What Happened?
The city of Ft. Lauderdale, Florida, is thinking about borrowing nearly $300 million to shore up its pension funds and reduce budget expenses.
So What?
This is extremely risky, and significant research and case studies demonstrate that the strategy is perilous; in fact, similar borrowing was blamed in the bankruptcies of Stockton and San Bernardino, California. Municipal leaders should take great caution before considering such tactics, and the Ft. Lauderdale revelation is worthy of review.
The Plan
Ft. Lauderdale plans to borrow $297.5 million using pension obligation bonds or “POBs”; the pension fund trustees would invest the money, according to reports.
What Are POBs?
A pension obligation bond is basically a form of interest-rate arbitrage. The idea is for a municipal issuer, like Ft. Lauderdale, to borrow money at a relatively low interest rate, and to invest the proceeds in the hopes that the money will earn a higher rate of return. “It’s speculating the way I would have speculated in my bond position at Goldman Sachs,” said former Goldman Sachs Chairman Jon Corzine. (Corzine has also called POBs “lousy public policy” and “the dumbest idea I ever heard”; he was saddled with former New Jersey Governor Christine Todd Whitman’s $2.8 billion POB when he became governor of the state).
Why It’s Tempting
The offering would make Ft. Lauderdale’s pension funds appear healthier, covering 75 percent of the $400 million in unfunded liabilities. And if the investments do well, interest could be paid back and money would be available in the city’s budget.
Why It’s Likely to Fail
If the investments perform poorly, the city would be forced to cover the debt payments and pour more money into the pension funds. This is what has happened to most recent POBs (see below). Ft. Lauderdale City Manager Lee Feldman apparently told local media that interest rates are low, so investments will likely outperform the anticipated 3.8 percent bond interest rate. But that’s simply not true, as evidenced in recent Gov1 coverage: New York and California—two of the largest and most sophisticated investment schemes in the country—just disclosed that they earned pitiful returns that were far below that interest rate; in fact, neither hit 2 percent.
History Shows…
A review of POBs and related research would push Ft. Lauderdale to consider other alternatives. For example, a recent report by The Center for State and Local Government Excellence noted that pension obligation bonds have not been successful over the last decade. A study of over 3,000 recent POBs showed that “most POBs issued since 1992 are in the red.”
Municipal bond expert Joe Mysak at Bloomberg recently recommended avoiding POBs like the plague, noting that 1990s era pension returns are extremely unlikely. Mysak also cites the Christine Todd Whitman POB disaster in New Jersey; another POB in Oakland cost the city $245 million. The Wall Street Journal concurred, calling POBs “dangerous games” and a “particularly potent weapon in the politicians’ debt arsenal.”
Additional Research
Boston College’s Center for Retirement Research recently published a report titled, “Pension Obligation Bonds: Financial Crisis Exposes Risks,” which looks at whether POBs are viable financing instruments, or simply devices for cash-strapped governments. Its conclusions are quite clear: “[M]ost often POB issuers are fiscally stressed and in a poor position to shoulder the investment risk. As such, most POBs appear to be issued by the wrong governments at the wrong time.”
The Government Finance Officers Association published a report back in 2003 titled, “Risky Business? Evaluating the Use of Pension Obligation Bonds, which looks at the conditions under which pension bond issuance may or may not be appropriate. An earlier report by the GFOA also recommended that local governments use caution when considering POBs.
For an advisory perspective, a 2009 overview of POBs from Deloitte, Hewitt and Segal is available. And if you’d like to see what a POB pitch looks like, have a look at this 2008 Kentucky POB update, which concludes that, while not a silver bullet, “POBs are a viable tool for funding a portion of the Commonwealth’s pension liabilities.”
Gov1 will continue to track POBs and related matters; please feel free to contact us at any time if you have insights, experience, or comments on this matter.