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Wednesday, February 01, 2006 | Stuck with a sunken credit rating and a sinking pension system, city of San Diego officials have formulated what they describe as a creative way to inject $100 million in public loans into a pension fund estimated to have a deficit approaching $2 billion.
The announcement of the complex financing plan Tuesday is new Mayor Jerry Sanders’ first major move toward filling the pension deficit that in no small way forced the resignation of his predecessor. At the same time, it also continues along a track laid down last year by former Mayor Dick Murphy.
With an important deadline approaching, Sanders announced Tuesday a plan that would dedicate the city’s $10.3 million in tobacco settlement revenue for the next 16 to 22 years to pay back the $100 million in public bonds. At the same time, officials would use $10.3 million that otherwise would have gone to employee raises and employee pension contributions to instead fund the health, youth and after-school programs previously financed by the tobacco-settlement funds.
The switcheroo is necessary because the city is facing a June 30 deadline to spend the money freed up in concessions by labor unions to finance its pension debt. However, the city couldn’t simply issue public bonds like most municipalities because it is essentially barred from capital markets until it restores its fiscal credibility.
Sanders trumpeted the action as proof of his dedication to financial reform, but it was a move that had been contemplated at City Hall months before his arrival. Critics described it as an expensive, short-term measure that simply buys the city time until the next fiscal year begins.
The city has been long been grasping for a way to fund a pension deficit that has forced cuts to basic city services and threatens to consume bigger and bigger portions of the city’s annual operating budget. However, questions surrounding the veracity of its financial disclosures to investors have left the city suspended from public financing markets and, therefore, unable to issue pension obligation bonds.
The new mayor said the $100 million raised by the bond issuance would be added to the pension system on top of whatever the city contributes to the pension system out of next year’s budget. Officials have said the city’s annual pension payments could chew up as much as one-third of the city’s day-to-day operating budget in the coming fiscal year.
“I have and will make financial reform the hallmark of my administration,” Sanders said at a press conference.
He said the infusion is an effective way to begin paying down the pension deficit and his aides promised more announcements this week related to his financial recovery plan.
The wheels of this plan actually had been set in motion by the man Sanders replaced, Murphy. Labor contracts negotiated by Murphy obligate the city to make a move on the securitization by the end of fiscal year 2006, which draws to a close June 30. Sanders criticized the contracts during the mayoral campaign.
In negotiations finalized last May, employees agreed to salary freezes and to contribute more money into the pension system. In previous years, the city had gradually begun picking up an increasing share of employees’ contribution into the system. The system was designed for the city and employees to split the contribution evenly.
In total, the union concessions are projected to free up $17.3 million that would have otherwise been spent on employee raises and pension contributions. By contract, the money is to get ushered back into the pension system.
In a report last September that began to map out the city’s plan for dealing with the pension deficit, city staff said it was “critical” to leverage the $17.3 million in employee concessions by June 30 because contracts with three of the five employee unions expire at the end of the fiscal year. The lack of access to traditional financing left city officials looking for creative ways to use the funds freed up by the labor contracts.
Using tobacco securitization bonds was one method recommended by city staff in the September report, prepared under the leadership of former City Manager Lamont Ewell.
Council President Scott Peters said the announcement was exciting, and he credited Sanders for making the plan reality.
“It’s a creative way to get some money into the pension system without having access to the public markets,” he said. Peters said the council will vote on the bond issuance during Monday’s hearing.
In order for the city to keep its access to the $17.3 million freed up in concessions, Sanders and his negotiators will have to keep similar salary and pension contribution provisions into the contracts it inks with police officers, firefighters and the deputy city attorneys, all of whose contracts will be up for renegotiation again this year. General employees are set to get a 4-percent salary increase in the third year of their contract.
Administration officials said they wouldn’t budge on those conditions at the negotiating table.
Pat Shea, a La Jolla attorney specializing in structured finance, said the bond arrangement was an extraordinarily costly way to capitalize city assets.
“None of this will get the city out of its financial crisis,” he said. Shea was one of the lead attorneys in the Orange County bankruptcy and believes San Diego can only be saved through the same process.
Pension trustee Bill Sheffler said there is no guarantee the money freed up in this year’s labor contracts will be available in the future to fund Sanders’ financing plan.
“He’s simply trying to bootstrap his way through one more year and solve his problems one year at a time,” Sheffler said. “If you look at it from a big picture point of view, it doesn’t sound a whole lot different than what the mayor and City Council have being doing for years, which is to keep pushing the debts off on to the future.”
Tobacco securitization bonds also aren’t without their critics, as they cash out long-term assets and many governments around the United States that have issued such bonds have later abandoned the health programs that are supposed to get the tobacco money.
Tobacco companies settled lawsuits with a coalition of state governments in the late 1990s for health problems caused by smoking and have agreed to give a portion of their revenues to governments into perpetuity. The strength of tobacco companies’ revenues allows the city to bond in public markets at competitive interest rates based on their share of the money.
The city hasn’t had access to public markets since its credit worthiness came into question in late-2003 because of errors and omissions in its financial disclosures.
The “pension solutions” report of last September called for an additional $500 million to be pumped into the pension system through either land sales or the offering of pension obligation bonds. (If a total of $600 million aren’t infused into the system by the city by 2008, concessions by the city’s blue-collar union will revert back to employees’ pockets.)
In his press conference Tuesday, Sanders said he hadn’t yet made up his mind on either method, although he had expressed support for both ideas during his campaign.
Pension obligation bonds allow municipalities to immediately infuse cash into their pension systems on the assumption that the money they borrow will earn more in investment returns than the cost of paying off the bond over time. Critics say it is simply a method for rearranging debt, while supporters say it is a sound way to stabilize a troubled fund.
Goldstone said Tuesday’s financing plan was essentially a pension obligation bond, only done in a nontraditional way.
“We’re in the exact same position we would be in if we did a POB,” he said.
The pension system’s deficit is the result of a practice dating back to the 1990s in which the city annually shortchanged the system. At the same time, it routinely increased benefits for employees, a practice that was obscured for years by an overachieving stock market.
Sanders was elected in November essentially to turn around a financially troubled city and resolve its pension issues. One of the central tenets of his financial recovery plan is returning to the negotiating table with unions to exact further concessions. The mayor and unions have yet to begin negotiations.
Also on Tuesday, the American Lung Association ranked the city of San Diego as one of the county’s “laggards” in regards to tobacco prevention policies.
Please contact Andrew Donohue at