LA WATCHDOG - In a stunt that would make South American strongman Hugo Chavez proud, the imperious California Public Employees Retirement System (“CalPERS”) and the bankrupt City of Stockton conspired to give an absolute preference to Stockton’s $147 million pension obligation ($245 million over the next ten years) to CalPERS over Stockton’s remaining creditors who are owed an additional $550 million.
But this sweetheart deal where bondholders and other creditors are treated like dirt will have major ramifications in the markets for California bonds and notes as credit rating agencies will lower their ratings and investors will require greater security and significantly higher rates of returns on these higher risk investments.
Stockton claims that the City has already made numerous sacrifices (layoffs, reduction of vital services) and that this arrangement with CalPERS is necessary to maintain the “basic health and safety of the community.”
CalPERS asserts the pension rights of public employees are “constitutionally protected” and have a “priority over other creditors, including bondholders.”
But not of all of the creditors agree with this underhanded deal, including MBIA Inc. and Assured Guaranty Ltd., two bond insurers who have guaranteed the timely payment of interest and principal on $250 million of outstanding indebtedness.
Ironically, Assured Guaranty insured over $120 million of the 2007 Taxable Pension Obligation Bonds, where the proceeds were used to pay down part of Stockton’s unfunded pension obligation to CalPERS. Unfortunately, this self righteous $243 billion pension fund lost about 25% of this investment.
These two publicly traded companies will argue that Stockton negotiated its Chapter 9 bankruptcy filing in bad faith by not seeking concessions from CalPERS even though “similarly situated creditors were asked to take reductions.”
In any case, the bond insurers are not going to take a disproportionate haircut without a fight. This will result in a long and contentious legal battle where the courts will make the ultimate decision on whether Federal bankruptcy law trumps the California constitution and its laws.
And regardless of the outcome, the damage has been already done.
Politically wary credit rating agencies who have their heads buried in the sand for the past few years will finally be forced to consider unfunded pension liabilities and other post retirement employment benefits as real obligations, resulting in lower ratings for California issuers who have significant off balance sheet liabilities.
And quality oriented bond buyers and mutual funds will boycott the lesser rated credits or demand a higher rate of return given the increased financial and political risk associated with California paper.
The fallout from the Stockton / CalPERS fiasco will have a decidedly adverse impact on the fiscally stressed City of Los Angeles, which, as a result of the $800 million escalation in salaries, benefits, and pension contributions, is projecting a four year budget deficit of $1.1 billion, an average of $275 million a year.
More than likely, this will result in a downgrade in LA’s existing credit rating (AA minus) as the $10 billion unfunded pension liability will be factored into the credit analysis as being senior to any newly issued bonds or other general obligation indebtedness.
But given that the credit rating agencies will need to look at a worse case analysis, the unfunded pension liability will increase to about $20 billion as the investment rate assumption is lowered to 5% from the overly optimistic rate of 7.75%. The funded ratio would decrease to 55% from an already unacceptable 72%.
With the downgrading of the City’s credit worthiness, rates on next year’s Tax and Revenue Anticipation Notes will increase because quality oriented institutional investors will be reluctant to purchase any of the City’s lower rated paper.
But this unsavory episode involving Stockton’s bankruptcy and its associated backlash is minor compared to the devastation caused by CalPERS and its persistence in relying on overly optimistic investment rate assumptions. This scam that has allowed governments throughout the State to underfund their overly generous pension plans, resulting in unfunded pension liabilities estimated to be in the range of $300 billion to $500 billion based on more realistic investment rate assumptions.
And like the City of Los Angeles, the State, with its $16 billion deficit that relies on numerous budget gimmicks, does not deserve an increase in revenues until it is willing to engage in real pension reform and endorse a ballot measure that requires it to “Live Within Its Means.”
(Jack Humphreville writes LA Watchdog for CityWatch He is the President of the DWP Advocacy Committee and the Ratepayer Advocate for the Greater Wilshire Neighborhood Council. Humphreville is the publisher of the Recycler -- www.recycler.com. He can be reached at: [email protected]) –cw
CityWatch
Vol 10 Issue 66
Pub: Aug 17, 2012