More Columns
BENEFITS BEAT
Avoiding Benefits Bankruptcy
The financial mess in Vallejo, California, provides lessons for all public officials.
Questions, success stories or anecdotes about benefit issues in government? Girard Miller wants to hear from you.
E-mail him
After months of posturing, brinksmanship and negotiating with employee unions, city officials in Vallejo, California, have abdicated their authority to a federal judge by filing for bankruptcy. The city and its labor unions are like two spendthrift spouses now approaching the divorce judge to ask her to divvy up their debts and see who gets to keep the best car and the pet dog, and who will pay for credit cards and the mortgage.
A rarity. Historically, municipal bankruptcies are quite rare. We've only had a handful in the history of some 87,000 state and local government entities. States, counties, cities and school districts are fundamentally different from private companies and individuals because they have the coercive monopoly power of the state to tax, and thus enjoy a near-certain claim on future revenues. On the other hand, the capital assets of public agencies include hard-to-sell infrastructure, such as streets and roads and special-purpose public buildings. This means that despite their financial powers, municipalities can become illiquid or insolvent in a financial crisis. For example, in the case of Orange County, California, its 1994 bankruptcy was the product of leveraged investment losses.
The federal bankruptcy law works in a different way for public agencies, in recognition of the sovereign authority of state and local governments. Essentially, the federal bankruptcy judge first oversees a short-term plan to restore the municipality to solvency in order to pay wages and overdue bills, and then works out a longer-term plan for repayment of overhanging debts and bills. This seldom involves the liquidation of capital assets.
What bankruptcy does accomplish is the re-opening of contracts. This includes labor agreements and benefit promises, as well as the possible suspension of interest payments on debt if necessary. This is why Vallejo has teetered for months on the brink of declaring bankruptcy, as city officials now find themselves unable to pay rising employee salary and benefits costs that they accepted in previous labor agreements.
Two views of the Vallejo mess. One camp blames everything on public-employee labor unions, which extracted generous contract terms for public-safety workers. They point to six-figure police and firefighter compensation that represents something like three-fourths of the general fund budget, a far higher percentage than the average municipality. The union retorts that the city has shifted other expenses to special revenue funds and thus comparisons are not realistic.
As with any typical family fight, there are two sides to this story. From afar, it looks like the city has indeed gone overboard with its public-safety compensation plans in light of its fragile economic base. Blaming it all on the unions, however, is not going to solve the issues in the long run. Unions will be unions. At the bargaining table, they are entitled to seek the best the possible salary and benefits package they can obtain for their members — within reason, of course. But like a spendthrift spouse who failed to take personal responsibility until the divorce trial, they need to now be accountable for their actions and join with the city to forge viable long-term solutions.
Where the public sector has a huge problem, unfortunately, is that public-safety contract negotiations don't start and stop at the bargaining table. Because of their political popularity, high visibility and organizing skills, police and fire unions have gained special clout in elections and sometimes enjoy undue influence with elected officials who are prone to promise them anything today and leave the bills to the next guy's term in office. On this score, this century's self-serving "public-sector union & benefits" complex is hauntingly akin to President Eisenhower's 1961 farewell forewarning of the "military-industrial complex" which still plagues the federal taxpayer.
At the end of the day, the only answers to Vallejo's problems will be better management, shared sacrifices and a new mutual watchword: sustainability. Employee contracts and city services must be sustainable. Just as we can't overtax our planet environmentally, we can't overtax our local governments' economic bases with promises that politicians can't keep. If it takes a bankruptcy to put the house in order, then so be it, although it's a sad commentary on government in America that some local officials can't run their communities like a sound business.
As to the rest of the country, elected officials must invoke stronger discipline in their finances, or else Vallejo will be just the tip of the iceberg. It is no small wonder that a California taxpayers' group has abandoned hope and written a referendum proposal to prevent public agencies from granting unsustainable retirement benefits. If self-discipline is lacking, then we can't fault the voters from stepping in with measures that remind us all of the fiscal straightjackets they created with 1978's Proposition 13.
Personally, I'd prefer to see elected leaders do the job we've elected them to perform. They should adopt responsible financial policies and take the actions necessary to implement them. As you'll see below, it doesn't require rocket science.
An ounce of prevention. With the Vallejo fiasco in mind, here are some suggestions excerpted from my forthcoming book, "An Elected Officials' Guide to Government Finance" (2008 edition), to be published in June by the Government Finance Officers Association. (For more information about this book, click here.) I wrote the original edition in 1984, and it was time for an update, so I volunteered my time pro bono to work with GFOA's 150 committee members to lay out a 60-page booklet that I can now say will keep America's municipalities out of bankruptcy if our elected officials would simply read it and put its precepts into practice. These excerpts represent a few germane thoughts taken from just four of those 60 pages of guidance for elected officials:
Adopt sound long-term financial policies:
• Long-term financial sustainability and accountability should take precedence over short-term expedience.
• Deficit finance, in any form, should be openly and widely debated, as it often leads to fiscal demise.
