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Monday, September 19, 2005 | Just like tacos, car tops and pornography, pension deficits can apparently be both hard and soft.

In case you hadn’t noticed it yet, for years now at the heart of the tumultuous debate about the city’s pension system was the question of whether the retirement fund faced a “hard debt” or a “soft debt.”

Last week the question was largely settled – or at least, that it had been settled was finally announced to the public. And during the announcement, Councilman Scott Peters gave us the perfect opportunity to diagram what had been the debate about the elasticity of the pension debt.

First off, what the heck are “soft debts” and “hard debts”? City staff for a couple years now has insisted that the pension system’s shortfall – now estimated at anywhere between $1.37 billion and $1.9 billion – is a “soft debt.” A hard debt is one that, like a mortgage, you have to pay off or you lose your house.

Some argue, of course, that the city’s pension debt is as hard as they come. Not only is it hard, but – as they regularly remind us – it’s getting harder. For every year that the billion-dollar-plus-sized hole remains in the pension system, it grows by the exact amount it would have been expected to earn had it been filled with investments instead. The contributions needed to pay it down only get larger, and if those payments don’t match the growth of the debt, well, the debt will only swell.

A soft debt, on the other hand, is one that you can choose to pay off or you can choose not to.

In other words, a soft debt may take care of itself someday. The pension debt is so soft, city staff argued, that things – assumptions, investments, mortality rates – might change to make it a smaller debt (then again, things might change to make it a larger debt). But it could be unwise, they warned, to throw money at it if there’s any chance that the debt is so soft that it will someday morph into an actual surplus or something.

This position was maddening for some members of the Pension Reform Committee last year, who consistently argued with former Deputy City Manager Pat Frazier about it. The reason San Diego was in so much trouble, they contended, was that it had for so long considered its pension obligations, soft debt.

But these days the ranks of managers and elected officials who argue that the pension shortfall is a soft debt – we’ll call them “soft-liners” – are growing thin.

That doesn’t mean they’ve given up (Pension Board President Peter Preovolos argues, for example, that the system’s investments will earn enough to make it whole in a couple of decades, even if the city didn’t give the fund another dime). Every once in a while the soft-debt arguments come out again, as they did last Monday.

Before you start to assume who’s on what side of this debate, however, wait a second.

One of the most remarkable things to come out in the last two weeks was the revelation that the city’s employee unions are beginning to embrace the fact that the pension debt is indeed a hard one. As has become clear recently, the unions have started to maneuver for a fight to get the city to pay off the debt, not to restate it.

More on that in a minute.

Peters and four of his five colleagues last week received and accepted an official report documenting possible ways the city could bring its pension fund up to a more respectable level.

The report’s significance cannot be overstated. Now, city staff is officially on record reporting that if the city continues on the same path it is on now, it will end up contributing massive amounts of taxpayer dollars to the pension system and yet the retirement fund’s deficit will only grow. By 2010, if the city did nothing more than contribute to the pension system as it has planned to, for every dollar that goes to a city employee as a salary, an additional 38 cents will have to go to the pension system. In 2004, the city contributed an additional 13 cents for every dollar it paid city employees.

If the city had to cut services and defer maintenance to make this year’s contribution to the pension system, wait until 2010.

To alleviate that pain a little bit, the city manager’s staff came up with some proposals. But they also revealed that those proposals aren’t necessarily optional. They disclosed that the city has already made a deal with one of its employee unions to pay $600 million into the pension system through some additional means by 2008. The city manager is proposing that to do that, the city sell real estate, sell some of its revenue streams to investors and issue pension obligation bonds.

And that’s not all.

“This is just the beginning. There is going to need to be other infusions in 2009, 2010 and 2011 to really get this back where it needs to be,” said Deputy City Manager Lisa Irvine, who gave the report. She said the city’s payments to its pension system envisioned in the report will be “very difficult” for the city to make.

That’s even with the bonds. But let’s talk about pension obligation bonds for a second.

It’s illegal to issue bonds in California without a vote of the people affected except under certain conditions. One of those is if a bond is being used to refinance an “existing obligation.” In order to go over voters’ heads to get pension obligation bonds like the manager proposes, the city must prove that it has a debt in its pension system – a hard one.

Now forget for a moment that this bombshell of a report put out by city staff is almost certainly understated. (For instance, most officials, including those at the retirement system, acknowledge that the pension deficit is more than $1.7 billion yet city staff started their projections out at $1.37 billion.)

Let’s get to Peters. After the city manager’s staff presented its report to the City Council, Peters asked a couple of questions.

His first suggestion: the debt’s burden was being exaggerated because the city – by will of voters last November – imposed a short 15-year term by which the pension system should be without debt.

“There’s nothing irresponsible about having a 30-year mortgage on your house,” Peters said, listing other cities and counties that allow their pension plans a longer term to pay down shortfalls. He asked city staff to review the impact of that short “mortgage” and hinted that there should be a change to the terms.

Voters approved the 15-year limit last year after the Pension Reform Committee and the City Council recommended it. A longer term, unlike a home mortgage, would allow the debt to actually grow for several years before the city started paying it down. In a 30-year amortization, the debt would grow for several years and the city would have not begun to pay it down until the 12th year – in this case 2021. That’s called negative amortization.

That would be one of the changes that morph a soft debt into a larger one, but Peters was aiming to find ways to make the city’s payments to its pension not seem so daunting.

So he then suggested that city staff could be exaggerating the future of the pension debt because they assume that city employees’ salaries will grow by an average of 4.25 percent every year.

“I don’t know that I’ve ever seen that let alone as an average at least as long as I’ve been here. That seems quite high,” Peters said.

Yet, according to city and pension system records, even though there were 243 fewer city employees in 2004 than in 2001 – the year Peters began serving on the City Council – the city’s payroll as of June 2003 was nearly $60 million higher. The average city employee’s salary went up 7.7 percent in 2001, 5.5 percent in 2002, 2.8 percent in 2003 and 4.9 percent in 2004.

Peters had more points and they were classic soft-liner arguments: that the pension system’s investment returns were higher than the city manager was assuming; that some of the more “drastic” measures he and others were “uncomfortable with” could be avoided. In the end, despite his misgivings, Peters and the majority of his colleagues approved the report and gave the city manager their blessing to pursue loans, pension obligation bonds and land sales to put hundreds of millions into the pension system as fast as possible.

He may not have had much choice. As part of their negotiations with the city, the city’s blue-collar union representing 2,100 workers made their salary concessions contingent on the city once and for all – recognizing that the pension fund is a hard debt.

If the city doesn’t put $600 million “from wherever” into the pension system by 2008, those employees get all their salary concessions back. If they want to sell bonds to raise those funds, city officials will have to formally declare that they can do so without a vote of the people because the pension system is already facing a “hard debt.”

That’s now, apparently, the hard truth.

E-mail Scott Lewis at

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