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05
Tue, Jul

LA Just Took a Record $7.6 Billion Equity Hit … and No One Bothered to Mention It

PERSPECTIVE--Did you see it?

Can’t blame you if you missed it. It is sad when only numbers geeks take notice – nothing wrong with being a numbers geek, though, because they are a rare breed in City Hall.

 

As reported in the Comprehensive Annual Financial Report (CAFR) for FY June 30, 2015, issued by the City Controller on February 5, 2016, the equity of the City of Los Angeles took a hit to the tune of $7.6 billion, perhaps the most significant single adjustment ever recorded in its history. Most of the adjustment ($6.7B) fell on the Government Activities segment of the balance sheet. That segment went from positive territory of $5.1B to a negative ($.5B).

The adjustment was required under Statement 68 issued by the Government Accounting Standards Board (GASB). Statement 68 required government entities to recognize unfunded pension liabilities in the body of the financial statements instead of buried in the footnotes.

There was no discussion as to the background and reasoning behind it, nor the ramification – moving the liability from the hypothetical realm to the real world.

It would have been worse had the earnings rate assumption for pension assets been more realistic – say somewhere around 6.5% instead of 7.5%.

As revolutionary as Statement 68 was by requiring recognition of the net pension liability, it failed to rein in the discretion cities have in setting the earnings rate. Only the worst of the worst government pension plans would be subject to the application of a low risk-free rate. Please read my earlier article on the subject

City Hall likes to suppress controversial news. Encouraging open debate over a delicate political issue, such as public pensions, creates tension.

To be fair, though, most people would not understand the nature of an unfunded liability, but it’s not complicated when you think about it. The liability is not much different than a negative amortization loan – and more than a few people wrestled with one during the mortgage meltdown.

Your loan balance grows faster than the value of the house because the variable interest rate runs higher than the one used to calculate the monthly payment. The balance grows to the point where refinancing is impossible and selling the home requires a short sale.

We are seeing a version of that scenario playing out in the city’s finances. Employer contributions as a percentage of payroll has steadily grown from 19.9% in 2006 to 36.5% in 2015 for Police and Fire, and 14.2% to 20.8% for civilian employees (LACERS) – Source: 2015 CAFR.

Controller Ron Galperin has done an unprecedented job of educating the public about the city’s finances. I particularly like his Community Financial Report, sort of a CAFR-light for the vast majority of the population with no times to review the 400 pages of the mother document. 

The CFR covers the $7.6B as a one-liner on page 6.

Ron, whose public outreach should be a model for other officials to follow, needs to take this issue on the road and encourage an open discussion as to what it means to the city’s long-term capability of delivering cost-effective services.

(Paul Hatfield is a CPA and serves as President of the Valley Village Homeowners Association. He blogs at Village to Village and contributes to CityWatch. The views presented are those of Mr. Hatfield and his alone and do not represent the opinions of Valley Village Homeowners Association or CityWatch. He can be reached at: [email protected].)