The Week in Public Finance: Gambling Kansas, Detroit's Lessons and a Different Kind of School Spending

A roundup of money (and other) news governments can use.
by | August 14, 2015

For previous editions of The Week in Public Finance column, click here.

Kansas’ Big, Scary Gamble

Ratings companies have panned Kansas’ planned sale of bonds to cover pension funding even before they go on the market. The financially troubled state has struggled with budget deficits since passing income tax cuts in 2012 and 2013 that it couldn’t afford. Now short on cash to pay its annual pension contribution, Kansas plans to sell $1 billion in pension obligation bonds later this month. Governments sell these bonds and then usually dump all the proceeds from the sale into the pension system to get the funding level higher. The idea behind these bonds is that the interest rate the government pays back to bond investors will be lower than the average annual return on investment the bonds are earning in the pension fund, so the government comes out ahead.

But POBs haven’s always worked that way. Such schemes tend to end poorly for governments that can’t afford the risk that the pension investment can sour. That’s what happened in Stockton, Calif., in 2007 when the city sold POBs at the height of the stock market boom -- the bonds went into the pension system and promptly lost a quarter of their value. But the city still had to pay back bond investors in full. The debacle is just part of what led Stockton into bankruptcy in 2012.

Unlike general obligation bonds, pension obligation bonds are taxable. This means the state will pay a higher interest rate back to its investors than it does on its regular debt. That puts even more pressure on the pension system to get good returns or the gamble doesn’t pay off for the state. Moody’s Investors Service estimates the pension system has to average at least a 5 percent return on investments before the bonds start to pay off.

And, as Moody’s noted in an Aug. 11 analysis, Kansas’ POBs give it some budgetary relief for the next few years but won’t fix the state’s root problem: it's not regularly contributing to its pension plans. Kansas has a long way to go. Its two biggest plans -- its state employees and teachers -- combine for a $7.2 billion unfunded liability and a 59 percent funding ratio. “Even if the state's pension bonds work as designed,” Moody’s said, “contributions must rise in order to address growing unfunded liabilities.” Instead, the analysis continued, the state has lowered its projected pension contributions for the next few years in conjunction with this bond sale, “taking on some additional long-term risk, to achieve near-term budgetary relief.”

How to Not Be the Next Detroit

“The next Detroit” makes an eye-catching headline, but a new report by Pew Charitable Trusts aims to help cities avoid that publicity by outlining some lessons learned from the last seven years of municipal bankruptcies. “Until now,” the report said, “lawyers and financial analysts have conducted most post-bankruptcy analyses, focusing on the effect on investors who buy and insure municipal bonds. But state and municipal leaders need to weigh broader impacts on residents and workers.”

Among the lessons were:

  •   Early state intervention in local governments’ financial emergencies can help avert a crisis. 
  •   Governments in bankruptcy should develop broad outreach plans that include all stakeholders to help resolve conflicts.
  •   It’s critical for governments to have long-term recovery plans upon exiting bankruptcy that outline immediate financial fixes and long-term strategies (like investing to promote economic growth).
  •   Local officials can promote fiscal health and increase their city’s capacity to deal with the ups and downs of the business cycle by budgeting over the long term.
  •   Regular monitoring of local government finances can help state officials detect early signs of distress.
  •    A temporary manager or financial monitor can be a successful alternative to filing for Chapter 9.

Back to School Blues

Retail industry watchers are predicting that this month’s back-to-school sales won’t meet up to last year’s numbers, a development that will take a bite out of state and local sales tax revenues. Even the National Retail Federation, which Janney Montgomery Scott analyst Guy LeBas calls “a comically-upbeat trade organization” reported that shoppers expect to spend 9 percent less this back-to-school season than the last. The late summer shopping season is the third-biggest of the year (the winter holiday season and Easter season are the other two). Even with the short sales tax holidays that some governments enact to encourage spending in August, the back-to-school season represents a significant amount of consumer spending and sales tax collections for governments.

The lowered expectations this year may seem at odds with job growth and relatively high consumer confidence readings. But here’s the crux of the issue, according to LeBas: the number of jobs may be increasing, but wage growth is slow. “Job gains meanwhile impact a small portion of the overall population, while wage growth theoretically benefits a wider swath,” he said in an analysis. “In addition, there appears to be a much greater demand for savings among consumers…. Put simply, the headwinds for back-to-school 2015 dwarf the tailwinds.”