MOORLACH UPDATE — LOOK BACKS — May 10, 2010

I hope you had as wonderful a Mother’s Day weekend as our family did. 

It’s been quiet on the news front.  And that’s a good thing.

But, there were some interesting themes in the Look Backs that I wanted to forward.

FIVE-YEAR LOOK BACKS

May 6

1990

Twenty years ago I served on the Mesa Verde Homeowners Association’s Board of Directors.  It was an interesting time in Costa Mesa’s history.  Many residents were opposed to further development in the city and they organized.  The “no-growthers” were also successful in getting like-minded candidates elected to the city council.  The focal point of the debate centered around the development of the city’s new general plan. 

The lightning rod was a large tower that was proposed for the corner of Harbor Boulevard and South Coast Drive.  It had many of us concerned.  But, it should not have been the cause of an overreaction.  So the debates started.

On March 25, 1990, I had a Letter to the Editor printed in the Daily Pilot that was titled “General Plan survey misleads public.”  Within days I received a letter from fellow Board member Gene Hutchins clarifying one of the points I raised in my submittal.

On April 8, 1990, there was also a response from the officers of the Board, titled “Mesa Verde Homeowners’ Association strikes back.”

After reviewing Mr. Hutchins comments I wrote another Letter to the Editor, titled “Mesa Verde board member clears air,” that acknowledged the difference of interpretation.

The “Granny” I’m referring to is Granny Brasser.  She always provided sage advice during our times together at a summer camp in the San Gorgonio Mountains.  We did a lot of camping at Laurel Pines, off of Highway 38, with our kids while they were growing up.

And, yes, when I make a mistake, I do apologize.  Here are a few paragraphs of my submission:

                As a member of the Mesa Verde Homeowners Association’s Board of Directors, I would like to say that I am sorry.

Granny told me that whatever you believe in, believe it.  And if you’re wrong, someone will pull you aside and correct you.  Gene Hutchins, another member of the board and a member of the General Plan Steering Committee, corrected me.  I was in error when I contested that the Planning Commission’s recommendation did not approximate the Proposed General Plan submitted by the staff of the City of Costa Mesa.  I deeply regret the error.  And I am very appreciative to Gene for politely and courteously clarifying my misunderstanding.

               

I confused the Proposed General Plan with the existing 1981 General Plan.  As such, the Planning Commission’s recommended General Plan, which “approximates the Proposed General Plan,” would be the compromise between the existing General Plan and the Steering Committee’s recommended General Plan.

My concerns lie with the restrictive nature of the Steering Committee’s Plan as it pertains to future potential appropriate development.  I’m all for limiting inappropriate growth that will generate traffic but I don’t want our city to be so repressive when it comes to free enterprise needs for healthy commercial and residential development.  To that end, I wish to encourage the Steering Committee and the City Council in its ongoing efforts to forge a balanced General Plan.

May 7

2000

As the escapades continued with the Orange Unified School District’s union running wildly with incorrect facts and figures, Orange County Auditor-Controller David Sundstrom and I co-wrote an editorial submission for the OC Register.  The OC Register titled it “Toward common ground in Orange schools.” 

It’s fun when two C.P.A.s dissect an agency’s financial records and come up with observations and recommendations.  Because these issues are now on top of us, I’m providing the entire piece.

As reported recently by the press, there is great cause for celebration in the Orange Unified School District. Four of the district’s schools have been designated as “California Distinguished Schools” — an impressive accomplishment considering that the only other Orange County district that matched OUSD was Newport-Mesa. This is a time to celebrate the remarkable accomplishments of the District’s teachers, parents, administrators and board. It clearly demonstrates that the overall mission of the District is being achieved.

Unfortunately, all is not as well as it may seem.  There is an acrimonious battle raging over teachers’ salaries.  How could a district so polarized by a history of collective bargaining impasse produce such an extraordinary program result?  Think about how much more that could be accomplished if the current labor dispute were put behind them.

Given the news of late last week, it appears the gap between the two sides could be narrowing.  However, some sticking points remain.  For instance, the teacher’s union has insisted that there is more money available than the District is telling.

At one point, the union used the District’s $25 million cash balance in the County Treasurer’s Educational Investment Pool to bolster its position. Cash balances have nothing to do with guaranteeing the teachers’ annual salaries and District solvency.  It does not justify the union’s recent $21 million proposal.  In fact, this overreach is more than double what the District can afford.

