The Week in Public Finance: Federal Budget Chaos, a Bankruptcy Win and Pension Portfolios
A roundup of money (and other) news governments can use.
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Chaos on Capitol Hill ... and in Statehouses
As state lawmakers begin preparing for their fiscal 2018 budgets, their biggest challenge is in the unknown. With Donald Trump’s election, the future for key state and local funding is almost anybody’s guess.
With Trump in the White House next year, Stan Collender, author of The Guide to The Federal Budget, predicts that a Republican-controlled Congress will move quickly on making major changes before the 2018 midterm elections. But after this unpredictable election, few are willing to predict what exactly those changes will be. All we know now is what’s on the table.
In particular, Republicans in Congress and Trump's administration have proposed changes to Medicaid and municipal bond taxes that would yank millions of dollars in financial support for health care and make borrowing more expensive.
“It’s going to be a constant series of uncertainty of what’s going to happen, how it’s going to happen, when it’s going to happen and who’s going to do it,” warned Collender.
That leaves little for states to count on when it comes to figuring out how much revenue they should expect from the federal government for certain programs. On average, federal funding accounts for 30 percent of a state's budget.
The Takeaway: Collender’s advice for states is to start assessing their reliance on federal funds that could be impacted and to develop alternative budget scenarios in the event that those funds get trimmed. The same goes for planned capital spending: If financing becomes more expensive, governments will have to consider back-up plans or halting projects altogether.
San Bernardino’s (Finally) on the Road to Recovery
After four years in court, Southern California’s San Bernardino is closer than ever to exiting bankruptcy.
Earlier this week, the judge presiding over the Chapter 9 case approved the city’s recovery plan. In a three-page brief the city issued after the ruling, officials called it a “watershed moment” for San Bernardino.
The recovery plan involves slashing bondholder debt and retiree health-care costs while protecting pensions. Some of the plan has already been implemented, such as consolidating the fire department at the county level and contracting out waste management services. Those department eliminations were the main way that San Bernardino reduced its employment rolls by almost half in four years -- from 1,140 to 600 people.
San Bernardino’s bankruptcy was unusually long. This is mainly because it was so unprepared to address its fiscal hardship until it was too late.
City leaders were court-ordered to file for bankruptcy in August 2012 on an emergency basis. The following year was tumultuous. It wasn’t until April 2013 that the city even assessed the reality of its finances. And that November, the mayor and city attorney were both recalled.
But things have settled in recent years and started to look up: Last month, voters approved a new city charter that addresses many of San Bernardino’s management issues.
The Takeaway: That San Bernardino’s bankruptcy almost caught lawmakers by surprise makes it a little unique among the small club of municipalities that have gone through Chapter 9 bankruptcy in the past decade. But once it unpacked all its problems, it found the solutions weren’t that different from other municipal bankruptcies: manage the current costs and make uncomfortable cuts to set the city on a reasonable revenue path going forward.
Given San Bernardino’s particularly grueling process, it’s natural to celebrate the end being near. But it’s important to remember that exiting from bankruptcy is just the beginning for municipalities. In this respect, Chapter 9 is really a prologue for the story yet to be told.
Aging Pensions’ Problems
Pension plans have a host of issues, but one that doesn’t get talked about as much is how investment strategy should relate to how “old” plans are.
A quick explanation: When it comes to personal retirement investment portfolios, most financial professionals advise making investments less risky as a person approaches retirement age. That is, a portfolio that starts out mostly investing in less predictable but higher-yield stocks would slowly invest more in lower-yield but stable bonds.
Pension plans don’t need to make these kinds of shifts because they always have people entering the portfolio and exiting. However, that's changing.
With public-sector hiring having slowed and baby boomers retiring, many pension plans are starting to skew "older." Some already have more retirees than active participants, and many are nearing a one-to-one ratio.
Picking up on this, the Nelson A. Rockefeller Institute of Government released an analysis that highlights how pensions now have increased investment risk because of these demographic changes. The results aren’t encouraging.
Taking the average funded level of pension plans -- 75 percent -- researchers looked at different possible scenarios. It found that a typical pension plan with a workforce that’s increasing by 2 percent a year still has a 1 in 8 chance that its funding level will drop to crisis-level (less than 40 percent funded) in 30 years. By contrast, plan with a workforce that’s dropping by 2 percent each year faces a 1 in 5 chance of hitting crisis level in the next 30 years. When looking at an aging plan, the numbers get worse. Even with a slightly growing workforce, a mature plan faces a 1 in 3 chance it will reach crisis level over the same time period.
The institute didn't break out how many plans fall into each scenario, but it did note that about half of pension plans have hit the "mature" milestone where its current contributions into the fund aren't enough to cover annual payments to retirees. For these plans, investment income has to cover the rest or the fund loses money that year.
This analysis is different from pension plans’ actuarial projections because the institute relied on a model “that allows investment returns to vary in plausible ways.” That's because the stock market has been more volatile over the past decade, and many people aren't sure whether pension plans' longstanding assumptions about investment returns will withstand the test of time.
The Takeaway: Some plans, like California Public Employee’s Retirement System, have a de-risking plan in place that involves adopting more conservative investment assumptions over time. But for plans that don't, the stakes are now higher if they don’t perform as they have historically. Those stakes amount to increased risk that's passed on to taxpayers who have to foot the pension bill.