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Sunday, March 1, 2009 | San Diego city officials are still interested in pursuing pension obligation bonds at some point, despite the recent market downturn that has illustrated the argument of those who say borrowing to pay down the pension deficit is risky and unnecessary.
In 2006, Mayor Jerry Sanders proposed borrowing $674 million to inject into the pension system. Those plans were stymied by the city’s lack of a credit rating — which was finally restored last year — and, to a lesser degree, by former City Attorney Mike Aguirre’s legal opinions.
Now that the city has returned to the public bond market and is facing a multimillion-dollar shortfall for the upcoming budget year, the idea of issuing pension bonds has resurfaced. The Municipal Employees Association, which represents the city’s white-collar workers, recently brought up the idea as part of its proposal to balance the budget.
The city’s chief operating officer, Jay Goldstone, said city officials will revisit the idea, but only after they’re done coordinating hundreds of millions of dollars in public bond offerings to fund improvements to the city’s water and sewer systems.
“It’s something that we will still consider at some point, and I don’t know when,” Goldstone said of pension obligation bonds. “We’ve got so many other things on our plate right now from a bonding standpoint and a capacity standpoint, it’s not a high priority. But on the other hand, it’s a tool in the arsenal that we’ll revisit at some point in the future — six months to a year, conceivably.”
Goldstone said such bonds couldn’t be a solution to this year’s budget process because of the lengthy process used to validate the legality of the bond offering, which could take from nine months to two years.
Pension obligation bonds have been issued by San Diego County and some local cities as a way to manage pension liabilities. The county decided to increase pension benefits in 2002, resulting in a pension deficit topping $1 billion. From September of that year until August 2008, the county issued more than $1 billion in pension obligation bonds.
The financing plans work like this: A municipality borrows money to invest into the pension system, expecting it will earn more on those investments than the interest it is paying on the bonds. The bonds can also be used to minimize a municipality’s annual payment into its pension fund, reducing the amount being pulled from the general fund every year in favor of borrowing.
However, if investments tank, the city can be stuck paying off their bonds at the same time they are losing money on the investments.
Michael Zucchet, the former city councilman who spoke about the idea on behalf of MEA at a recent meeting of the council’s Budget and Finance Committee, said issuing pension obligation bonds could free up millions each year in the city’s day-to-day budget.
“Simply put, it’s debt restructuring and the most appropriate and obvious parallel is refinancing your home,” Zucchet said.
Steven B. Frates, senior fellow at the Rose Institute of State and Local Government at Claremont McKenna College, had a different analogy. “It’s like using a credit card to buy a car,” he said.
He said issuing bonds is a sign that cities can’t afford the pensions they’ve approved.
“No matter how you slice it, it’s going into debt,” Frates said. “You have to look at the proximate cause of that debt. In San Diego, the proximate cause is the incredibly lavish benefits awarded to the employees and the elected officials too.”
Another option to reduce the pension deficit is to plow cash into the fund from the annual budget rather than taking on more debt.
Goldstone said issuing pension obligation bonds may make sense in the near future because the troubled financial markets have resulted in “cheap stocks” that are likely to rise in price.
However, he acknowledged that such borrowing is not without risks. For one thing, investment losses could stick the city with fixed debt payments at the same time its pension liabilities were increasing because of the poor performance.
For instance, if the city had issued pension obligation bonds in late 2006 or early 2007, it would have lost money on them.
“In hindsight, it would not have had the effect everyone wanted because of the investment losses over the last 28 months,” Zucchet said. “Of course, five years from now it may have been looked at as a brilliant move. It all depends on your time horizon and when you take the snapshot.”
He noted that the pension debts are long-term ones subject to annual fluctuations. While the San Diego City Employees’ Retirement System has experienced losses recently, the system experienced double-digit gains in many years that exceeded the 7.75 percent rate the system assumes it will earn over the long term.
April Boling, a former City Council candidate who headed the city’s Pension Reform Committee, agreed that the market’s recent losses aren’t an argument against pension bonds because of the long-term nature of the investment.
Rather, she said, the important consideration is the interest rate a city receives on its pension bonds. If the city could lock in a 4.5 percent rate, for instance, borrowing would probably be a good idea. She pointed to Chula Vista as an example of what not to do.
Chula Vista is paying off $8.8 million in pension bonds issued in 1994 at interest rates ranging from 6 percent to 8 percent. The higher rate is actually a quarter of a percent higher than the assumed rate of return for Calpers, the state pension giant that manages the city’s pension obligations. That means on some of its debt, the city is paying more in interest than it’s expected to earn.
“That’s exactly the position you do not want to be in,” Boling said.
When the bonds were issued, the Calpers rate exceeded 8 percent but has since been lowered. The city is also prohibited from recalling the bonds to take advantage of lower interest rates before they finish paying them off in 2011.
Maria Kachadoorian, Chula Vista’s finance director, said city officials have never studied whether the city earned or lost money from the pension bonds.
“We’ve had some high years and we’ve had some low years,” she said.