The Morning Report
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Saturday, November 19, 2005 | A Sacramento judge ruled Tuesday that the state of California should not be allowed to issue pension obligation bonds without voter approval in a case that may eventually scuttle the plans of local leaders hoping to solve San Diego’s pension crisis.

The ruling, issued by Judge Raymond M. Cadel from the Sacramento County Superior Court, rejected the state’s contention that it could sell $550 million worth of the bonds to make its annual payment to the California Public Employees’ Retirement System. The ruling only affects the state’s ability to issue pension obligation bonds and not local governments.

But if it is appealed, a more far-reaching ruling could follow, which would force the city of San Diego to either drop the idea of using pension obligation bonds to help buttress the retirement system or put them to a citywide vote.

“If an appellate court upheld it, it could have a more broad-reaching effect,” said Roger Davis, chair of the public finance department at the law firm Orrick, Herrington and Sutcliffe. That firm has helped several governments, including the county of San Diego, issue pension obligation bonds.

Davis said, however, that for now the effect of the judge’s ruling is limited and it’s not “a matter of concern” for places like the city of San Diego, which is looking to issue bonds once it has regained credibility on Wall Street.

City officials have initiated plans to issue up to $600 million in pension obligation bonds and other types of debt to replenish the city’s retirement system, which is currently facing a more than $1.37 billion deficit.

Mayor-elect Jerry Sanders said during the campaign he would support issuing bonds to help the city’s pension fund recover.

Local cities and counties have assumed they could issue those bonds – essentially borrowing money to invest in their separate pension funds – without a public vote. While the state constitution forbids cities and counties from selling bonds without a public vote, there are some exceptions.

Courts have ruled, for example, that if a city is already obligated to pay a debt off, it can issue bonds to refinance it without a public vote. But what Judge Cadel decided Tuesday was that the state of California did not enjoy the same exception.

Furthermore, while cities can issue bonds to pay off existing debts, the contention that pension debts incurred voluntarily are qualifying obligations has not been challenged.

For now, however, Cadel’s ruling will only affect the state.

The state was hoping to borrow money to make its annual payment to the pension system.

Harold Johnson, a lawyer from the Pacific Legal Foundation, argued against allowing the state to fund its pension that way. Johnson’s client was the Fullerton Association of Concerned Taxpayers.

“It’s bad policy to take out a loan to pay one of the routine annual expenses of government,” Johnson said. “Borrowing like that commits not just this generation but future generations to pay back an expense being generated now.”

Pension obligation bonds, however, can be used to save money being lost in an underfunded pension system. The county of San Diego last year borrowed $450 million using pension obligation bonds and immediately invested it in the county’s pension system. The money was expected to make more in the investment market than the county was losing each year in interest costs on its more than $1.2 billion pension deficit.

It’s a practice the county has embraced over the last three years. It now owes $1.27 billion in pension obligation bonds.

Regardless of what an appellate court rules following Tuesday’s decision, the existing pension obligation bonds issued by counties will not be affected, Davis said.

“All the local government pension obligation bonds have been validated final and conclusive,” he said.

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