The core of the conflict is the numbers that both sides are using to support their positions. Therefore, a clear understanding of the District’s financial position is essential if the labor dispute is to be resolved.  Once both sides are on the same page there will be room for mutually beneficial efforts that can get them closer to where they want to be.

THE KEY QUESTIONS

There are two financial questions that need to be answered:

·         “How much can the District afford to pay the teachers?” 

·         “What is the market salary for teachers?”  

As concerned elected officials who share the same constituency, we endeavored to review the documentation provided by the district and that disseminated by the  union’s leadership.

There is an abundance of public information available to answer the affordability question, which likely accounts for some of the confusion.  Information made available included a 110-page unaudited financial report, a 111-page budget document, two 40-page budget reports, a 38-page actuarial report and a 104-page set of audited financial statements. 

The audited financial report was our primary source of information. After all, it was certified to present “fairly in all material respects, the financial position of the Orange Unified School District for the year ended June 30, 1999 and the results of its operations” and was prepared by a highly credible and licensed certified public accounting (CPA) firm.

According to the certified report, the District had $10,371,945 left over after accounting for all the expenses and revenues for that year. 

This represents a very good fiscal year for the District, and not the norm, but it is our starting point.  In a prudent move, $750,000 was transferred to a deferred maintenance fund, which receives a dollar-for-dollar state matching contribution. 

This leaves a balance of approximately $9.6 million.  (Although the District allocated $3.4 million for restricted purposes, which reduces the balance to $6.2 million, this was not disclosed in the certified report and is therefore not considered in our analysis.)

FUTURE LIABILITIES

If we have $9.6 million to work with, and before allocating it to salaries, we need to look to a financial statement footnote entitled  “Postemployment Benefits.”  

There we find that the District has an anticipated future cost, in excess of annual current costs, of nearly $87 million to certain employees representing the liability from the promise of lifetime healthcare benefits.

This is an unusual and generous benefit that has only been awarded to employees of four other California school districts.  For this fiscal year nearly $5.4 million was set aside toward this obligation, the third annual payment at this amount.

What does this have to do with how much we can afford to pay the District’s teachers?  Its impact is extremely significant.  In order to keep the District solvent, a regular contribution must be made toward covering this $87 million liability as it becomes due.  In fact, until the most recent actuarial study, the unfunded liability was anticipated to be as high as $168 million.  Reducing the $9.6 million by the $5.4 million only leaves $4.2 million for salaries.  Not enough, but the most recent actuarial study provides some relief.

With a reduction in the actuarially determined total liability from $168 to $87 million, the recently made annual contributions have been greater than what is now needed annually to fund future medical benefits.  

An actuary estimated that only $2.1 million annually would be needed to fund the liability over a 25-year period.  Therefore, we now have $7.5 million available.

The District has already imposed an across-the-board salary increase of 8 percent.  The anticipated annual cost of this decision is between $5.7 and $6.4 million.  This fits.  It even leaves $1.1 million for recent staffing and curriculum upgrades, contingencies, emergencies and restricted allocations. 

The actuarial reduction of $3.3 million in the annual funding of lifetime benefits is only half of the good news.  The other half is that funds are available to buy out the lifetime benefits from the affected employees, should they chose to elect this option.  If all of the impacted employees do so, then the District has an additional $2.1 million available annually for potential salary increases.

FAIR VALUE FOR TEACHERS

To accomplish this, a fair value must be paid to the teachers and district employees in the plan.  Both the District and the union have made such offers. This is the area where honest debate and dialogue should be addressed.  With proper leadership, funds could be made available for both sides to come closer to the appropriate market salary for teachers.

Annual funding will continue on a “pay-as-you-go” basis to cover current medical costs for 867 retirees (both certificated and classified), which amounted to $4.3 million in the past year.  This amount will increase dramatically over time which will exasperate future budgets if it is not prudently dealt with now.  A buyout of this benefit will result in a gradual decrease in the amount required to fund benefits for current retirees.

Could additional funds be trimmed from the budget and freed up for teacher salary increases?  Approximately 80 percent of the district’s expenses are payroll and debt related, with only 20 percent potentially subject to discretion (if you assume utilities and maintenance costs are discretionary).  We believe the District’s Board and Administration have worked diligently to contain these costs.

During a recent conversation, District leadership appeared receptive to implementing a five-year financial planning process, similar to the one used by the County to successfully emerge from bankruptcy. Orange is the only county in the state to implement a five-year strategic financial planning process. If adopted by the District, it would be a trendsetter among districts for financial planning.

