Tom Wolf’s dilemma

Governor-elect Tom Wolf has a hard job ahead of him. For the second time in two months, Pennsylvania borrowed money for operating costs because its cash balance hit zero. Treasurer Rob McCord’s office announced on Nov. 13 the state had nearly exhausted a $1.5 billion line of credit created two months ago via an internal state fund called Poll 99 managed by the treasurer. The state borrowed $750 million this week. Back in September it borrowed $700 million. The current administration indicated it expects to borrow the remaining $50 million left in the credit line next week.

Borrowing from Pool 99 instead of selling bonds helped the administration avoid the higher interest rates and fees it would have incurred through the financial markets. But the internal loan isn't much of a fix for a state that has suffered from budget deficits and a credit rating downgrade and has failed to find a long-term solution to its growing pension obligations. Pennsylvania’s string of hasty fixes will leave Wolf with an unsustainable operating plan when he takes over in January. Lucky guy.

What Stockton and Detroit taught us

The past few weeks have marked a new shift in municipal bankruptcies. In general the exit plans placed retiree pensions ahead of municipal bondholders, in terms of who gets back promised money. Even as federal judges in Stockton and Detroit both ruled that cities could cut pensions in a municipal restructuring, both places left bankruptcy in recent weeks with promised pensions largely intact. Bondholders’ recoveries, however, varied widely.

Credit rating agencies are generally wary of such restructurings. “The disparate treatment of pension obligations and investor-owned obligations means that pensions are likely to enjoy better treatment than general government debt in Michigan and California Chapter 9 cases, and potentially in bankruptcies filed in other states,” wrote Moody’s this week in a credit analysis. “[This has] negative credit implications for local government bond investors in Michigan and California, and the U.S. as a whole.”

On the plus side, Moody’s added that the clear option to cut pensions in bankruptcy now may give cities leverage in union negotiations. This could be helpful to distressed cities. Meanwhile, Standard & Poor’s reminded observers that municipal bankruptcies remain extremely rare; recent results won’t change how it approaches rating muni debt.

New math

Speaking of pensions, the Pioneer Institute released a report this week that provided more evidence to conservative groups who say that U.S. pensions are over-valued. Most pension funds calculate their assets and unfunded liabilities using an assumed rate of investment return between 7 and 8 percent. The Pioneer Institute advocated using a market rate. Its report outlined how to create a rate of return for each individual plan based on the historical returns of each investment asset type. For example, for a portfolio with a mix of investments ranging from stocks, which historically average an 8.3 percent return rate, to real estate assets, which average a 3.4 percent rate of return, Pioneer would assume a rate of return around 6.6 percent.

With pension accounting changes being rolled out everywhere this year, the institute’s paper provided a glimpse into what changes may be in store for many plans. In one of the starkest examples, the unfunded liability of the Illinois State Teachers Retirement fund, which assumes an 8 percent investment return, would increase by more than one-third to nearly $79 billion, according to the Pioneer Institute. (The institute’s formula yielded a 6.3 percent investment return for the teachers’ fund.)