Simi Valley Pension Obligation Bonds - A Risky Financing Maneuver Without a Public Vote
Inheriting a predecessor's underfunded public pension debts is never fun, but the need to address them is unavoidable. The question before Simi Valley City Council was how - and there is both a right way and a wrong way.
The right way is to adopt policies that keep the pension debt from growing, help pay it down, and avoid it growing out of control. The wrong way is to kick the can down the road. Unfortunately, council opted for the latter route. They voted to borrow $150 million in the form of Pension Obligation Bonds which just converts one type of debt to another and makes no effort at reform.Pension obligation bonds, or POBs, are a financial mechanism that allows state and local governments to reduce their current unfunded liabilities by borrowing against future tax revenue.
In California, cities can borrow up to the amount they owe without voter approval. All that was needed was a simple majority of Simi Valley City Council to authorize millions of taxpayer backed debt.
The simplest way to think about POBs is this: The money borrowed is then invested by CalPERS into various investments where, hopefully, returns on those investments will exceed the interest on the bonds, therefore earning money for the pension fund.
Since higher yielding investments often come with more risk, these bonds are inherently precarious. And when they go bad, they go very bad.
The attraction of POBs - an idea Interim Simi Valley City Manager Gabler has floated - is that they can superficially look like "refinancing," but they're not. The City can use POBs to lower their current payments into their pension plans, but long-term savings are illusory. Whether a seven percent rate or another rate is chosen by CalPERS to determine the present value of pension benefits for financial reporting purposes will not change the future benefit payments. And issuing a POB and reducing the expense reported, in total, because of a lower interest rate, does not impact the ultimate cost of those benefit payments.
The liabilities are still out there. The bonds have to be paid back. The taxpayers gain only if the actual return on the money invested with those POBs exceeds the interest rate the city pays to bondholders.
Although Simi Valley risks big losses from POBs, they carry profits with almost no risks for the consultants, law firms and banks that help arrange them. They aggressively market deals in which they get their fees up front, no matter what happens in the long term.
Their sales pitch is that borrowing at today's low interest rates all but guarantees a profit for the city because they can invest the proceeds in their CalPERS pension funds and for decades earn returns higher than the four percent or so in interest that they will pay on the bonds.
But there's a catch: If the timing is wrong, these POBs could clobber the finances of Simi Valley. Pension funds and beneficiaries will be better off because pensions will be more soundly financed. But taxpayers-present and future-might be considerably worse off. They will be running huge risks and could get stuck with a massive tab.
Ultimately, Simi Valley taxpayers end up assuming 100 percent of the risk, and that makes this city finance tactic the least taxpayer friendly. In recent years, academics and analysts, including the Government Finance Officers Association (GFOA), have strongly advised against pension bonds, suggesting that the instruments constitute an overt act of gambling with taxpayers dollars. In a blunt statement, the GFOA says it "recommends that state and local governments do not issue POBs". This approach only delays and compounds the financial impacts by paying potentially additional debt costs on what is effectively already debt.
The GFOA's warning cannot be more clear. We hope this warning will deter fiscally sound cities like Simi Valley from ever considering or issuing pension obligation bonds. Our Taxpayers Association has always maintained a position to oppose bonds that are issued by government agencies without an affirmative public vote prior to their funding. If the Simi Valley City Council wishes to issue pension bonds to reduce their current unfunded liabilities by borrowing against future tax revenue, then it should place that Advisory Question before voters on the November 2020 ballot. The Ventura County Taxpayer Association is made up people who recognize the importance of government to our communities. Government should be efficient, effective and always transparent.
If you would like to support our efforts, please click here to go to our website and join us.