There is no argument that school district budgets are very tight.  Irvine Unified’s public budget shortfall struggles are a reminder to all of us about the tenuousness of school finances and the importance of genuine efforts needed for diligent financial stewardship. 

Properly dealing with the facts will provide a distinguished resolution.  Then the teachers, students, parents, leadership and the Board of OUSD could again totally focus on the District’s award-winning educational mission.  

May 8

2000

Peter Brennan of the Orange County Business Journal covered an interesting facet on a topic that will recycle again soon.  The article was titled “Bidders, Lobbyists Line Up for Big County Contract.”  Ten years later, the contract is up again and it is still a very big financial commitment.  For this round the county has explored bifurcating the components, has had our Performance Audit Department working on a multi-reporting analysis of our IT activities, and focused on new technologies, such as VOIP (Voice Over Internet Protocol).

I’m mentioned once in this lengthy piece.  Allow me to give you the opening three paragraphs, the segment where I am mentioned (without giving too much history to provide the context) and the following two paragraphs, as they relate to the concerns I raised recently in my April 30, 2010 Update.

                The home stretch is near for five teams of companies aiming to win the largest contract ever awarded by the Orange County government—a five-year pact worth $120 million or more to run the county’s data-processing and telecommunications center.

                If a five-year renewal option is exercised, the deal could top $200 million.

The pending contract award has created a bonanza for lobbyists who have been hired by the competing teams of bidders to help them win the contract.  But it is also a process under a cloud, with the 1995 renewal of the data-processing contract still a sore point between the county and at least one of [the] bidders, and the county’s contract-letting process under scrutiny because of a more recent controversy.

The bidding also comes at a time when the county contract system is under scrutiny for the way it awarded a taxi-service contract at the John Wayne Airport in March.

“I think (the taxi controversy) might cast a shadow,” said OC Treasurer John Moorlach, who is on a committee overseeing the data-processing contract.

However, [Randy] Smith, representing Lockheed this time around also, said it’s too late to change the current bidding process.

“Once the RFP [is] issued, it lays out the process for how it’s done.  It’s not good to change this in mid-stream,” he said.

May 9

2005

The City of San Diego was “the” story five years ago.  In the Orange County Business Journal, Rick Reiff, in an editorial titled “Skeptical,” addressed the Governor’s 2005-06 budget, which dropped pension reform (and why I find his current posturing so disingenuous).  Rick also mentions my column, “Lessons from San Diego.”  They are provided first and second, respectively, below.

It’s quite amazing how little has changed in five years, except for the magnitude of the numbers involved.  Talk about letting a problem fester into a mess.  You can see that I was on this topic five years ago and that I followed through in my first term.  The final caution in my piece may find itself as a topic in my second term.

Skeptical

Todd Theodora, high-powered lawyer and member of OC’s well-heeled New Majority, makes a strong case for Gov. Arnold’s proposed budget reforms in his letter to the editor below.

But I’m skeptical.

The budget reforms are fine as far as they go, but they’re water-downed from tougher measures, including a hard cap on state spending that the governor declined to embrace.

And the governor has abandoned, at least for the foreseeable future, an overhaul of the state’s pension system.

It’s a much bigger version of the San Diego crisis and the looming Orange County problem that John Moorlach describes in the Viewpoint on this page. In fact, the state’s underfunding for CalPERS and CalSTRS is $31 billion.

Schwarzenegger’s retreat on pension reform in the face of a withering assault from public employee unions, and his backtracking on other issues when his opponents have tugged on heartstrings, appealed to emotions or simply flexed their political muscles, has me and others questioning his resolve.

The New Majority has put $4 million into the initiatives. We’ll find out soon whether it’s been money well-spent.

Lessons from San Diego

Dick Murphy resigned on April 25 as the mayor of the second largest city in California, San Diego, which has become the poster child of public defined-benefit pension plan abuse.

San Diego has been referred to as "Enron By The Sea" by the New York Times, and Murphy’s lack of leadership and complicity with its pension plan travails caused Time magazine to recently recognize him as one of the three worst mayors in the country. A nearly $1.4 billion pension plan underfunding can do this to a mayor.

With Orange County looking at its pension plan being underfunded by as much as $1.5 billion by the first of July, it would serve us well to take notice of what’s happening south of our county’s border.

The participants of defined benefit pension plans will lay the blame on recent poor market performance. But one would be wise not to hang one’s hat on this excuse. An analysis of Contra Costa County’s underfunded pension plan found that only 2% of its $1 billion liability was due to market performance.

