New FRAC Report Sounds Budget Alarm

Thomas Breen file photoCut the accounting gimmicks. Don’t backload pension payments. And watch out for money lost to active investment fees.

Those were a few of the recommendations and reprimands issued in the latest sharply worded letter from the city’s independent Financial Review and Audit Commission (FRAC) to the Board of Alders. FRAC, an independent commission of citizen financial experts appointed by the mayor to routinely review the city’s budget, sent the letter to the board on May 15.

FRAC, particularly in the person of its chair, Mohit Agrawal, has been a vocal critic of the financial assumptions behind the mayor’s proposed $547.1 million operating budget that is scheduled to take effect on July 1.

In past testimony and FRAC analyses, Agrawal has singled out the city’s proposal to bond a quarter of a billion dollars to shore up the two public pension funds as particularly risky, noting that city assumptions on potential interest rates and assumed rates of return on investment are more optimistic than FRAC is comfortable with.

And during an appearance on WNHH FM’s “Dateline New Haven” program Wednesday, a day before a consequential Finance Committee deliberation on the budget at City Hall, Agrawal argued that long-term obligations of $2 billion threaten to plunge the city into receivership in five years if it doesn’t take drastic action. (Agrawal, who is pursuing a PhD in economics at Yale, formerly worked on the big data team of President Obama’s 2012 reelection campaign.)

Following up on an initial report at the end of March that argued that the mayor’s proposed budget could be between $27 million and $50.2 million out of balance, FRAC’s latest analysis includes new cautionary commentary on the $250 million Pension Obligation Bond (POB) proposal. The updated analysis comes the same week that the Finance Committee of the Board of Alders begins its final deliberations on the proposed budget.

The alders must amend and approve a final, balanced version of the budget by the first week of June.

Click here to read FRAC’s full report.

“Our city finds itself in a financial crucible,” FRAC’s latest letter begins. It argues that the mayor’s proposed budget is at least $27 million out of balance, and that the city currently faces liabilities of around $2 billion across its pensions, OPEB (Other Post-Employment Benefits), and general obligation bonds. “This liability amounts to $15,000 per resident of New Haven,” the report continues, “which is very high when compared to our city’s per capita GDP of $24,000.”

The report ascribes the structural deficit in the proposed budget to an alleged underfunding of the Board of Education (BOE), the city pensions, medical costs, and police and fire budgets, as well as to a potentially unrealizable revenue initiative that seeks to get $6.1 million from Yale, the state, and other sources. The report also criticizes the city for chalking up $9.5 million of a $136.8 million bond issuance in August 2016 as revenue to the city.

“Why would Wall Street give the city a ‘gift’ of $9.5 million?” the report asks. It says that the city is actually paying 60 percent above the market rate of interest on the underlying bonds and will be making payments on that debt for 20 years. This is not revenue, it reads, but debt. “Over the last few years,” it continues, “these kinds of financial maneuvers have raised the city’s future costs of interest and fees by many millions.”

Will POB TCB?

 

The latest detailed focus of concern by FRAC is on the city’s proposal to bond $250 million to shore up the two public pension funds, the Police & Fire Fund (P&F) and the City Employee Retirement Fund (CERF), both of which are currently funded at around 40 percent.

The authors of the report argue that the likely interest rate on the bonds will be 5.18 percent, and that the pension funds will likely return 6.5 percent on investment over the 30-year life of the POBs. City assumptions, on the other hand, predict a 4.85 percent interest rate and a 7.5 percent rate of return, which FRAC calls too optimistic.

In a subsequent financial model that assumes average rates of return of 5.5 to 8 percent and average interest rates of 4.85 percent to 5.18 percent, FRAC shows that the city could save between $10.1 million and $63 million by using POBs. The model also shows that the city has between a 6 to 41 percent chance of losing money by using POBs.

Click here to download the calculations behind FRAC’s financial model.

City officials, like Controller Daryl Jones, have repeatedly promised in recent weeks that if they can’t be sure they meet that spread, they will pull back on the borrowing plan.

FRAC questions whether a gambling strategy of trying to beat the spread — rather than a conservative investing strategy — makes sense in the first place.

