Cut 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.
“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.
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.”