Houston Business Community Needs to Take Principled Stand on City’s Pension

I find it incredible that some elements of the Houston business community are still considering endorsing the pension “reform” plan that has been proposed by Turner.  Before getting too far off in the weeds on the details of the plan, let me pose five questions regarding this issue.
    1.  Do you think that the City should commit to maintaining defined benefit pension plans for the next 30 years, which will add tens of thousands of new employees to this broken financial model?
     2.  Do you think that the City should commit to 32%, and perhaps up to 37%, of its payroll to the pension system for the next 30 years?
     3.  Do you think that the City should commit 50% of the property taxes it will collect over the next 30 years to the pension system?
     4.  Do you think that the City should issue $1 billion of pension bonds, which will be the largest bond issue in the City’s history, without voter approval?
     5.  Do you think the City’s property tax cap should be repealed?
   If you disagree with any of these five propositions, then you should be opposed to Turner’s plan because each of them is a critical element of it.  While the property tax cap is not formally part of the plan, it is impossible to pay for it, even in the short-term, without the repeal of the cap and, of course, Turner has said that he intends to put the repeal on the ballot in November.
If you need more reasons to oppose the plan, consider the following:

     1.  Turner has claimed that there will be $2.5 billion in savings from the plan from benefit reductions and increases in employee contributions.  However, the City has refused to release the calculations from which these proposed savings were derived, notwithstanding the repeated requests to do so by third parties attempting to vet the plan.  From the limited information we have, most of those familiar with the plans have been unable to generate a number anywhere close to $2.5 billion.  Craig Mason, the City’s chief pension officer under Bill White, has flatly said the changes to the plan will not generate $2.5 billion in savings.

     2.  No drafts of the proposed legislation have been made public.  A secret draft of the legislation for the police has been circulated to some select organizations but not made available to the public.  Apparently some Houston residents are more important than others.  This week the City refused to release the draft of the police bill claiming it was exempt from the Open Records Act.  Of course, the mere fact that a “secret” draft is being circulated tells you all you really need to know about this process.   How can any organization or individual endorse the “plan” without the actual legislation being released to the public?

     3.  The only potentially redeeming feature of the plan is the so-called “corridor” which would limit the City’s contribution to 37% (as absurd as that level is).  According to the term sheets, once the contribution goes above 37% of payroll, the pension plans would either reduce benefits or increase employee contributions.  The problem is that the enforcement mechanism for even this minimal protection for the City has never been defined.  What exactly happens if the pension systems do not make the specified changes is anybody’s guess.  That kind of vagueness and the inherent complexity of such a mechanism virtually guarantees that the pension systems and the City will be in litigation for decades.

    4.  The plan uses a repayment schedule that negatively amortizes the pension debt for about the first six years.  Conveniently, the payments begin to dramatically ramp-up after the current administration will be out of office.  At the end of the 30-year period, the annual pension payments would be over $1 billion.

  Some have expressed the view that the current situation is so dire that any improvement is better than nothing and that since this is all Turner is willing to put on the table, the business community should support it.  Of course, it is remarkable that the business community now has so little influence that a mayor can now dictate terms to it.  But laying that embarrassment aside, a bad deal is not better than no deal.
    If there are no changes to the pension plans this session, the City’s payments will rise by about $200 million annually over the next two years.  That means the City will have to tighten its belt, which is not a bad thing.  And the higher payments will actually help shore up the plans’ financial condition.  But even more importantly, a little financial pain may pave the way for real reform in two years.  If Turner’s plan is adopted, real reform will be dead until the payments escalate beyond the City’s ability to cover them, probably ten years or so hence depending on whether the property tax cap is repealed.
    As many of you have heard me say repeatedly over the last ten years, there is no pathway to true reform of the pension system without a plan that phases out defined benefit plans.  Had the City started moving new employees to defined contribution plans ten years ago as many of us suggested, we would not be facing the crisis now before us.
    This plan, to the extent we can even discern what it really entails, is not true reform.  It is a complex shell game that does little more than kick the can down the road to the next administration.  It will make the City a financial cripple for the next 30 years and I believe will set off a downward spiral in City services that will hollow out Houston’s core much like we have seen in other cities.
     Houston’s business community failed our City by not being on top of this unfolding disaster over the last two decades.  Let’s not compound that omission by endorsing a plan that none of us would even vaguely consider for our own businesses.  It is frankly inconceivable to me that any serious business person or anyone who claims to be a fiscal conservative can even consider supporting this “plan”.
     It is time for our business community to make a principled stand and get our City back on the road to true fiscal responsibility.  That means some transition to defined contributions plans.  Anything short of that is not true reform and should be soundly rejected.

Happy New Year from the City of Houston: We’re Insolvent!