“These simulations lay bare the key question,” says the report, “what is the city’s risk tolerance? The POBs do save money on average, but (depending on the interest rate and the assumed average rate of return) there is a 6-41% chance that the city loses money on these bonds.”

The report offers two alternatives to POBs that may help shore up the city’s pensions without taking on as great of a risk.

First, FRAC recommends that the city flat fund, rather than backload, its pension payments. Currently, the city pays around $21 million per year into CERF and $34 million per year into P&F. The report states that city payments into CERF are scheduled to increase to $33 million per year by 2041, and city payments into P&F are scheduled to increase to $62 million per year by 2043.

But that’s with an assumed rate of return of 7.5 percent, which FRAC says the city is unlikely to achieve. With a more realistic 6.5 percent return assumption, the report reads, FRAC’s financial model shows payments to CERF increasing to $51 million per year by 2041 and payments to P&F increasing to $84 million per year by 2043.

“The option that is least risky,” the report reads, “is that the city should flat fund the pensions and assume a return rate of 6.5%. In this scenario, our contributions to CERF would be constant at $29M and our contributions to P&F would be constant at $43M.”

The report also estimates that the city is losing 0.15 percent to 0.2 percent of returns on investment for the pensions every year because of fees related to active investment.

“While 20 basis points of return are not significant in any given year,” the report reads, “over the long term this adds up.” FRAC recommends that the city transition its investments from active to passive investments, which could save the city upwards of $11 million under the current funding plan with an assumed return of 7.5 percent and with backloaded contributions.

In addition to the above stated pension reforms, the FRAC report recommends that the city take a number of steps to make its finances more transparent and responsible.

Those recommendations include publishing a monthly check register, which lists every dollar spent by the city; continuing to seek lower costs and higher quality for employee, retiree and dependent medical coverage; working with the state’s Municipal Accountability Review Board; looking into regionalizing certain services; and studying the impact of a potential bankruptcy or state receivership.

“Alders should recognize that given our high liabilities, already high tax rates, and fiscal distress as a state,” the report reads, “bankruptcy (or receivership) remains a significant risk for the city… Given this reality, the Corporation Counsel should be asked to prepare an opinion regarding the impact of bankruptcy on pensioners, employees, taxpayers, bondholders, and residents in the context of Detroit, Central Falls, and other recent
municipal bankruptcies (and of state receivership in the context of Bridgeport, Waterbury, and West Haven).”

Click on upload the above aduio file or the Facebook Live video below for the full interview with Mohit Agrawal on WNHH FM’s “Dateline New Haven.”

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posted by: Esbey on May 16, 2018  3:46pm

This report is so sensible it almost hurts to read it, the contrast to political reality is physically painful.

The state is not going to bail us out. They are broke. Yale is not going to bail us out. They don’t want to help much more, and the suburban state legislators are not going to force them. To think otherwise is pure fantasy.

So, while we can push the state & Yale on the margin, we mostly have to solve the problem ourselves. Continually increasing property tax rates will eventually set off a Hartford style collapse. We can massively cut the budget and/or we can cut the budget moderately while focusing on economic growth.

The problem is that a large part of New Haven suffers from overwhelming status-quo bias: they truly feel that all change is bad. Since growth involves change, it is bad. But the alternatives are *really bad*.

posted by: Statestreeter on May 16, 2018  4:33pm

Esbey

The flaw with your assumption is that the budget increase somehow correlated to economic growth. The budget increase is so to a poor economic plan coupled with gimmicks and incompetence. Mind you Harp was in control of the spending side of the state budget for years and we ended up in massive debt with little economic growth. We rank almost last. I’m am not insinuating that you are doing this but that always the sales pitch by the Mayor and her crew that it’s somehow an investment that will pay dividends. Harp hasn’t balanced one budget yet. Using schemes to cover financial overruns and the pension proposal is just another one of those schemes.

