MOORLACH UPDATE — GASB — July 21, 2011

Today’s OC Register editorial touches on a very sensitive topic.  If you’ve heard any of my speeches of late, I have been stating that the Government Accounting Standards Board (GASB) is in the process of issuing promulgations on how governments should report defined benefit pension liabilities on balance sheets.  GASB’s private sector counterpart, the Financial Accounting Standards Board (FASB), did this 25 years ago.  It is with great embarrassment that I must confess that my profession of choice, the accounting industry, will be considered as a responsible party for the unsustainable pension liabilities facing nearly every level of government.  GASB failed to address the most critical issue facing municipalities in a prompt and appropriate manner.  GASB has been remiss before.

When I ran for Orange County Treasurer in 1994 against the incumbent, the County’s financial statements did not report that the investments held by Treasurer Robert Citron, had lost significant market value.  My concern was even reported in the April 15, 1994, issue of The Wall Street Journal:

Unlike mutual funds, pension funds, hedge funds and most other money managers, who have to recognize losses and gains in their portfolios as market prices move, Mr. Citron says he doesn’t have to mark his portfolio to market values.

“I can hold to maturity,” Mr. Citron says.  “We don’t believe in taking paper losses and paper profits.”

Mr. Moorlach says he isn’t impressed by Mr. Citron’s comment.  “Mutual funds and everyone else marks to market, and if I’m county treasurer, I will mark investments to market,” Mr. Moorlach says.  Not marking to market is just a way of concealing losses, he charges.

In 1994, Orange County and other municipalities technically were not required to report cash investments at fair market value in published financial reports.  The rest is history.

In October 1994, the long-time county treasurer for Cuyahoga County, Ohio, saw his investment portfolio, ironically known as SAFE (Secured Assets Fund Earnings), implode in a manner similar to what Orange County would experience a few weeks later.

The Plain Dealer, a Cleveland-based newspaper, did a comparison of the two county investment pools in its December 31, 1994, issue.  The article, “Some analysts did see it coming – SAFE woes foreshadowed Orange County’s collapse,” by Timothy Heider and Joel Rutchick (who were awarded the prestigious Loeb Award for their journalistic efforts in exposing the financial scheme – something that did not occur with reporters in Orange County) made the following interesting observation:

Both [county investment pools] helped doom themselves by not accounting for the falling market value of their holdings.  By failing to “mark to market,” as the practice is known, they also camouflaged the dangers to investors.

Not marking to market allowed SAFE to report a $37 million gain for the first eight months of the year, when the real figure was closer to a $41 million loss, according to a Plain Dealer analysis.

“As soon as you can hide things, people are going to take advantage of that,” said Michael Peskin, who heads a New York investment consulting firm.  “It’s a dangerous situation and it exists in spades in the public arena.”

Three years later, GASB Statement 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, became effective.  Had it been in place four years earlier, Citron would not have been able to hide the $1.6 billion in losses that put the County into Chapter 9 bankruptcy protection.

Had GASB been on the ball and issued promulgations on adequately reporting promises to pay in the future, I would venture that most governmental agencies would not have the massive unfunded actuarially accrued liabilities (UAALs) that they do now.  If they had to report it, the taxpayers would have gone ballistic twenty years ago.  But, if you can hide it and play games in the shadows, it’s incredible how much mischief benefactors can get away with.

If Orange County had to add its defined benefit pension plan UAAL to its liabilities on its balance sheet, it would wipe out nearly 80 percent of its net worth.  That said, today’s editorial is a serious one to read and ponder.

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Editorial: Transparency for government pensions

New accounting rules would cause sticker shock over cost of public employee retirement plans.

Proposed accounting rules would change the way state governments and local municipalities report public employee pension liabilities, bringing more transparency to California’s alarming unfunded pension liability problem. These new rules would not necessarily change the economics of pensions, but could lead to major reforms.

The Government Accounting Standards Board, the Connecticut-based organization which establishes standards of state and local government accounting, proposes requiring governments report pension liabilities on balance sheets as opposed to in footnotes, as they are currently reported. If enacted, such standards would reveal the true situation, and undoubtedly give lawmakers sticker shock.

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MCT ILLUSTRATION

In California alone the pension liability is as high as half a trillion dollars for state public employees, as estimated in the much-publicized Stanford University study, which used accounting procedures similar to what GASB proposes.

Andrew Biggs of the American Enterprise Institute said, "While the proposed rules would be good for transparency, GASB’s rules have really been more a part of the problem than the solution."

Orange County Supervisor John Moorlach, an accountant, shared a similar view when we asked him about the new rules. "It’s a good thing," Mr. Moorlach said, "but GASB should have done this 30 years ago because, by not requiring the reporting of liabilities, it allowed some to work in the shadows."

The lack of a reporting requirement allowed for the "pillaging and plundering of public employee pensions," Mr. Moorlach said. "GASB is finally stepping up to the plate but they are too little too late."

Mr. Moorlach went so far as to say, "Orange County could have avoided bankruptcy [in 1994] had GASB required reporting of investments at market value" and noted that GASB’s private sector equivalent, the Financial Accounting Standards Board, has required this type of actuarial reporting for some time.

The ultimate reform that could result from increased transparency of pension liability would be to shift public workers from traditional, defined-benefit plans, which promise a set amount of retirement pay, to defined-contribution plans, which resemble private-sector retirement packages like 401(k)s.

Interests that oppose GASB’s proposed rules realize that if municipalities were to adopt such rules, defined-benefit plans might go the way of the dinosaurs. The National Association of State Retirement Administrators and the National Council on Teacher Retirement both realize this threat. In a joint statement, the organizations warned, "Government sponsors and their defined-benefit pension plans will be challenged by the tough new changes to its regulations that GASB is proposing."

Public comments on the proposed rules are due by Sept 30; GASB is expected to announce the final rules next June.

Simply changing actuarial procedures for reporting pensions will not solve the problem, nor excuse past rules that allowed for abuses in the system, but it will, at least, tighten the focus on the unsustainability of the public employee pension system.

Mr. Moorlach said under the new rules, "50 percent of municipalities in the state would show negative equity;" it would show the municipalities as "theoretically bankrupt."

"This will have an amazing impact up and down the state and around the country."

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