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Michael Riley: Pension Obligation Bonds? Oh My!!

Tuesday, September 23, 2014


Pension Obligation Bonds are debt instruments issued by a Governmental entity. The purpose is to fund all or part of the Unfunded Actuarially Accrued Liabilities (UAAL) for pension and/or OPEB. Theoretically the goal of issuing POB is to lower long term funding costs for the system.

They have been in the news lately not as “saviors” but as anchors that contributed to the bankruptcy filings in Stockton, Ca. and Detroit, MI. To quote the infamous Jon Corzine:

“It’s the dumbest idea I ever heard,” Jon Corzine told Bloomberg.com in 2008 when he was still governor of New Jersey. “It’s speculating the way I would have speculated in my bond position at Goldman Sachs.”

What Do Candidates for Providence Mayor Think?

This comment by Corzine and the general failure of Pension Obligation Bonds the last several years as an “easy way out” for politicians, seem to fly in the face of Buddy Cianci’s or Jorge Elorza’s potential solutions to deal with potential bankruptcy in Providence should they be elected. Republican candidate Dan Harrop has suggested forcefully that the better alternative is a “reset” produced by a receivership filing and a renegotiation of all contracts to the city by a receiver. Elorza has basically avoided any discussion of city finances and any solutions, leading me to believe he is inexperienced and knows little about finance or is unprepared for the difficult circumstances he will face if elected.

Buddy Cianci, however, is on public record supporting POBs and has on several occasions in Investment Commission Meetings in Providence argued for issuance. These linked minutes make for fascinating reading as Cianci reveals he twice needed legislators’ approval and could not get it.

MAYOR CIANCI: The pension obligation bonds are up at the State House now. And as a matter of record, the pension obligation bonds, if we had incurred pension obligation bonds eight years ago when it was brought to us by Fleet, we would have increased our portfolio by about $100 million dollars. That’s the number that was run by Quick and Reilly for me just two weeks ago in New York. It was a little over a hundred million. If we had taken – they took the statistics of what we would have borrowed, and what we would have borrowed and what we would have made. And even now it was a hundred and something million.

So clearly Mr Cianci regretted his not being able to “time the market” in 1990 and now was ready to do it again in 2002. Interestingly in 1990, Pension Obligation Bonds were only a few years in existence and also, during that same time period 5 and 6% COLAs were being issued by Cianci’s administration. There was an implicit set of economic assumptions that went into the COLA decision while at the same time seeking a bundle of taxpayer financed cash to place bets with.

Oakland, California launched the first pension obligation bond in 1985, at the time it appeared to be a reasonable strategy. It qualified as a tax-free bond that could be issued at the lower municipal bond rates. A state or city could then pivot and invest the funds in safe securities - a corporate bond, for instance - at a slightly higher rate. That arbitrage made sense.

However, the Tax Reform Act of 1986 ended that strategy by prohibiting state and local governments from reinvesting for profit the money from tax-free bonds.

Nevertheless over the subsequent 30 years many “taxable” POB’s were issued almost all by cities towns or states in severe financial distress. The names are commonly associated with distress still today and many have since declared bankruptcy or something close to it (states can’t declare Bankruptcy). Illinois 2003, New Jersey 1997, Wisconsin 2002, LA 1994, Philadelphia 1999, Detroit 2005, and Chicago Transit 2008 are just some of the 400 issuances since 1986 totaling $57.6 billion.

What About Statewide Candidates?

So we know Buddy Cianci will likely recommend POB’s if elected but how do the other candidates feel about this risky solution? It’s also conceivable that the next Governor, Treasurer and Mayor will all have something to say about Providence POB’s. I think we should know what they believe especially because RI Legislative law passed late in 2014 cycle exposes State taxpayers should a POB bond backfire. That second Central Falls bailout in June 2014 makes the State and its taxpayers largely responsible for bailing out any pension plan, Providence and several other towns on the tipping point so any municipal POB bet now becomes a state taxpayer bet by proxy.

It is interesting to note the universal Democratic opinion is that “stocks” are too risky and should be no part of Social Security portfolios. Yet in municipal and state pension plans they have huge equity exposure. And now what? Will they contemplate issuing debt to buy stocks? That’s what a POB is.

Can Fung, Raimondo, Almonte, or Magaziner assure us they will not bail out Providence on the state taxpayers dime? Should Tiverton or Charlestown citizens be exposed to tax hikes caused by Providence profligacy and mismanagement or a pension obligation bet?

A POB in Providence without a corresponding reset of contracts and imbedded costs is an invitation to disaster. Remember, it’s not the politicians’ money; he just rolls the dice. 

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.


Related Slideshow: Timeline - Rhode Island Pension Reform

GoLocalProv breaks down the sequence of events that have played out during Rhode Island's State Employee Pension Fund reform. 

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In the five years before Raimondo was elected, pension changes included a decrease in established retirement age from 65 to 62, increased eligibility to retire, and modified COLA adjustments.
Read the Senate Fiscal Office's Brief here.
(Photo: 401(k) 2013, Flickr)
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January 2009

Governor Don Carcieri makes pension reform a top priority in his emergency budget plan. His three-point plan included:

1. An established minimum retirment age of 59 for all state and municipal employees.

2. Elimination of cost-of-living increases.

3. Conversion of new hires into a 401(k) style plan.


See WPRI's coverage of Carcieri's proposal here.

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Rhode Island increased mandatory employee contributions for new and current employees. New Mexico was the only other state to mandate current employees to increase their contributions. 