Why don’t we sit back and ask the question do we really need almost 500 cops or 360 firefighters? We’re did these numbers come from? Under what professional standards are they justified. Crime being down does not justify the amount of cops we have. It’s kinda of like saying I didn’t get wet because I use a 10 foot wide umbrella, even though a 4 foot wide umbrella would accomplish the same. This city is full of waste. Just look at the brass that these department heads, including the Mayor, have to request the ridiculous position they’ve requested. They wouldn’t be justified in normal times. In these times all they show is a clear disregard and disconnect from the taxpayers in this City.

Here’s a start. Cut every position requested and also eliminate every position that the Mayor proposes to eliminate to justify her new requests. The later by omission she does not need.

We might want to start taking a look at getting our arms around the $120,000 to $170,000 annual pension’s that public safety personnel are retiring at. Yes should heard it right. Most of these guys are in their mid 40s to boot. Not their fault its the contracts that allow this insanity.  The contracts that the Mayor has her people negotiate and our Alders approve. You know the same Alders that have that vast budgetary knowledge.

posted by: robn on May 16, 2018  5:12pm

Insane,

Prepare for torches and pitchforks.

posted by: Esbey on May 16, 2018  6:22pm

Statestreeter, I think you read me to say that a budget increase is necessary for economic growth.  That’s not what I meant.  I meant that we could stop saying “no” to growth (as with the airport and with our too-strict zoning laws), which would then produce both jobs and tax revenue. While you are right that there is much that could be cut, I am not sure that in the long run (as the pension bills come due) we can cut all the way into balance without harming the city quite a bit.

posted by: MohitAgrawal on May 16, 2018  7:30pm

Hi all: FRAC is meeting tomorrow (Thursday, May 17) at 5pm in Meeting Room 2 in City Hall.

posted by: Noteworthy on May 16, 2018  8:40pm

Wake Up Call Notes:

1. This FRAC report is a wake up call for Mayor Harp, the BOA in general and the Finance Committee in particular.

2. Ignoring the warning is stupid, irresponsible and reckless.

3. Financial modeling that overpays for bonds while booking rebates as revenue in order to balance the city budget is the dumbest thing ever and the actions/recommendations of people who are both desperate and who don’t care about the impending problems.

4. Any alderman who votes for this irresponsible budget after three public hearings in which you were given specific recommendations on how to lower expenses, who witnessed for the first time in New Haven history, a school board forced to consolidate schools and cut expenses; who have been told by the very people you represent not to raise taxes and the harm it will do - needs to either be voted out in November or have votes withheld from them and their political machine.

posted by: FacChec on May 17, 2018  11:19am

The Frac has made a compellingly strong argument in opposition to the POB bond plan of $250M. However, that still leaves a $50M bond request within appropriation #4 which FRAC has not addressed and in which the BOA has approved in the previous two budgets. ($100M approved but not allocated. The FRAC has failed to provide a recommendation to the Mayor and BOA to resolve its deficit spending plans and its misaligned tax structure including automobiles. It is clear that the solution to these budget problems cannot be left to Jones and Gormany, whose jobs may hang in the balance of the credit rating agency Moody, if their efforts fail.

Compounding the deficit is the city’s plan to increase the capital bond request from $43M last year to $59M currently. Some of the major bond request line items are public works dept. $6.2M to $16M, BOE from $5.8 to $6.4M,engineering dept. from $1,2M to $3,9Myouth services from $200K escape teen center to $50K although no construction progress has been made at Bethel Church center. The walls are receding as evidence by the quiet exit of Joe Clerkin last year when cracks began to appear and which the state of CT would not repair.

The point here is that throughout this seven part budget there are blatant spending increases, while at the same time the Mayors budget forecasts a reduction in state aid… a fallacy in the making.. Therefore, the FRAC has more work to do in their effort to knock knowledge into BOA heads that refuse to take it.

posted by: Christopher Schaefer on May 17, 2018  1:07pm

“Those recommendations include…studying the impact of a potential bankruptcy or state receivership.” Nothing happenin’ here, folks. Just move along…And whatever you do, keep voting for Democrat 1-Party status quo rule—especially incumbents. I mean, who cares about State and City fiscal collapse, escalating taxes, failing schools, government mismanagement and incompetence? Political ideology is all that REALLY matters. Right?