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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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Comments:

The worst part is most folks don't seem to care, and they won't until it affects them directly. Ignorance is bliss, as we all march fat and happy over the cliff.

Comment #1 by Dan Marion on 2014 03 25

Mr. Riley, You fail to consider Rhode Islands full employment and the booming expansion of our economy. We will grow ourselves out of this deficit by borrowing!

Oh never mind

Comment #2 by Redd Ratt on 2014 03 25

Mr. Riley:

Spot on! This echoes the comments made by Mr. Vandemersch about Narragansett's finances and the rash of bond issues Narragansett wants on the ballot in November. The Council cut one off, big deal! Still no inclination of funding their share of the pension. It will be interesting to see if the Council duplicates cutting what the Town Manager recommends like they did last year.

Comment #3 by Gansett Proud on 2014 03 25

A few years ago I was in Glencoe (wealthy Chicago suburb) and my friend told me that his property tax had gone up 7%. When he called the tax assessor he was told that the 7% was only the beginning.

Comment #4 by Redd Ratt on 2014 03 25

There will be only one answer - raise taxes.

Eventually the State will consist solely of illegal immigrants and State workers.

Comment #5 by Jim D on 2014 03 25

The potential tax burden is real. Narragansett is up to $27,000 per household . I wonder if any lawyers out there want to opine on whether the real estate agent and/or home seller is required to disclose this "time bomb"?

Comment #6 by michael riley on 2014 03 25

If you are an ERSRI retiree and want to continue the Court challenge to the RIRSA of 2011,please email [email protected]

Comment #7 by catherine celeberto on 2014 03 25

In the wake of the financial crisis of 2007–2010, the rating agencies came under criticism from investigators, economists, and journalists. The Financial Crisis Inquiry Commission (FCIC)[39] set up by the US Congress and President to investigate the causes of the crisis, and publisher of the Financial Crisis Inquiry Report (FCIR), concluded that the "failures" of the Big Three rating agencies were "essential cogs in the wheel of financial destruction" and "key enablers of the financial meltdown".[40] It went on to say
see below:

The biggest of the big 3 rating agencies responsible for the sub-prime crisis -Moody's.

"The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. In some cases, they were obligated to use them, or regulatory capital standards were hinged on them. This crisis could not have happened without the rating agencies. Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms"

Further info.re;the above is readily available on the internet.

Comment #8 by catherine celeberto on 2014 03 25

Unfortunately the above poster has not told us anything. The process of "hired guns" in municipal pensions is that the actuary is hired by the town. Those are the people with conflicts the town officials and their "hired guns". Not the ratings agencies who were, I agree, definitely conflicted in the subprime CDO ratings process of 2004 -2008. Unfortunately you are a bit confused about the ongoing municipal crisis and the conflicts & fraud which happens at the town and actuarial level where there is a mutual interest in making the problems disappear or look small.You have it backwards.

Comment #9 by michael riley on 2014 03 25

This is RI so one of two scenarios will play out. 1. The dumb voters will again ignore all this and then be shocked and enrages when the state ends up like Central Falls, the unions are forced to bankruptcy court to fight for a portion of their pensions. 2. The dumb elected leaders will postpone the problem a couple of years by raising everyone's property taxes long enough to patch a hole, and then several thousand of RI's top earners will move out of the state, taking their businesses with them. I predict it will be #2.

Comment #10 by Katy Sloop on 2014 03 25

Katy I fear you are right. I am hoping to get people educated and asking their town officials what they are doing to head this off.The Pension Study Commission grows more disappointing daily.But what can you expect from a Chafee commission?

Comment #11 by michael riley on 2014 03 25

I love the posts that advocate for sticking our heads in the sand and acting like all will be just fine.

Comment #12 by Redd Ratt on 2014 03 25

Quite apart from the pension issue, note that we have an $8 billion budget. Only about $3.3 billion comes from R.I. revenues, including taxes. The remainder comes from the U.S. Government. What will happen when the President and his lackeys in Congress decide to duck the responsibility for raising taxes or inventing other sources of revenue and cut back on the support they now give the States? They will look good; the states will have to pick up the burden of taxes, fees, etc. to maintain the status quo. Of course, R.I. probably can't make up any substantial loss from the feds. Then, in concert with the financial problems set forth here, how will the tax increase, bond issue solutions look?

