MOORLACH UPDATE — San Diego U-T — October 13, 2013

Several months ago, Bill Osborne, editorial and opinion director of the San Diego U-T, invited me to participate in an editorial series titled “Fixing California” (see MOORLACH UPDATE — ACA Savings? — June 3, 2013). The best part of the assignment was that twice the normal number of words was suggested. I focused on the topic which was the main component of the concluding slides of my “State of the County” address last January, that pension liabilities can be addressed at the bargaining table. The San Diego U-T published my submission in yesterday’s Sunday edition.

Fixing California: Why cities go broke

Public employee pensions are in bad need of a fix – and unions should take the lead

By John M. W. Moorlach

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Three of the five largest local government bankruptcies in American history occurred in California — Orange County in 1994, Stockton and San Bernardino, both in 2012. Numerous other local governments in the Golden State face severe financial peril. John Moorlach, a certified public accountant, accurately predicted the Orange County collapse as a candidate for treasurer/tax collector in 1994. In this commentary, Moorlach, now a member of the Orange County Board of Supervisors, makes a compelling case for fixes to the pension fund problems that are at the root of financial turmoil in most California cities.

The market has a way of communicating to cities and counties through the bond market. The reverberations of the recent filing for Chapter 9 bankruptcy protection by the city of Detroit were swift and dramatic. The bond market generated losses in July and August, only the second time in 25 years that obligations fell in both of these months. The loss for the month of August was 1.6 percent, the largest drop for this month in 14 years.

At the end of August, federal Judge Meredith Jury ruled that the city of San Bernardino qualified for its Chapter 9 filing, sending further tremors in the tax-exempt fixed-income marketplace.

Addressing employee wages should be the top priority of public employee unions. Somehow in recent history, this was inverted and an emphasis on pensions was pursued. But defined-benefit pension math is not pleasant and its costs have pushed other total compensation components (salary and benefits) out of the way. Now the unfunded liabilities are so severe municipalities are entering federal court for remedies.

What should be hoped for from the desperate act of filing for bankruptcy protection in a federal court? For Stockton, San Bernardino and Detroit, it appears to be the receipt of some form of debt reduction or modification. What should that relief look like and can it be transferred to other cities without the stigma of having to actually file for Chapter 9 bankruptcy?

Orange County is a model of restraint in the area of retiree medical benefits. With an unfunded actuarial accrued liability of some $1.4 billion in 2006, the county negotiated with its bargaining units and agreed to several plan changes that reduced the unfunded liability by 71 percent, or $1 billion. The modifications reduced the annual required contributions by some $100 million. Such is the benefit of debt relief.

Adjusting the retiree medical plan for the employees and retirees of the city of Vallejo was a component of its bankruptcy restructuring plan. But, Orange County’s method of pursuing these changes at the bargaining table is certainly preferable. This solution can be pursued by any city, county or state outside of a federal bankruptcy courtroom. And, in fact, they should pursue such negotiations as quickly as possible. This is the first minimal step that should be taken in the journey to fix California.

The biggest debt facing most cities and counties is the unfunded liability in the defined-benefit pension plan. A report released on Sept. 3 by State Budget Solutions puts the total underfunding for state plans alone at $4.1 trillion.

The most popular method for addressing this underfunding has been to make changes that only impact new employees. This is a smart first step, but doesn’t go far enough soon enough.

Another approach that has been gaining huge momentum is to have current public employees pay in for their share of the normal cost of the pension benefits. In fact, both of these solutions were incorporated into Gov. Jerry Brown’s Public Employee Pension Reform Act enacted last August.

Two more dramatic remedies will soon have to be considered by municipalities to address their defined-benefit pension plan liabilities.

Let me illustrate them by sharing Orange County’s story.

In 2001, shortly after the terrorist attacks of Sept. 11, the Orange County Board of Supervisors voted to adopt the implementation of SB 400. This legislation allowed for a 50 percent increase in pension benefits for public safety employees, retroactive to the date an employee was hired. The increase became effective the following year. This did not sit well with the general non-safety employees and they negotiated an increase in their own, less-generous, formula, retroactive to the date of hire, effective the next year.