Read the NCSL report here

(Photo: FutUndBeidl, Flickr)

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Rhode Island's state administered public employee pension system only held 48% of the assets to cover future payments to its emplyees.

"This system as designed today is fundamentally unsustainable, and it is in your best interest to fix it" - Gina Raimondo


Check out Wall Street Journal's coverage here.

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November 2010

Gina Raimondo defeats opponent Kernan King in the election for General Treasurer of Rhode Island using her platform to reform the structure of Rhode Island's public employee pension system. She received 201,625 votes, more than any other politician on the 2010 Rhode Island ballot. 

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April 2011

Raimondo leads effort to reduce the state’s assumed rate of return on pension investments from 8.25 to 7.5%.

Her proposal includes plans to suspend the Cost of Living Adjustment (which allows for raises corresponding with rates of inflation for retirees), changing the retirement age to match Social Security ages, and adding a defined contribution plan.

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May 2011

Raimondo releases “Truth in Numbers”, a report detailing the pension crisis and offering possible solutions. She continues to work to raise public support for her proposal.

"Decades of ignoring actuarial assumptions led to lower taxpayer & employee contributions being made into the system." - Gina Raimondo (Truth in Numbers)


Read GoLocalProv's analysis of the report here.

Read the Truth in Numbers report here

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October 2011

Governor Lincoln Chafee and General Treasurer Gina Raimondo present their pension reform legislation proposal before a joint session of the General Assembly.

“Our fundamental goal throughout this process has been to provide retirement security through reforms that are fair to the three main interested parties: retirees, current employees and the taxpayer…I join the General Treasurer in urging the General Assembly to take decisive action and adopt these reforms.”- Gov. Lincoln Chafee

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October 2011

Head of Rhode Island firefighters’ union accuses Raimondo of “cooking the books” to create a pension problem where one did not exist. Paul Valletta Jr. states that Raimondo raised Rhode Islanders’ assumed mortality rate to increase liability to the state, using data from 1994 instead of updated information from 2008, and lowered the anticipated rate of return on state investments.

“You’re going after the retirees! In this economic time, how could you possibly take a pension away?” Paul Valletta Jr (Head of RI Firefighters' Union)

Read more from the firefighters' battle with Raimondo here.

Check out the New York Times' take on RI's  pension crisis here.

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November 17, 2011

The Rhode Island Retirement Security Act (RIRSA) is enacted by the General Assembly with bipartisan support in both chambers. RIRSA’s passing is slated to reduce the unfunded liability of RI’s pension system and increase its funding status by $3 billion and 60% respectively, level contributions to the pension system by taxpayers, save municipalities $100 million through lessened contributions to teacher and MERS pension systems, and lower the cost of borrowing.


Read more from GoLocalProv here.

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November 18, 2011

Governor Lincoln Chafee signs RIRSA into law. According to a December 2011 Brown University poll, 60% of Rhode Island residents support the reform. Following its enactment, Raimondo holds regional sessions to educate public employees on the effects of the legislation on their retirement benefits.


Read about how Rhode Islanders react to RIRSA here.

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January 2012

Raimondo hosts local workshops to explain the pension reforms across Rhode Island. She also receives national attention for her contributions to the state’s pension reforms.  The reforms are given praise and many believe Rhode Island will serve as a template for other States’ future pension reforms.


Read about the pension workshop here.

Read Raimondo's feature in Institutional Investor here

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March - April 2012

Raimondo opposes Governor Chafee’s proposal to cut pension-funded deposits. She continued to provide workshops on the pension reforms.

“The present law is sound fiscal policy and should remain unchanged.” -George Nee (Rhode Island AFL-CIO President)
See WPRI's coverage of Chafee's attempt to cut pension fund deposits here.
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December 5, 2012

Raimondo publicly opposes Governor Chafee’s meetings with union leaders in an effort to avoid judicial rulings on the pension reform package.  In response, Chafee issues a statement supporting the negotiations.


Read more about Raimondo's opposition here.

Read about Chafee's statement http://www.golocalprov.com/news/new-chafee-issues-statement-supporting-pension-negotiations/">here

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March 2013

Led by the Rhode Island State Association of Fire Fighters, unions protest the 2011 pension reform outside of the Omni Providence where Governor Lincoln Chafee and General Treasurer Gina Raimondo conduct a national conference of bond investors.


Read about Raimondo's discussion of distressed municipalities here

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April 2013

The pension plan comes under increased scrutiny as a result of the involvement of hedge funds and private equity firms. Reports show that $200 million of the state pension fund was lost in 2012.

"In short, impressive educational credentials and limited knowledge of investment industry realities made Raimondo ideally suited to champion private equity’s public pension money grab." - Ted Seidle (Forbes)


Read GoLocalProv's coverage of the State Pension Fund's losses here

Read Ted Seidle's criticism of Raimondo in Forbes.

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June 2013

Reports show that the State’s retirement system increased in 2013 by $20 million despite the reforms being put into effect the previous year.


Read GoLocalProv's investigation into the rising pension costs here.

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September 2013

Matt Taibbi publishes an article in Rolling Stone detailing Raimondo’s use of hedge funds as a questionably ethical tool to aid with pension reform. 

Read Taibbi's article in Rolling Stone.

Read GoLocalProv's response to Taibbi here.

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October 2013

As Raimondo eyes the role of Governor of Rhode Island in 2014, more behind-the-curtain information about the 2011 pension reform comes to light.


Read more from GoLocalProv about the players in the pension battle here.


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