Another well-worn excuse is that every other pension plan in the country is facing the same underfunding issues. Well, not everyone is.

The state of Georgia’s two major public pension plans, the $42.4 billion Teachers Retirement System and the $12.4 billion Employees’ Retirement System, are fully funded, 101.1% and 100.5%, respectively (Institutional Investor, February 2005).

The state of Georgia is succeeding because it utilizes conservative asset allocations and actuarial assumptions. But what makes Georgia stand out is a statutory requirement that any increase in retiree benefits be immediately funded after they are authorized by the state Legislature. Brilliant!

In August 2004 the Orange County Board of Supervisors approved another extremely generous retroactive benefit that created another $300 million pension plan funding obligation. If the county had an ordinance in place requiring immediate payment, I sincerely doubt that it would have been approved.

I am reminded of the time I counseled a client who was living large and was complaining about being financially strapped. I casually mentioned that I followed the principal of not borrowing money to purchase depreciating assets, like an automobile. "Are you crazy? If I had to pay cash, I would never have purchased my new Corvette." Exactly.

Here in California we have been adding and adding generous retirement benefits to public defined-benefit plans and doing it with a credit-card mentality.

The city of San Diego has done some serious soul searching. In September, its Pension Reform Committee released the following recommendation, among many:

"The city charter should be amended to require that for all new pension benefit improvements the plan will use an amortization period no greater than five years for any past service liability, effective immediately."

That’s a little more generous than the state of Georgia. But the county of Orange relied on a 30-year amortization period for its most recent pension plan enhancement.

That means the $300 million obligation will cost another $450 million in interest by the time the last payment is made in June 2036. If it were paid off in five years, the interest costs only would be about $72 million, or $378 million less! Such is the joy of not paying off your debts earlier.

The Orange County Employees Retirement System board of directors changed the amortization period for any plan enhancements to 15 years at its April meeting. Unfortunately, this only applies to future increases and not the one that becomes effective in July.

Thanks, but I believe the horses already are out of the barn. They did not approve my five-year amortization proposal. San Diego also is using a 30-year amortization for its enhanced benefits.

San Diego also sold additional retirement credits (years) on the cheap, over the protests of its actuary. This is another area where public defined-benefit plans can be abused.

Mayor Murphy purchased five years for $71,760. He’ll receive an additional $17,500 per year for this maneuver. He’ll recoup his investment in only four years. This small detail was released on Friday, April 22. The following Monday morning he stepped down.

The big killer for San Diego, however, was the use of assumptions that were not conservative. It raised its assumed rate of earnings (known as the interest-rate assumption) well over 8% in order to overstate the plan’s funding level, which lowered its employer contributions. Thus compounding the underfunding problem.

When the Orange County Employees Retirement System board conservatively voted to lower its interest rate assumption to 7.5% a couple of years ago, two OC supervisors publicly criticized it. However, the California Public Employees Retirement System recently followed suit and lowered its rate to 7.75%.

If California and its municipalities had followed Georgia’s conservative approach to managing defined-benefit pension plans, we would not be debating about pension reform.

Our state’s elected officials must stop the over-promising. They must stop the many forms of abuse that a defined-benefit plan is vulnerable to. And they must purpose to pay for new enhanced benefits immediately.

Short of this, the car keys must be taken away. And defined-contribution plans will become the norm for new employees joining the municipality workforce.

Taxpayers still will have the large rat of costs, foisted on us by our elected leaders, going through the proverbial python. But, revving the car at too high an RPM level eventually will kill the engine from stress.

Mayor Murphy is our first victim. Before we have any more we had better learn from our successful neighbors in the Peach State.

Moorlach is the Orange County treasurer-tax collector.

Pat Broderick of the San Diego Business Journal also did an exhaustive piece on the big topic of the day:  “Bankruptcy Still S.D.’s Buzzword.”

The City of San Diego was in turmoil back in 2005.  The City of Los Angeles could be next.  It’s former mayor, Richard Riordan, is already recommending that LA file for Chapter 9 bankruptcy.

Although this piece is lengthy, it may be a helpful read as this topic is really big right now.  For some municipalities it’s not a matter of “if,” but “when?”

 

The big bad "B" word , bankruptcy , continues to be bandied about San Diego as a solution to the city’s fiscal misfortunes.

While most San Diego officials have dismissed it as an option, some outside analysts say bankruptcy deserves serious consideration.

