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Thursday, April 20, 2006 | The lynchpin of Mayor Jerry Sanders’ financial recovery plan hit a major snag Wednesday after the city attorney opined that the mayor must seek voter approval before borrowing more than a half a billion dollars for San Diego’s troubled pension fund.
City Attorney Mike Aguirre said the city does not qualify for a key exemption in state law that has allowed scores of municipalities across California to unilaterally issue pension obligation bonds because of outstanding questions surrounding the legality of a decades’ worth pension benefit increases granted to employees and public officials.
“I will not sign off on the bonds because it’s not legal under these circumstances,” Aguirre said.
The city attorney, who has filed the two suits challenging the legality of the benefits, also used a significant portion of his report and ensuing press conference to pan the borrowing plan from a policy standpoint, calling it a risky proposition that wouldn’t solve the city’s pension problems.
Sanders proposed last week a financial recovery plan and fiscal year 2007 budget that are anchored in his hope to borrow $674 million and inject it into a pension fund struggling with deficit estimated to be at least $1.4 billion.
The prospect of the borrowing plan provided Sanders two important tools. The borrowed money allowed him to dedicate less of the city’s annual budget to the pension system, giving him the wiggle room to pump more than $50 million into long-neglected infrastructure needs and depleted emergency reserves.
The borrowing plan also would have likely satisfied a clause in contracts with a City Hall labor union that mandates that $600 million be infused into the pension system by 2008. If that clause is not met, money freed up by pay cuts will return to employees.
Aguirre’s opinion would put a stop to plans to borrow $574 million of the $674 million, leaving the future of the mayor’s pension funding plan in question. It also is the first public test of the early alliance between Sanders and Aguirre, one that has surprised most around City Hall.
The mayor authored a memo to the City Council following Aguirre’s statements, saying that the bond proceeds would only be allocated to cover sizable obligations even if Aguirre’s legal challenges to the benefits prevail.
“I do believe that we need a judicial determination on the legality of the benefits. However, that determination does not impact our need to fund the Pension System,” the memo states.
Sanders told the council that they will not be asked to decide on pension obligation bonds until the city regains access to public finance markets. But, in a marked change, he promised to provide the council with analyses of two other options for funding the pension system: selling city assets and going into municipal bankruptcy.
Both Sanders and Aguirre made a point to express their respect for each other and attempted frame the issue as a philosophical difference.
“I want to make it absolutely clear: He is trying to deal with an almost impossible situation in a very good faith way,” Aguirre said of Sanders. “My remarks today are meant to be in no way a criticism of him or his administration. In fact, if anything, I can’t sing his praises loud enough.”
At the same time, the report issued Wednesday states that the mayor’s “pension borrowing plan could be perceived as a deliberate effort to avoid coming to terms with fiscal reality.”
The merits and risks of pension obligation bonds have resurfaced as a focus of debate since the mayor released his plan last week. Municipalities around the state and nation have employed the bonds to bolster sagging pension systems, betting that they can earn higher investment returns on the borrowed money than they pay in interest.
Typically, municipalities can’t issue debt of such magnitude without a vote of the public. But an exception in state law allows municipalities to do so if the proceeds from the pension bond sales go toward “obligations imposed by law,” such as obligations passed down from state government or courts.
To date, pension debts have been determined to be “obligations imposed by law” because municipal employers have been found to be bound by law to pay retirement benefits. Therefore, pension obligations have been interpreted to be a refinancing of existing debt rather than the issuance of new debt.
The city attorney’s report argues that the outstanding legal challenges to the web of pension benefits leaves the city’s obligations indefinable and, for the time being, unknown. Money collected from the loans can’t be used to fund benefits that could be illegal, he said.
“There are very serious questions about hundreds of millions of dollars that are on paper owed by the city to the pension board – hundreds of millions of dollars involving benefits that might not be legal,” said Aguirre, who has said his challenge could take five years.
The city attorney’s two suits in state court seek to have the benefits overturned on the grounds they were created in illegal and corrupt political deals.
Council President Scott Peters said the benefits should be considered legal for now.