     It has become standard bill of fare for the City of Houston to hold the release of its annual audit until sometime between Christmas and New Year’s Day, hoping that the awful news normally contained therein will go unnoticed by the local media, which it normally does.
     Holding true to form this year, the City dropped its audit for the fiscal year ended June 30, 2016 on the internet late in the day on Friday, December 30, notwithstanding that the auditors signed off on the report a month earlier on November 30.  You may recall that last year the City released its audit, which had been completed on December 2, at 4:00PM New Year’s Eve, which was also conveniently after the December 12 City run-off elections.
     The headline news from the report is that the City is now officially technically insolvent, that is, the City’s liabilities exceed its assets.  According to the report the deficit is a little under $100 million, although the real number is much larger (more on that in a moment).  The fact that the City was, for the first time in its history, insolvent was timely reported by the Chronicle.  [click here]  But unfortunately, the story also included the swill from Turner and our financial watch-dog turned lap-dog, Chris Brown, that the City going insolvent really was not that big of deal and that the solution to the City’s fiscal woes is to double down – for another 30 years — on the defined benefit pension system that got us into this mess.
     Turner was quoted as assuring everyone that the City had $2.5 billion of cash on hand, plenty to pay all its bills.  That is, of course, if you don’t count the $8 billion of pension bills the City has accumulated in the last fifteen years.  Nor does he mention that about 90% of that money is tied up in restricted accounts that are not available for regular expenses.
     There are hundreds of pages in the report, so there is much yet to be unpacked.  But here are some of the things that jumped out at me in the few days we have had to examine the reports.
     1. Are we insolvent by $100 million or $2 billion?  One of the more bizarre and deeply troubling aspects of these reports is that they continue to assume that our pension plans will earn an 8-8.5% rate of return indefinitely.  Of course, these assumptions are absurdly unrealistic.  Last year the plans, on average, lost about 2%.  It appears that the fire fighter plan assumption of 8.5% is the highest in the country and the only plan to continue to perpetuate this fantasy.  None of the other 10 largest cities in the country used a rate of 8% or higher in their most recent audits.  Even Turner has admitted as much by proposing lowering the rate to 7% in his new pension plan.  The police pension plan dropped its rate assumption last year to 7% and then arbitrarily raised it back this year to 8% notwithstanding it lost over 3% last year.
     The difference is not trivial.  Buried deep in the notes to the report is a schedule that shows the effect of lowering the plans’ assumption by a mere 1% on the city pension debt.  That small change balloons the pension debt from $6 billion to about $7.8 billion.  If the auditors had used Turner’s new numbers, the pension liability would have swollen to over $8 billion.  In other words, if the auditors had used the new assumptions proposed by Turner, the City would have been insolvent by over $2 billion instead of the $100 million it has officially reported.
     This kind of cherry-picking assumptions out of thin air allows the City to manipulate its audit results.  It is difficult to understand what the auditors were thinking about when they signed off on these absurd assumption.  Generally speaking, auditors are supposed refuse to issue a “clean opinion”if their client’s assumptions are patently unsupportable.  In their transmittal letter, the auditors specifically state: “Government Auditing Standards . . . require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.”  How is understating the amount of the City’s insolvency by 20-fold by using assumptions everyone agrees are not realistic not a “material misstatement” of the City’s financial condition?
     2. “Elite” Club of Bankrupts.  One of the City’s other favorite propaganda lines is to suggest that its financial woes are typical of other cities around the country.  Well, not so much.  I have looked at the latest financial reports for the 30 largest cities in the country.  While it is hard to compare the financial statements of one city to another, all must report their “net asset” position.  I have only found six others which are technically insolvent (New York, Chicago, Philadelphia, Jacksonville, Indianapolis, and Boston).  To be fair Baltimore has not issued an audit on the internet for over two years and is almost certainly insolvent.  Also, Dallas and El Paso will probably join the list when their reports are issued later this year as both are struggling with crippling pension debts as well.
     However, many other cities like Los Angeles, Charlotte, Seattle, Phoenix, San Antonio and San Francisco are still very much solvent notwithstanding their own pension issues.  So, while it is true that virtually every large city in the country today is struggling with financial issues to one degree or another, Houston’s predicament places it among those with the most grave fiscal challenges.
     3.  The Police Pension $676 Million Flip-Flop.  One truly amazing entry on the City’s books this year is a write-down, that is reduction, of the City’s debt to the police pension plan by $676 million due to “assumption changes.”  It appears that this is the result of police pension changing its investment assumption for 8% to 7% last year and then going back to 8% this year.
     Now just think about this for minute.  The amount that taxpayers supposedly owe just one of the pension funds changed by $676 million in one year purely on the whim of some nameless actuaries and a pension board which is mostly elected by the pension members.  By the way, that change is equal to more than half the property taxes collected by the City last year and about 15% of the total pension liability for that plan. And the taxpayers, rank-and-file police officers and even City Council had absolutely no say in the matter.
There cannot be a clearer example of the vagaries of the costs and debt associated with defined benefit pensions and the utter hubris that we can predict investment returns and demographics that will ultimately determine the true cost of these plans over the next 30 years.  This is why Turner’s plan to double down on defined benefit plans for another 30 years is such a dangerous idea.
     4.  Other Metrics
Here are a few other comparisons to the previous year noted in the report:
Total Revenues: Up 3.4%.
Total Expenses: Up 5.6%.
Amount Expenses exceeded Revenues: $288 million or 6%.
Increase in Total Debt: $820 million (larger than any bond issue ever approved by City voters).  Had it not been for the police pension’s flip-flop on its rate assumption, the increase would have been $1.5 billion.
Miles of Streets Resurfaced: Down by 42 (152 vs. 194, 28% decline).
Tons of asphalt used for pothole repairs: Down by 2,842 (13,130 vs 15,972, an 18% decline).
I expect to have more to say about the annual reports for the City and its pension plans after I have had more time to study them.  Till then . . . .