The accompanying chart reveals the dramatic impact of taking a fully funded plan and increasing the benefits midstream by half. This once fully funded system is now less than two-thirds funded (currently 63 percent) and it occurred in a relatively short period of time.

To save the sustainability of the retirement system and to reduce the annual contribution requirements by the county into the plan, there is a daring solution that can be proposed at the bargaining table. Ask the bargaining units to rescind the pension enhancements approved in 2001 and 2004. This would be difficult to swallow, but it would reduce the unfunded liability by anywhere from $1 to $3 billion. Reducing such a massive debt will provide more operating cash for the county, which means that the salary increases that public employee unions are clamoring for could actually be discussed with a straight face for the first time in some six years.

This idea is not new.

In 2009, the Orange County Board of Supervisors negotiated a one-time option for current employees to decrease the defined-benefit pension formula. It also provided for an employer-matched defined-contribution plan, similar to a 401(k). Unfortunately, Internal Revenue Service Revenue Ruling 2006-43 has obstructed implementation of the Orange County option, because the IRS does not permit a change in formulas. This can be modified with federal legislation, which is currently before the House of Representatives, in the form of H.R. 205. Regretfully, national public employee unions also have a stranglehold on the Treasury Department. But, one public employee union, the Orange County Employees Association, showed that working at the bargaining table can provide creative results that can reduce not only unfunded retiree health care liabilities, but pension liabilities, as well. And it can also reduce the employee pension contribution withholding amount, resulting in higher net paychecks.

Modifying down pension formulas is the prudent approach to pursue. Employees would be assured a reasonable pension. It may not be the “formula on steroids” they recently negotiated, but the modified formulas were still very generous equations compared to any private-sector retirement plan, and certainly compared to Social Security. Such a change would preserve the defined-benefit pension model and avoid the obvious cry to freeze plans and convert wholesale to defined-contribution models similar to the 401(k) retirement approach of many Fortune 500 employers.

Although it is often framed as an all-or-nothing issue, from a rational perspective California’s public employees should be willing to take the initiative to moderate their pension formulas, knowing that they could possibly lose a significant percentage of benefits if municipalities start declaring bankruptcy. Low-funded defined-benefit pension plans are exposed to the risk of eventually paying out a much lower benefit, one that can be afforded over time, versus what was actually promised.

Some airline pilots of now-bankrupt carriers are receiving 40 percent of their formerly promised annual benefits. This scenario is bound to be duplicated in the public sector as taxpayers reach a tipping point and refuse to pay more and more for equal or reduced service levels. In fact, certain retirees of Central Falls, Rhode Island, recently agreed to pension reductions of 50 percent as a resolution of that city’s bankruptcy filing.

The third difficult proposal that should be considered would be to modify or temporarily suspend the cost-of-living increases for current retirees. Providing a generous annual increase when a pension plan is only 63 percent funded means that getting out of the hole will take even longer, as the hole keeps getting deeper. Everyone needs to chip in to reduce the unfunded liability.

Many states have constitutional provisions that allow for the overriding of pension contracts. If such a provision were available in California, it could mandate that public pension plans put annual cost-of-living increases on hold until a plan is at least 80 percent funded or achieves some other critical solvency milestone.

Solutions require the contribution of all parties, including retirees. And, if my memory serves me right, I did not hear protests from any retirees when SB 400 was approved, adopted or implemented.

While these last two proposals would be difficult to implement in a public employee union-run state like California, the landscape for their pension plans may be about to change. With the recent filing for Chapter 9 bankruptcy by the cities of Detroit, Stockton, and San Bernardino, the inference that pensions are untouchable will be questioned.

