Risky business: Anchorage channels its inner Detroit

BERKOWITZ ADMINISTRATION TO SELL OVER $68 MILLION IN PENSION-RELATED DEBT 

By PETER CALTAGIRONE
COMMENTARY

This past October, the Anchorage Assembly voted in favor of Ordinance No. AO 2017-133, authorizing Mayor Berkowitz’s plan to incur $68 million in new debt, plus interest, leveraging municipal property in the process.

The relatively minor but glaringly myopic advantages of doing this are greatly outweighed by significant risk, new and unnecessary long-term debt, and liabilities. Taxpayers may be left cleaning up the mess in coming years.

Under Berkowitz’s plan, $68 million, collateralized by Municipal property, will be transferred, in lump sum, to the Police and Fire Retirement System.

Currently, the Municipality is required to make an annual $10.3 million payment to the PFRS for the next six years. These payments are required under a settlement agreement executed by the Municipality that resolved PFRS litigation during the 1990s. The payments were a known quantity, consistently budgeted for and terminated in six years.

Berkowitz’s plan involves “Certificates of Participation,” similar in concept to the $3.5 billion in pension obligation bonds that the Walker administration tried, and failed, to sell in 2016.

The Assembly Memorandum accompanying the Ordinance defines COPs as a secured interest in municipal property; the Municipality essentially repays its debt by making lease payments on its own property. Until then, the property is held by a trustee for the creditors.

The Assembly, despite approving this new debt, has not seen a list of the municipal properties Berkowitz intends to encumber. Those decisions are at the sole discretion of the Anchorage Chief Fiscal Officer.

Using numbers in the Summary of Economic Effects accompanying the Ordinance, the current $10.3 million annual obligation, which terminates in six years, vanishes from the Municipality’s budget.

But, before anyone gets too excited, the debt service of the new loan begins in FY2019 at an annual rate of $6.4 million and lasts until 2033. The net, short-term savings to the Municipality for the next six years is only $3.9 million, not $10.3 million.

Further, the lump-sum payment to the PFRS raises funding levels from 80% funded to approximately 88% funded (based on numbers from a recent PFRS newsletter; the Memorandum claims 90%). Berkowitz, according to the Memorandum, gambles that the remaining funding gap can be closed by the PFRS investing the lump-sum payment.

For this gamble to work, the current high-yield environment in equity markets would have to continue well into the future.

Berkowitz’s plan has major flaws that expose the Municipality and, in reality, taxpayers to significant risk and long-term liabilities.

First, the Municipality must pay back not only the $68 million principal but also interest. We are now saddled with a new, $6.4 million annual liability until at least 2033.

Second, transferring municipal property to a trustee sets up a perennial lost opportunity to appropriate potential lease revenues to the budget, eliminating a potential revenue stream that mitigates the tax burden on property owners. Instead, these funds go to our new creditors.

Third, if the Municipality defaults, our new creditors could foreclose on municipal property. These are our fire stations, police headquarters, snow plows, etc. At this point, one can only speculate what property is actually encumbered since those selections rest solely with the Chief Fiscal Officer.

Finally, and perhaps most frightening, much of the $68 million paid to the PFRS could vanish in an equity market correction or crash. According to the PFRS newsletter, since 2010 the pension fund has enjoyed positive, annual returns of 1% – 18%, with only one year in the negative (losses of only one-third of a point).

This is consistent with the nearly decade-long climb we have seen in equity markets, an arguably historic anomaly. Typically, an uninterrupted climb only lasts 3-4 years.

Nobody can predict when the next correction or crash in equity markets will occur. Similarly, nobody can reasonably rely on continued, record growth in equity markets that are, according to conventional wisdom and the lessons of history, long overdue for a correction.

Worse, if equity markets are at the edge of a “bubble” that bursts, a significant portion of this $68 million could quickly disintegrate.

By maintaining a consistent, annual payment from the Municipality into the PFRS, the Muni could hedge against that risk by allowing the PFRS to alter its investment strategy with each payment as market conditions change.

This is a lesson that has already been learned by the Municipality and throughout the Lower 48. Let’s not forget that equity markets lost approximately 50% of their value between 2000-2002 during the first “dot-com” bubble burst and then again in 2008 precipitating the “Great Recession.” The Memorandum admits that from 1997 to 2009, the PFRS went from being overfunded to 75% funded in part as a result of these crashes.

THE RISKS ARE GREAT

As reported by Pew Charitable Trust, other municipalities that took on pension-related debt preceding these market corrections have witnessed disastrous results.

For example, Stockton, California, similar in population numbers to Anchorage, declared bankruptcy in 2012 due to the sale of $125 million in pension obligation bonds in 2007. Equity markets crashed in 2008. As part of its bankruptcy exit plan, Stockton now has a 9% sales tax.

A similar lesson was learned by Detroit, a city with a 2.4% municipal income tax and 6% sales tax. Detroit filed for bankruptcy in 2013 for many of the same reasons.

On a larger scale, Illinois issued such bonds throughout the mid-2000s. After 2008, the state was unable to pay both its pension obligations and incurred debt. Their legislature then increased personal income taxes 67% in 2011 and another 32% in 2017, along with increases in corporate income taxes.

Anchorage is not Detroit, California, Illinois, or the myriad examples of cities and states that have tried iterations of what the Berkowitz administration intends.

Let’s put a stop to reckless borrowing and spending before we unnecessarily burden not only ourselves, but also the next generation of Anchorage residents with new liabilities and taxes.

Peter J. Caltagirone is an Anchorage resident, property owner and trial lawyer licensed in five states, specializing in Oil & Gas-related litigation. Before obtaining a Juris Doctor from Villanova University School of Law, Mr. Caltagirone earned a Bachelor of Arts Degree from Claremont McKenna College with a dual major in Economics and Government.