• Taxpayer interests, special interests and employee interests must be carefully balanced.
• Budgets should be based on realistic revenue estimates, and current operating expenses should be fully budgeted — not deferred to future years.
• Every government should adopt fund-balance policies to set parameters for the financial reserves it needs to maintain.
• Rainy-day or fiscal-stabilization funds should be incorporated into the long-term financial plan.
• Retirement benefits should be pre-funded or currently funded, and not left to future taxpayers.
Review and assure the sustainability of current employee benefits plans and any proposed benefits increases:
• Avoid burdening future taxpayers with nearsighted, cost-deferred funding of benefits.
• Obtain complete actuarial analyses of all long-term benefits and post-retirement benefits plans.
• Fully cost-analyze and make public all proposed unfunded long-term benefits increases before they are approved. (In a collective bargaining environment, this means that the negotiators must take accountability for this part of their deal in public before it arrives at the governing body's table as a fait accompli.)
• Establish cost controls to trim growth rates of benefits expenses in line with revenue capacity.
• Employees' shares of benefits costs often must increase to achieve sustainability, especially when those costs rise faster than governmental revenues.
• Retirement eligibility ages may require upward adjustment to be realistic, in light of increasing longevity.
• The amortization period for unfunded benefits should not exceed the service lives of the employees and certainly not the lives of retirees (otherwise unborn taxpayers will be paying for benefits of then-deceased retirees, for services provided to their grandparents).
I would add one more point this month, as readers will note in this month's companion column.
• Avoid retroactive pension benefits increases, and the financial windfalls they create without benefit to taxpayers.
In a perfect world, elected officials would figure out how to implement these principles without having the state impose detailed and arbitrary rules to invoke them. However, if Vallejo is joined by other municipalities that cannot themselves avoid fiscal purgatory, then it may be necessary for the state legislatures to step in and impose principles through rules to prevent abusive practices and financial foolishness.
A READER RESPONDS
I read this article and the related articles with great interest. I have been trying to make similar points to the Vallejo City Council, city managers and finance directors for the past 15 years, both one-on-one and in the council chambers at budget time each year.
You see where my efforts got me: my city in bankruptcy.
While I agree with nearly every one of your observations — especially the unsustainable increases in retirement benefits that include unfunded retroactive coverage, with the bill passed on to future generations — I disagree with your observation that the city council members abdicated their authority to a federal judge.
Vallejo's current council members have no authority to abdicate. Vallejo’s current council members are handcuffed twice-over.
First, the firefighters contract includes binding arbitration clauses that make virtually no substantial change possible unless the firefighters union agrees to it. I'm not familiar with the police union contract. I don't think it includes the same binding arbitration clauses.
Second, even if the unions were willing to remove the binding arbitration clauses from their contracts, Vallejo is one of, I believe, 22 cities in California that have binding arbitration in the city charter.
The firefighters and police unions have demonstrated over more than seven years that they have no interest in "negotiating." During those seven years, the only things that the police and firefighters have "given up" in terms of compensation is a portion of current raises, all of which were only deferred to the next fiscal year. Current deferrals spring back July 1, 2008, with additional raises in the contract added to the deferred amounts, bringing next year's raises to about 14 percent. It’s these raises that create virtually all of the projected $16 million deficit in the next fiscal year. And raises the following fiscal year only increase the deficit further.
The firefighters contract also includes a minimum staffing requirement, meaning that the city must maintain 28 sworn firefighters on duty throughout every 24 hour period. For the last three or four years, the city has been using overtime to meet this requirement rather than hire additional firefighters, because it saves money.
My point is that current contracts and the binding arbitration clause in the city charter means that the public safety unions run the city. The council has no authority to change anything that the firefighters and the police unions do not agree to.
In 1992, when I served on the Citizens Budget Advisory Committee, the fire chief told us that one way to save the city approximately $300,000 a year was to do away with the fire chief position, because the fire chief is powerless. The firefighters’ contract controls everything: discipline, scheduling, promotions, training, time off, vacation scheduling — everything. Management had no control over the firefighter employees.
Over the last 15 years, the city has cut in virtually every other part of the budget where it could. Employee positions in other departments were eliminated. Money spent to maintain the streets was eliminated. Funds that used to be allocated to support many community programs — like City Parks and Recreation, the Vallejo Library services, Vallejo Senior Center activities — were either drastically cut back or eliminated.
Vallejo ended up in bankruptcy because the city came to the point where they finally had to deal with the unsustainable police and fire contracts because they had no alternative. That's where the money is.
So, Girard, I disagree with your observation that the city council members abdicated their authority. They had no choice. They had no authority to abdicate. The only way they could fix the problem that was created by the culture of government, particularly the culture of the Vallejo City government, was to take the city in to bankruptcy protection.
Having said all this, if you know of anybody who is actively trying to fix what our generation has allowed to happen in government, and to change the frightening legacy that we are leaving to our grandchildren, I'd like to be involved.
J. D. Miller, CPA
Vallejo, Calif.
Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities. More biographical information.