The Morning Report
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Thursday, Sept. 18, 2008 | The meltdown on Wall Street this week has undoubtedly touched the city of San Diego, just like it has anyone with an investment portfolio or the need to borrow money. But when it comes to borrowing, the city might be better off than other borrowers, even when considering its recent financial exile.
Yet any optimism among experts in such matters is qualified by the acknowledgment that the current financial crisis is so severe, and so complex, that no one really knows what may happen in the coming year — just as the city returns to Wall Street after a four-year exile.
After all, 2008 has seen one venerable Wall Street institution after another either go into bankruptcy or be bailed out by the government because of bad bets on the U.S. housing market. In March, federal taxpayers bailed out the 85-year-old investment bank Bear Stearns. Two weeks ago, mortgage giants Fannie Mae and Freddie Mac received government bailouts. Just this week the investment bank Lehman Brothers went into bankruptcy and taxpayers had to rescue insurance giant AIG.
“What we are seeing in the marketplace is the structure of the capital markets changing, perhaps forever,” said Pat Shea, a former mayoral candidate and finance expert.
The city purchases liability insurance from one of the companies facing recent headline-making troubles. But because the city is covered through an insurance pool with other governments, it should not be adversely affected if AIG does go under, said Jay Goldstone, the city’s chief operating officer.
Nonetheless, the effects of the growing crisis go far beyond the few mighty firms that have fallen. It is front and center at City Hall, which just recently re-entered the public credit markets after a four-year banishment following the pension debacle.
“We are definitely watching what is happening,” Goldstone said. “But it will not prevent us from going out into the public markets.”
Wall Street’s woes have already hit the pension system this year. As of June 30, the city’s pension fund investments were down about $250 million, or 4.69 percent, said San Diego City Employees’ Retirement System CEO David Wescoe. And the losses are certain to be greater after the market meltdown this week.
The pension system’s investment portfolio has taken a hit “just like anyone who is invested in anything,” Wescoe said.
Wescoe, however, is quick to point out that the pension fund enjoyed a 16.25 percent boost last year.
But more important in the short-term is the city’s access to credit. In the fall of 2004, Standard & Poor’s suspended San Diego’s credit rating in response to the city’s dishonest financial disclosures relating to its pension obligations. As a result, the city was forced to postpone basic projects, such as the construction of fire stations and water and wastewater projects, or seek financing in the more costly private markets.
The banishment has been costly to the city. It spent tens of millions of dollars on lawyers, consultants and auditors attempting to remedy its troubles, lost out on less expensive financing methods and saw former top officials be charged with securities fraud by the Securities and Exchange Commission.
Standard & Poor’s restored the city’s credit rating in May and the other ratings agencies have followed suit, giving the city the ability to refinance the private debt, and begin issuing what could be billions of dollars in infrastructure bonds for the projects postponed during their years in exile.
But the credit crisis on Wall Street means that the low interest rates the city was counting on might no longer be realistic, especially given that the city’s newfound credit rating is less than sterling. Standard & Poor’s gave San Diego’s general obligation bonds an AA rating before its fiscal meltdown. In May, the agency rated San Diego’s general obligation bonds at an A.
“Now it is much more important for a municipality to have good credit,” Shea said.
However, Shea and others also say that with the way things are going on Wall Street, almost any municipality — even one with so-so credit — might seem like a safe bet in the bond market, especially when compared to all of the private corporations that have lost billions this decade either through poor investments in mortgage-backed securities, or bad management as in the case of the American car companies.
Beginning in January, the city will be going to Wall Street to refinance roughly $425 million in water and sewer bonds, Goldstone said. About half of this debt is in the form of private, short-term loans the city had to get from Citibank and mortgage brokerage house Morgan Stanley in 2007 when it was still barred from the public markets. The rest is in long-term bonds issued years ago that will mature next year.
The city might be hurt in these deals, Goldstone said, if the companies that insure big municipal bond issues increase their premiums. This is entirely possible because there are likely to be fewer of these bond insurers in business.
Typically, an institution that’s issuing a bond can lower its interest rate by buying insurance that guarantees repayment of the debt no matter what happens to the borrower. But some of the biggest bond insurers — most notably MBIA and Ambac — are in deep trouble themselves due to their bets on mortgage-backed securities.
Yet, Goldstone added, it is also quite possible that the city will be able to secure good interest rates, even without bond insurance, because municipal bonds will be considered good investments as Wall Street continues to unwind from the excesses of the past two decades.
Shea, who advocated taking the city into bankruptcy during the pension crisis, said that regardless of what happens in the short term, the city will ultimately benefit from the end of the reckless borrowing that in recent decades had become, in his words, “the U.S. business model.”
“The marketplace we are moving into is a more transparent, more critical market than we had before,” Shea said. “It will provide incentive for San Diego to deal more directly with its financial condition, which is good for the community.”