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Michael Riley: Moody’s Lowers the Bomb…Look Out Rhode Island

Tuesday, March 25, 2014


Yeah, yeah…I know the police are surrounding the State House. Back to the Rhode Island Pension Time Bomb…recently, the Civic Federation blogged about the Chicago City Council granting the city authority to issue general obligation (GO) bonds for the payment of various capital projects and legal judgments, which includes refunding and restructuring debt. The city was expected to sell $388 million in GO bonds on March 6. In anticipation of the bond sale, Moody’s Investors Service downgraded the City’s credit rating from A3 to Baa1, giving Chicago a lower credit rating than any major US city except Detroit. This immediately made me wonder exactly how Moody’s arrived at their numbers and what metrics they used. Then I could compare that data to Rhode Island. The result will surprise you.

As I have been emphasizing, it is very important to be aware of Moody’s recently made modifications to the way it assesses local governments’ credit risk. These changes include an increase in the weight attached to measurements of debt and pension obligations (from 10% to 20%) and a decrease in the weight attached to measurements of the economy and tax base (from 40% to 30%). The city’s debt and pension obligations and diverse tax base were discussed in Moody’s rationale for the downgrade.

Moody’s identifies the following major financial issues as contributors to the ratings downgrade:

Unfunded Pension Liabilities

Chicago has large and growing unfunded pension liabilities that threaten the city’s fiscal solvency. According to the ratings report, Chicago is an extreme outlier. Using at least one indicator, the city’s FY2012 adjusted net pension liability, as calculated by Moody’s according to their methodology, is eight times the City’s operating revenue, the highest of any rated U.S. local government. Note that there is something very odd about Chicago pension accounting in that they use an open amortization period of 30 years. This is a big no-no and further evidence that ‘actuaries are hired guns’ often incentivized to produce a rosy forecast by the cities that hire them. It appears that Moody’s used a discount rate well below 6% for Chicago.

Additional Revenue and Budgetary Adjustments

The city needs substantial new revenue and other budgetary adjustments. Moody’s opines that the city is “unwilling” to utilize its full taxing authority to adequately fund pensions and says that is credit negative. The ratings agency goes on to say that the near doubling of the city’s property tax that would be required to fund pensions at an actuarially determined amount could be absorbed by the city’s tax base. However, Moody’s also cautions that the city has overlapping needs with similar pension and budgetary crises at Chicago Public Schools.

Providence is very different. They have been more than willing to tax. Providence has maxed out its main source of revenue of “property taxes”, where it leads the nation. The populous is already over-taxed. Providence will need to start selling assets and finding new tax revenues and importantly, cut spending and/or benefits.

Large and Growing Debt Obligations

The city’s high debt levels continue to grow, placing an additional burden on the city’s tax base. The city’s net bonded debt per capita has grown from $1,565 per resident in FY2002 to $2,886 per resident in FY2012, an increase of 84.3%. At $2,886 per resident, the city’s bonded debt burden is second only to New York when compared to thirteen other large US cities. Let’s compare that debt burden to Providence as well as town other metrics, and see that Providence has higher burden per Capita than Chicago.

This recent downgrade by Moody’s is a huge warning shot over the bow of cities across America and will directly affect Rhode Island. After several years of warning every city official and actuary that Moody’s clearly was going to focus more on pension accounting, pension debt and OPEB, it is now official. Providence ignored this, and now is very vulnerable to downgrade. Moody’s is using much more reasonable and lower discount rates (well less than 6% in Chicago) on pension liability to determine overall solvency and debt burdens. Cities in Rhode Island would be wise to look at my numbers, which use Moody’s and other leading institutions and economists’ calculations, and ignore the cities own ad hoc discount rates determined by ” hired guns.”


Michael G. Riley is vice chair at Rhode Island Center for Freedom and Prosperity, and is managing member and founder of Coastal Management Group, LLC. Riley has 35 years of experience in the financial industry, having managed divisions of PaineWebber, LETCO, and TD Securities (TD Bank). He has been quoted in Barron’s, Wall Street Transcript, NY Post, and various other print media and also appeared on NBC news, Yahoo TV, and CNBC.


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