A federal bankruptcy judge may just approve these two solutions in a plan of adjustment to allow one or more of these cities to exit Chapter 9 with the debt relief they need to survive financially. This may change the pension paradigm for municipalities around the entire country. This is the joy of federal bankruptcy court, where any contract, including pensions protected by state law, can be impaired by a federal judge. It is no wonder that the bankruptcy judge overseeing Detroit’s filing has demanded that a creditor committee representing the city’s more than 23,000 retirees be established as soon as possible.

Something will happen to the pensions of current and retired employees. It behooves public employee bargaining units around the nation to get in front of this imminent shift. They should negotiate a rescission now that is acceptable to their current and past membership, but also affordable to the taxpayers who foot the bill.

No one likes being forced to give back a gift. But, by being stubborn, bargaining units run the risk of seeing their pension drastically reduced with little or no input if their employer pursues Chapter 9 to obtain the results that these three cities are about to achieve.

It’s time for everyone to admit that recent pension enhancements, generated from an unachievable expectation created by the dot-com boom of the late 1990s, are no longer fiscally prudent. The direct beneficiaries need to take ownership and set a course to correct it. If city and county employees take the appropriate leadership role, fiscal calamity can be avoided and they will have saved their cities and counties, and their pensions.

Moorlach is a member of the Orange County Board of Supervisors and a certified public accountant.

About John M.W. Moorlach

Orange County Supervisor John Moorlach.

Member of the Orange County Board of Supervisors since 2006. He has been a major voice on the fiscal challenges facing local governments, the state and the nation and serves on the advisory board of the California Foundation for Fiscal Responsibility. He previously served as Orange County’s treasurer and tax collector for nearly 12 years. Campaigning for the treasurer’s position in 1994 against incumbent Robert Citron, Moorlach correctly predicted Orange County’s huge municipal portfolio losses and bankruptcy, the second-largest local government bankruptcy in history up to that time. Citron subsequently resigned and Moorlach was appointed to fill the vacancy in March 1995. He was elected to the post in 1996 to complete Citron’s term, and re-elected in 1998 and 2002. He hopes to formally announce his candidacy for Congress in California’s 45th District later this month.

· Political affiliation: Republican

· Earlier career: A certified public accountant who was vice president of the Balser, Horowitz, Frank and Wakeling accounting firm.

· Age: 57

· Born: The Netherlands

· Education: Bachelor’s degree from California State University, Long Beach

FIVE-YEAR LOOK BACKS

October 13

1998

The Foothills Sentry provided precise details of my visit to one of the members in the Orange County Local Government Investment Pool for schools in “Moorlach scores big hit with Orange Unified School District trustees.” The name of the reporter is not provided, but the writer of the piece provided a great summary of the investment side of the Treasurer-Tax Collector’s shop. It also emphasizes the “policies, procedures, and oversight” approach that I pursued while having the honor of serving as the County’s elected Treasurer-Tax Collector with a great staff that assisted in turning it around.

Orange County Treasurer-Tax Collector John M. Moorlach scored a big hit with the Board of Education of the Orange Unified School District.

His appearance at the Sept. 8 board session to report on how the district’s funds entrusted to the county treasurer are now invested was warmly received and even won the praise of Kathy Ward, a board member who is in the banking business.

Ward has been the school board’s toughest questioner of OUSD administrators on financial issues.

Moorlach painted an entirely different picture of how school district funds are handled by his office these days than existed when former Treasurer Bob Citron lumped them in with other county funds which were swept up in the Orange County bankruptcy.

By law, all 31 Orange County school districts must now place their money in The Orange County Treasurer’s Money Market Educational Investment Pool which had about $1.2 billion in assets as of April 30, Moorlach told board members.

Participation in this pool is limited to Orange County school districts.

This pool, along with the Orange County Treasurer’s Money Market Commingled Investment Pool are rated AAA/V1+ by Fitch IBCA, an international rating agency.

Moorlach explained that local governmental pools rated AAA “meet the highest standards for credit quality, conservative policies and safety of principal.”

The pool’s V1+ volatility ratings reflect low market risk and a strong capacity to return stable principal values to participants even in severely adverse interest rate environments, he said.