“Clearly we have an obligation until the court rules otherwise. The burden of proof is on the people who contend we don’t have an obligation,” Peters said.
Officials with the City Attorney’s Office have put different estimates on the amounts they hope to shave off the pension deficit if successful, putting the projected savings at $500 million to $800 million. Even a complete victory would leave the city with a sizable deficit.
If, for example, $650 million in benefits were ruled illegal, the pension system would still report outstanding obligations of $750 million.
“I am proposing that we fund the legally granted benefits. This amount (of legal benefits) exceeds the $574 million that we would receive in proceeds from Pension Obligation Bonds,” Sanders’ memo states.
The mayor encouraged the council to debate the merits and risks of his borrowing plan, saying that pension obligation bonds “certainly do not come without risks.”
Sanders continued to support his borrowing plan but said he would analyze for the council two other options for dealing with the pension deficit: selling city assets and Chapter 9 municipal bankruptcy. Others, including Aguirre, have suggested that tax increases should also be considered. Sanders pledged during the campaign not to raise taxes to manage the pension debt and will not provide an analysis for possible tax increases.
“The mayor does not believe we have the moral authority to even talk about taxes with the public,” said spokesman Fred Sainz.
Sanders has portrayed his borrowing plan as a sensible way to refinance the city’s debt, comparing it to the refinancing of a mortgage. Amid concerns of rising interest rates, the administration believes it can still fetch competitive rates on the bonds in fiscal year 2007, but has also said it will be closely monitoring the market and won’t go ahead if a favorable margin can’t be found.
Pension obligation bonds are used to stabilize troubled systems with a massive influx of cash. A municipality then hopes to make its debt less expensive by reaping investment returns on the borrowed money that is higher than the interest rate on the bonds.
Critics say the bonds don’t truly deal with the city’s problems, and only rearrange the city’s debts in a risky manner. Aguirre compared it to someone going to Las Vegas and hoping to win enough money to pay off a mortgage.
“I’m trying to protect [Sanders] from making a mistake, to protect the city from making a mistake,” said Aguirre, who also said that his signature would be necessary to release bonds.
If the mayor is unable to do the pension bond deal, he would have to pull back on his 2007 budget plans to funnel $11 million into long-deferred infrastructure repairs and $41 into depleted reserve funds. Under the mayor’s original proposal, the money that $52 million is freed up from the city’s annual pension payment by the cash influx of bond proceeds.
Sainz, Sanders’ spokesman, didn’t discuss the possibility of going ahead with the bonds without Aguirre’s signature. Sanders’ memo appears to discount the idea of going to voters to approve the bond deal.
“Only upon the time that we reenter the public markets does this become a ripe issue. Until that time, it’s a largely academic discussion,” Sainz said.
The city has been unable to borrow money in public finance markets for more than two years because of questions surrounding the information it provided to potential investors. Long-stalled investigations and audits must be completed in order for the city to regain its fiscal credibility.
The relationship between the mayor and the city attorney is sure to be watched closely after Wednesday’s events.
Aguirre took office at a time of financial and political unrest at City Hall and began a reform push that some found refreshing and effective, and others counterproductive and abrasive. He had made few allies prior to Sanders’ election in the fall.
The city attorney tried to stay neutral throughout last fall’s mayoral election, but in the final weeks of the election he through he support behind ally and Councilwoman Donna Frye’s financial plan. The plan, which called for a tax increase and mimicked some aspects of bankruptcy reorganization, closely mirrored Aguirre’s own financial plan.
Aguirre said during the campaign that Frye’s was the only plan that would actually work. However, he has come out in lockstep with the new mayor since Sanders took office in December. The relationship has provided Aguirre’s ideas with mainstream credibility and given him a powerful ally. Sanders, in turn, has been able to govern without the unrelenting opposition from Aguirre that played a role in the resignation of former Mayor Dick Murphy.
The borrowing plan was Sanders’ first major proposal for dealing with the pension system.
Sanders was elected last fall to replace Murphy, who resigned amid numerous investigations into city finances and politics, and questions surrounding the legitimacy of his 2004 electoral victory and his handling of the pension deficit.
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