Chapter 9 bankruptcy, the only option available to municipalities, is a form of reorganization that essentially gives a city some breathing room, said the Atlanta-based Sajan George, managing director of Alvarez & Marsal, an international turnaround specialist.

George was part of the Arthur Andersen restructuring team that advised Orange County during its bankruptcy proceedings. The filing occurred following the December 1994 announcement that the county’s investment pool had suffered a $1.6 billion loss , billed as the largest ever recorded by a group of local government investors.

"The problem is, how to fund liabilities and provide essential services," he said. "You can’t tax the residents to death, because it would make San Diego unattractive not only to its residents, but in attracting future employers."

While Chapter 9 has its downside and carries a stigma, George said San Diego should consider it.

"I don’t think they’re in any position to rule out any options," he said. "I would not be taking anything off the table. One way to avoid bankruptcy is to be prepared to go into it, to have plans that lay out the pros and cons. When people see that you are that serious, it gets things done. It’s like when one side is threatening to strike or disrupt services, it has a galvanizing effect, being prepared to take drastic actions."

And there is one benefit, he said.

"It enables you to renegotiate all contracts," said George, adding that any stigma attached will be short-term.

"The point is, long-term survival," he said.

The city’s notoriety these days might actually ease any downside.

"The stigma would not be as bad as in some other places, where the problems are not as well known," he said.

Among the city’s woes: a pension deficit, now estimated at $1.4 billion, a budget deficit of $50 million, investigations into the city’s finances by the Federal Bureau of Investigation, Securities and Exchange Commission, and U.S. attorney, and two city councilmen now on trial for allegedly taking bribes.

Additionally, with the red-hot contest swirling over who would land the permanent site for the California Institute for Regenerative Medicine , the decision was to be announced after the San Diego Business Journal ‘s press time , San Diego already was smarting from its many woes. This included the April 25 resignation of Mayor Dick Murphy, effective July 15. San Francisco Mayor Gavin Newsom, whose city topped the list for the coveted institute, at one point had quipped that "San Diego didn’t even have a mayor," prompting Murphy to retort, "I’m still here , you might have noticed. San Diego is so much more than one person."

David Hitchcock, the director of Standard & Poor’s state and local government group in its New York office, tended to agree that ratings are influenced by more than one individual.

"We rate long-term debt, 20- and 30-year bonds," Hitchcock said. "We do look at politics, continuity, sound management. It’s not to say there hasn’t been problems in certain cases caused by management in a city and county. Quite often, the problem is because of management.

"These problems usually aren’t the result of one person, and it usually takes more than one person to clear it up. Who can say that one person is in charge of a city for the life of a bond issue? There is always going to be turnover."

San Diego’s current turnover issue could be resolved as early as July 26, when a special election is scheduled to be held to replace Murphy.

Among the candidates jockeying for the job are City Councilwoman Donna Frye, who ran as a write-in candidate and won more votes than Murphy in the November election. But the registrar of voters disqualified 5,551 of the write-ins because a bubble accompanying her name was not properly filled in, as required by state law. Murphy was sworn into office, but a number of lawsuits sprung up contesting his installation, including one that still is pending in the 4th District Court of Appeal.

Where does all this leave San Diego?

"If you have a strong economy, you can withstand a certain amount of mismanagement, but if the economy is weak, you can’t," said Hitchcock. "A lot of cities would love to have San Diego’s economy."

In his 2006 proposed budget message, delivered May 2, City Manager Lamont Ewell reported a positive economic forecast for San Diego.

"Overall, employment growth is anticipated to accelerate in the coming year," he said, "which is expected to result in improved consumer sentiment and increased business investment."

According to his proposed budget, the road ahead will require substantial belt-tightening, including layoffs, and what he called "conservative multiyear labor agreements, as well as new revenue sources."

A common refrain inside and outside of San Diego is that the city doesn’t have a revenue problem; it has a spending problem.

"San Diego is certainly among the strongest economies in the state," said Amy Doppelt, the managing director of the San Francisco office of Fitch Ratings. "But there are also significant challenges. They are in a good position. The revenue is good, but they also have big increases in expenses, rising costs of health care. These are challenging every city and county, the public and private sectors."

Murphy’s resignation will not necessarily improve the city’s ratings, she said.

"The city needs a strong consensus and leadership in solving the budget problems," said Doppelt. "Having leadership that has credibility and will bring parties together is a good thing. But it will be awhile before it’s clear who the new mayor will be. I don’t know if the resignation will be beneficial or negative."

Advertisements