He noted use of leverage, which practice led Citron’s investment pools astray, is prohibited by policy.

Both county pools, Moorlach said, invest exclusively in approved securities as required by the California Government Code.

To insure investment quality control, Moorlach cited a dozen steps his office takes to safeguard invested funds.

These include review of investments and investing policy by the Treasurer’s Advisory Committee, the Treasury Oversight Committee, a Daily Internal Compliance Review, and a Quarterly Compliance Review by Fitch IBCA which is also published.

In addition, there is a Quarterly Audit of Assets Held By The County Treasurer (to be published), Quarterly Internal Audit Department (to be published), and Annual External Audit by an independent CPA firm.

Moorlach meets monthly with members of the Board of Supervisors and has an annual interview with the Orange County Grand Jury.

The Investment Management Committee meets weekly.

Moorlach said another asset is a program in which interns conduct research which he said was proving to be very valuable.

He said he believed in the “flat yield curve – short end” which many experienced investors follow.

A federal act which governs Security and Exchange Commission (SEC) registered money market funds provides pools must maintain a weighted average maturity (WAM) of all portfolio maturities of 90 days or less.

As of April 30, Moorlach said, both county investment pools had WAMs of 81 and 88 days respectively.

Moorlach noted that the county’s 31 school districts had requested their funds be kept in a separate pool which was established in July 1995.

Both pools are subject to separate accounting and record keeping. The Bank of New York Co., Inc., holds the assets of the pools in separate custodial accounts.

Moorlach emphasized that both the commingled and the educational investment pools bear virtually no resemblance to the Orange County Investment Pool that filed for bankruptcy on Dec. 6, 1994, with losses eventually realized at approximately $1.6 billion.

October 14

2008

Election season continued, with significant media attention focused on the desire for Rossmoor’s leadership to incorporate their area into a city. The Long Beach Press-Telegram assessed the players in the campaign accurately and weighed in with its perspective in the editorial “Outsiders vs. cityhood.”

Why would outsiders, from the Orange County sheriff’s deputies union, step in and oppose efforts to create a City of Rossmoor? Because they aren’t complete outsiders.

In fact, assuming the incorporation campaign succeeds, the new city might have wanted sheriff’s deputies to continue to provide police services, as they do now. But that’s an attitude that could change.

The union, Association of Orange County Deputy Sheriffs, is pouring money into Rossmoor to see if it can block the incorporation. Often referred to as powerful, a better term for the union would be free-spending. Its reason for the Rossmoor spending, which is to protect dues-paying sheriff’s deputy positions, seems odd, since only about nine positions are involved. But more could be at stake.

If the new city of Rossmoor dumped the deputies and contracted elsewhere for police services, other cities with Sheriff’s Department contracts might get the same idea. Or Rossmoor (population 10,000) could have its own police department, as does neighboring Los Alamitos (population 11,000) or, across the line in L.A. County, Signal Hill (population 11,000).

One advantage would be that the new city wouldn’t have to commit to Orange County’s lavish compensation program, which includes pensions of 90 percent of salary after 30 years of service. (The county doesn’t know how it’s going to pay for those benefits now, and burden will increase unless the stock market turns around.) Another advantage would be much faster police response times than those of sheriff’s deputies, who also patrol Sunset Beach, several miles away.

Of course Rossmoor first has to incorporate, and there is opposition to Measure U on the Nov. 4 ballot. The argument against cityhood isn’t inspiring, but it is simple: If it’s not broke, don’t fix it.

The community’s Rossmoor Community Services District is efficient, but for some services the community has to depend on the county, whose offices are off in Santa Ana. Its representative on the county’s Board of Supervisors is John Moorlach, who is a responsive public official, but Rossmoor is a very small part of his district.

Also, Rossmoor isn’t paying its share of county expenses by about $600,000, and if incorporation failed, that should be corrected one way or another as a fairness issue. More seriously, response time by sheriff’s deputies on average is several times slower than police response time in Los Al, Seal Beach or Signal Hill.

