Another Fiscal Disaster for Philly
In 1991, Philadelphia enjoyed the lowest bond rating ever recorded by a major municipality in America. It had a structural deficit in excess of $270 million. There was no cash to pay vendors. To avoid illiquidity, the city put a cash flow loan together with local banks and the municipal pension fund. The effective cost of that borrowing? 27 percent. What confidence the city’s fisc inspired!
Every Philadelphian knew what was happening. Support from the state came in the form of increasing the state sales tax in the city and using that new income to pay off a loan that covered the deficit. A new agency, PICA, was born and Philadelphia had fiscal oversight.
Despite these and other woes, eight people headed to the starting gate seeking to be the city’s next mayor. Things looked bleak but there was a heated debate about what to do and some serious people lined up for that fight.
Flash forward 20 years. The fiscal discipline promised by PICA has evaporated. After a steady drumbeat of tax reductions, taxes are on the rise again. And for the forthcoming election, no Democrat has surfaced to challenge the incumbent. The Republicans look to be no-shows. Harrisburg and Washington are in their own fiscal free fall and after eight years of Rendell, the state is in no mood to hear the words “Philadelphia” let alone send a boatload of new cash down here. And this time, the problem isn’t a deficit. No it’s much bigger than that.
The four-ton elephant in the room is a municipal pension system that by any standard measurement is in deep doo. Financial wizards try to make the problem difficult to understand but it isn’t. It’s basic math.
When last audited (July 2009), the pension system owned investments valued at $4 billion. By looking at all kinds of age and mortality related data, the system anticipates retirement dates and life expectancies of city employees and calculates how much would have to be invested today to meet the expected retirement benefits to be paid to those employees in the future. That number is $8.9 billion. Here’s the really simple part. Subtract what we have, $4 billion, from what we will owe, $8.9 billion, and, presto, you have $4.9 billion. Or should I say, we don’t have $4.9 billion. That’s called the actuarial unfunded liability. Or, only 45 percent funded. Another good description for it is “a gaping hole.”
Now for a quick quiz. What do you call a business that knows it has to pay out $8.9 billion but only has $4 billion to do it?
Here is the really scary part. The value of what we will owe—relying on returns on all of the stock, bonds and other stuff in the investment portfolio—is based on the assumption that these investments will earn 8.25 percent. Much of the investment portfolio is weighted toward stocks. Over the past 10 years, the S&P 500 is down 2.9 percent. Bond yields are at historic lows with the 10-year Treasury at 3.46 percent. No doubt things will improve. Won’t they? But to think that the city’s pension fund will achieve a consistent return of 8.25 percent? Maybe you’d like to buy a bridge I know about? If the fund achieves a return closer to 6 percent, the real gap drops precipitously from 45 percent to something closer to 35 percent.
Philadelphia’s bold and visionary political class has a strategy for dealing with this problem. They use a can and kick it in a hard forward swinging motion. Hey it’s worked up until now.
But here’s the thing. The city has lots of retirees living longer lives and lots of older workers getting ready to hang it up. They’ve bargained for a nice fat pension check, and they expect to get it. A couple of bright university types took a look at local government pensions and concluded that Philadelphia would literally run out of pension fund cash in 2015, and that if these obligations were assigned to the rest of us it would pencil out at $16,690 per household. And that was based on earning 8 percent. No, we’re not alone. Other cities have similar problems though. There, that makes you feel better, doesn’t it? But, we rank #1 as the most broke system. Ah, the pride!
A problem of this magnitude deserves a good debate. What should be done? Take it to the unions? Another tax increase? Major service reductions? Break our commitment to retirees?
These are the questions that needed to be debated in the forum that is politics. And they needed to be debated in a mayoral campaign.
But we’re not having one of those.
Maybe the candidates for City Council will pick up the mantle and put this on their issues list. Oh right, they need union support to win, will promise no new taxes and won’t allow any service cuts.
I hear the sound of that tin can being set up on Broad Street.
And the kickers are starting to line up.