bonds, which he said he thinks he can get at interest rates of 3 to 4.5 percent. That’s unlikely.

The market offers rates in the range of 5 to 6 percent for these bonds, which are not tax exempt. That means Houston would take out a loan at rates no better than a decent consumer credit card, and use that money to play in the market, hoping to earn a better return. The police and fire pension funds, however, had a combined return of just 1 percent last year, meaning they would have lost 4 percent or more on any pension bonds.

The Center for Retirement Research at Boston College has studied how these bonds work out, finding that they’re at best a wash. If a city happens to issue them right before the market takes off, it might make a little money.

The lead researcher at the center calls such bonds “pernicious,” and the Government Finance Officers Association recommends against them.

Heavily backloaded funding assumptions?

Oh, I’ve never heard that one before.

So… let’s just call this one … nice try. We’ll see.

DALLAS CONTINUES TO HURT

Moody’s downgrades Dallas’ debt rating again, blaming city’s pension woes:

Credit ratings agency Moody’s knows Dallas city leaders are working to find fixes for the troubled Dallas Police and Fire Pension Fund as they stare down a multibillion-dollar funding hole.

But the agency still saw too much risk and downgraded $1.6 billion worth of the city’s general obligation bonds Friday to AA3 from AA2. Moody’s also changed the outlook to negative on both the city’s debt and Dallas Water Utilities’ debt, fearing an indirect financial hit on that department.

The change “reflects the challenging and complex landscape that the city must navigate to rein-in its growing pension predicament,” according to Moody’s report.
….
But Moody’s, which first downgraded the city’s debt last year, also pointed to the long-term unfunded liability projections of the city’s civilian pension system, the Employee Retirement Fund. The ERF is in better fiscal shape than its public safety counterpart, but will ask voters on the Nov. 8 ballot to approve benefit cuts for future employees to save it from long-term insolvency.

Still, the Moody’s report takes issue with legal limits on the amount the city puts into the fund. The city hasn’t paid its full contribution to the fund since 2009 because it is using the rest of the money to pay off $535 million in pension obligation bonds.

Did you see what I said above about Houston possibly using the POBs as an excuse not to pay pension contributions?

It was based on something that has already happened and happened in Texas, not New Jersey, California, or Illinois. This problem is not special to “blue states”.

More on the Dallas ballot question:

The Dallas police and fire pension board this month asked that city taxpayers contribute more than $36 million to pay for the pension fund’s overhead costs.

Dallas taxpayers may need to ultimately contribute hundreds of millions of dollars in additional funding to keep the pension fund solvent. About $115 million already is contributed to the fund each year by the city.

The $2.39 billion fund may become insolvent by 2028, The Dallas Morning News has reported. It became further unsettled by a rash of recent lump-sum withdrawals by retired police and firefighters wary of the fund’s troubles.

The fund was undermined in recent years by overvalued investments and risky real estate deals.

That’s a simplification, but you can see my prior posts at the bottom of this one to check that out.

GOODBYE CITY LIFE

Texas may be blue, but its cities aren’t necessarily:

Red State, Blue Cities
Will the Texas model become a victim of its own success?

……
Yet for all its success, Houston faces crippling unfunded pension liabilities, a result of its mayors’ obeisance to unionized public employees. On December 31, 2015, the latest date allowed by law, Houston restated its unfunded pension liability for city employees from $1.2 billion to $5.6 billion—a nearly fivefold increase. Houston’s actual liability is even higher—it’s closer to $7.7 billion—if retiree health care and outstanding pension bonds are included. To make matters worse, Rice University’s John Diamond has stated that the city’s 8 percent assumed rate of return is too high; using a more realistic rate, the city’s unfunded liability could be $10 billion, almost twice the city’s annual budget and dangerously close to the city’s net worth. That, on top of $3.3 billion in general-obligation debt coming due, sharply falling oil prices, and a ratings downgrade by Moody’s, has cast a shadow on Houston’s future.

Worse still, reform doesn’t look likely in the near future, since Houston voters, in last year’s mayoral election, elected the candidate pledged to preserve the status quo: Sylvester Turner, a progressive Democrat who ran with strong government-union backing. Turner narrowly prevailed over Bill King, who had run on a plan to institute a defined-contribution pension plan for new government employees. Turner will have a hard time providing basic city services—from fixing potholes to maintaining public safety—in the face of an impending budgetary calamity.

The story of Houston’s pension shortfall, a nearly inevitable feature of the unaffordable defined-benefit plans no longer used in the private sector, is depressingly familiar: politically powerful public employees manage to elect friendly politicians, who then stealthily grant them inadequately funded, overly generous guaranteed pensions that impose staggering liabilities on taxpayers. Local elected officials (with the complicity of hired-gun actuaries) try to minimize and obfuscate the magnitude of these liabilities through accounting gimmicks and rosy projections regarding future investment returns. Ultimately, the extent of the underfunding gets exposed, but usually long after the responsible officials have left office. Taxpayers are left facing sharp tax hikes or cuts in municipal services, or both. In extreme cases, as in Detroit, San Bernardino, and Stockton, cities are forced to file for bankruptcy under Chapter 9.

In Texas, urban fiscal problems aren’t confined to Houston. Dallas faces crippling unfunded pension liabilities, estimated at $5 billion for its public-safety retirement system. The problem arose thanks in part to gold-plated benefits enacted more than two decades ago that allow the city’s police and fire personnel to start collecting pensions after 20 years on the job, even while they continue working and earning a guaranteed return of 8 percent or more on their pension money. The city faces other fiscal woes related to employee pay. Three years ago, Dallas officials restored so-called step-pay increases—automatic annual pay hikes based on years of service—to police and fire workers during negotiations with the union. (Though Texas doesn’t officially have collective bargaining for public employees, city officials can allow unions to bargain with them through a process known as “meet and confer.”) The weight of those extra pay increases is helping to crimp the city’s budget as the Texas economy slows. The city also faces additional costs because last year, it passed a $10.37 minimum wage that it requires city contractors to pay their workers. Prompted mainly by the growing crisis in the city’s pension fund and other fiscal concerns, both S&P and Moody’s downgraded the city’s credit rating last fall.

While everybody else is working off their hangovers on November 9, I’ll be looking for the pension ballot results (and doing another Excel webinar).

And in the years ahead, I’ll be seeing if Dallas and Houston really do clean up their acts.

I do enjoy visiting Texas for business purposes, and it would be a pity if it got eaten up by pension costs just like those Yankee states.

PRIOR TEXAS PENSION POSTS

Compilation of Dallas posts


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