Do Villa Park and the other small cities envy Rossmoor’s unincorporated status? No sign of that. Each prizes its own identity and its local control.

We know how we’d vote if we lived in Rossmoor. Easy decision. But we don’t, and those of us who live elsewhere are leaving it up to the folks in Rossmoor.

So should the deputies’ union.

On the topic of defined benefit pension plan abuse, particularly with the California Public Employees Retirement System (CalPERS), OC Register columnist provided it in spades with the County’s poster child on the subject in “King of the platinum parachute – Double-dipper Ruiz is back.”

Three weeks from today, if history holds to form, a plurality of ill-informed voters in Area 3 of the Coast Community College District will re-elect Armando Ruiz to another four-year term.

I say uninformed because I do not believe most of the voters to be unintelligent – they are simply too busy to really pay attention to what they perceive as a relatively minor race. Were they informed, they would know Ruiz is a scoundrel of the most cynical ilk, a career bureaucrat and politician who systematically milks the system and, I presume, will continue to do so until he is too feeble of mind or body to put his signature to the re-election documents that election after election propel him back into office.

Ruiz first came to my attention during his last election, in 2004. In a series of deft moves, he created for himself a golden – nay, a platinum – parachute that would shame a bond-company CEO.

To paraphrase heavily from one of my own brilliant summations of this complex set of maneuvers, here’s how he did it:

In early 2004, Ruiz was an administrator in the South County Community College District. He also was a trustee of the Coast district; his term was up in November.

He wanted to officially "retire" from both jobs on the same day so he could take advantage of a loophole that allowed a person to pull the ultimate pension spike. He also wanted to run again for the Coast board, but if he "retired" from that part-time gig and ran again, he couldn’t be listed as an incumbent on the ballot and would risk losing.

Here’s how he accomplished both goals: Early in the year, he set his South County retirement for Oct. 31, the Sunday before the Nov. 2 election. Then on Friday, Oct. 29, at 4:32 p.m. – 28 minutes before the county education office closed and he would lose his opportunity – he faxed over a four-sentence letter in which he also retired from the Coast trusteeship, also effective Oct. 31.

This triggered a bizarre law that, until it was changed, allowed a person who left two state jobs on the same day to claim the higher of the two salaries and calculate both salaries for his pension. Ruiz’s pension was treated as if he had made $106,000 a year at his real job at the South County district (which he did) and $106,000 a year at the Coast district (which he didn’t), for a "salary" of $212,000.

In reality, the Coast trusteeship paid an annual stipend of about $10,000, so the most he ever really made was about $116,000 a year. The difference is that Ruiz will get about $108,000 a year for life instead of the $59,000 a year he should have.

And because he waited until the Friday before the election to resign from the board, he remained on the ballot as an incumbent. He won with 41 percent of the vote, two challengers splitting the rest.

When this was discovered, some citizens started a recall. The range of public figures calling for him to simply quit was impressively broad – from the faculty union to charity leader Jean Forbath to conservative then-Treasurer John Moorlach. A member of his own board – former Democratic Congressman Jerry Patterson – helped lead the charge.

But the effort lost momentum and then failed. Ruiz knew he could probably wait it out. So he has spent the past four years: collecting his inflated pension; traveling around the U.S. on the taxpayer’s dime; taking campaign contributions from people who do business with the district; and, notably, delaying making public a serious accreditation issue that faces the district he claims to have led so well as its most recent chairman.

I will discuss these issues in Wednesday’s column. As in the past, I put a call into Ruiz. He had not called me back as of deadline Monday. I don’t hold out much hope he will call today. He has never returned one of my calls and he hung up on education reporter Marla Fisher when she last tried to talk to him about the pension spiking. Nonetheless, I will give him until this afternoon – until 4:32, to be precise.

For excerpts of my 2004-05 columns on Ruiz, refer to the link up at the top of this column.

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