Comment #13 by Harry Staleyu on 2014 03 25

yup it's always the employees!
http://www.njspotlight.com/stories/14/03/25/gov-christie-retroactively-cuts-state-pension-payment/

Comment #14 by Stephen DeNinno on 2014 03 25

Stephen, fair comment. Should N.J. cut firefighters cops, or teachers? Social welfare programs, unemployment benefits, or infrastructure spending. Let me guess you think N.J. should raise taxes.

End all defined benefit retirement programs. They are a ponzi scheme that relies on growing government to keep paying the generous pensions that sometimes last for 30 plus years.

Comment #15 by Redd Ratt on 2014 03 25

Mr.Riley,
Please detail the "fraud".
I am willing to listen.

Comment #16 by catherine celeberto on 2014 03 26

Redd, my post above is exactly what got us to this position in the first place. Mr. Riley's weekly blog does nothing but tell everyone how unsustainable the system is. Without going back 3 or 4 decades and doing due diligence, his words mean nothing. Years and years of underfunding or no funding, and the loss of investment income on that money is the real fraud. Without a forensic audit looking into the crimes of politicians past, his words ring false. In Providence, just think about the gains lost on the hundreds of millions screwed out of the system over the last 40 years! Yes we have to spend that money now. But place the blame on where it belongs, the politicians that played the system, not the workers. Read that column above carefully, you will see how they wrote it into the budget as "pension surplus” Another Fat bastard looking for higher office on the backs of the working

Comment #17 by Stephen DeNinno on 2014 03 26

And don't get me started on the ratings agencies. They did such a good job with the mortgage backed securities, that they almost crushed every pension system. The Wall St. firms and banks got a bailout, but what about the victims of their fraud? Did you get a bailout in your 401K? Did pension systems get a bailout? Nope, but back at Wall St. it's business as usual. Big bonuses and more trying to get their hands on our pensions. http://www.digitaljournal.com/article/359792 For your reading pleasure!

Comment #18 by Stephen DeNinno on 2014 03 26

Placing blame is an ineffective way to deal with reality.

How many RI pols and Judges etc have been imprisoned over the years - several. Does that change anything monetarily? No.

Follow the money. How much is being spent on English as a second language teachers, bus monitors, teachers aides, school psychologists, welfare, medicaid, food stamps, section 8 housing?

Comment #19 by Jim D on 2014 03 26

Stephen I agree that politicians suck. However, as Jim D says above we must deal with the reality we have today. The unions, politicians and apathetic voters are all guilty. As I understand it Arlene Violet and Ernie Almonte both warned of this long ago. Blame also lies with a judicial system that found the unions had no standing in their well documented law suit years ago.

But today we need to deal with the reality we face today, just as private union retirees have faced cuts. Just as Social security benefits have been cut. Consider yourself lucky you have a Providence pension instead of social security.

Comment #20 by Redd Ratt on 2014 03 26

Redd, when not if the city goes BR, yup I will be so lucky. I would rather take my chances with the good faith of the USA. BTW as I stated before in these posts, the city did not take part in SS. This saved the city millions over the years, it will cost the police and fire their very lives! And to anyone that says that was then this is now...FU...They made the deals, we paid our end, they didn't, so take out a bond issue. Make the system whole for those vested, and switch non vested to 401K style plan.

Comment #21 by Stephen DeNinno on 2014 03 26

I don't come down on the people actually doing the work, Police, Fire/Rescue, teachers PW. It's all the politically appointed, middle management, bureaucrats we need to get rid of. So lets start with desk jockeys and pencil pushers.

Right now as I write this emergency personnel in Boston are battling a Brownstone fire in 30 mile an hour winds. I'm don't think I'm willing to take anything from them.

Comment #22 by Wuggly Ump on 2014 03 27

Yes, two of my brothers will not come home tonight! This is why we get the pensions we do. Sadly, two families are without their fathers.

Comment #23 by Stephen DeNinno on 2014 03 27

Cut the "my brothers" crap. friggin wierdo

Comment #24 by Odd Job on 2014 03 27




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