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New frontiers in cost cutting

Apparently, you can cut costs by defaulting on your bills. Why didn’t I think of that?

CM Helena Brown

Councilwoman Helena Brown has submitted a budget amendment aimed at solving the city’s decade-old pension problem: Stop paying.

Her amendment calls for defaulting on more than $200 million in contributions due to the city’s three public employee pension systems in the coming fiscal year.

The idea is that it would force the matter of escalating pension obligations into the Texas Supreme Court “to bring to question the state constitutionality of forcing a municipality into bankruptcy by obliging them to maintain an unsustainable pension plan,” according to the language of the amendment.

Sure. Because nothing says “fiscal responsibility” like declaring that you will not honor your fiscal responsibilities. Just like they do in the private sector.

Now I don’t know if CM Brown came up with this genius idea after reading the Chron story about some pensioners being able to earn more as retirees than as active employees or not, but it doesn’t matter. It’s dumb and a non-starter no matter what its pedigree. As far as that story goes, I will note three things.

1. The deal that the city of Houston has always had with its employees is that they have agreed to trade current compensation for future compensation. Putting it another way, city employees tend to get paid less than they would for doing the same kind of work outside city government, and in return they get a better retirement package. Maybe this deal isn’t so good for the city – or for the employees – any more. Maybe it’s not sustainable even if it is an otherwise good deal. Whatever the case, the point is that it’s a deal, which is to say a legally binding contract that was negotiated in good faith. I haven’t seen the text of Brown’s amendment so I don’t know if she has factored in the possibility that her hoped-for Supreme Court ruling would be in favor of the pensioners, with the city being required to pay zillions of dollars in damages and penalties for illegally denying them the money the city was obligated to pay, but if I had to guess, I’d say it’s not discussed in any detail. Bottom line, there’s a substantial amount of risk associated with summarily deciding that you are not obligated by your legal obligations.

2. All of the above is a longwinded way of saying that the way to alter the terms of a legally binding contract that was negotiated in good faith is to negotiate them. If the other party doesn’t want to reopen negotiations, you have to convince them it’s in their best interest to do so. That would be the right thing to do even if it weren’t the legally required way. It’s true that the city is limited in what it can do by state law, but the principle remains the same.

3. Again, as a reminder, over two-thirds of the General Fund budget is devoted to public safety. That’s way more than what we spend on pension contributions. If CM Brown is motivated by a sincere desire to help control the city’s expenditures, and not a crass and perverse motivation to screw public employees, there are other avenues to explore and bigger targets at which to aim. We can and will argue about the best way to achieve cost reductions, if such reductions are a good idea in the first place. Fixating on one means to achieve that end is almost certainly a suboptimal way to do it.

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18 Comments

  1. John says:

    Definitely not a fan of her but I do think everyone is ignoring the pension issues and given that Unions are not going to give an inch because they say a contract is a contract and will never be altered will hurt them. My main concern is that everyone looking at this issue knows these are unsustainable and something must be changed. We are basically in a 0% interest rate world but the assumptions include 8.5% returns on the funds. fiscal years for pensions are about over and the S&P is up less than 5%. Just like the power of compounding helps you the power of compounding crushes you when you underperform that 8.5%

    Here is a great analysis from the Economist about when the well runs dry

    http://www.economist.com/node/17248984

    but also the Wisconsin recall and more importantly the San Jose and San Diego votes I think are more telling about if public sentiment supports the Unions or not

    http://www.nytimes.com/2012/06/07/us/politics/san-diego-and-san-jose-pass-pension-cuts.html?pagewanted=all

    Those 2 votes passed pretty easily and if they survive legal challenges (I am not a lawyer so no clue there) I think you will see more of these types of ballot initiatives hitting the rest of the country

  2. B. K. Oxley (binkley) says:

    In the private sector the solution is obvious. There are several chapters of bankruptcy law to cover cases where a business cannot pay its bills, including full liquidation in payment of creditors.

    For a city, Chapter 11 seems appropriate.

    http://www.americanbar.org/publications/gp_solo/2011/july_august/chapter_11_bankruptcy_primer.html

  3. Joseph Houston says:

    One of the tenants of bankruptcy law is that the entity be unable to pay its bills. This is simply not the case for the city of Houston since none of its pensions are in danger of default anytime soon, nor are the even larger amounts of bonded debt going to sink the city for now.

    At this writing, the pension obligations amount to under 5% of the total budget (less than 9% of the general fund if considered alone). Defaulting on pensions would trigger a variety of financial consequences including making it near impossible to issue any more bonds as well as causing existing city bonds to turn to junk status, the federal bankruptcy courts able to force the city to pay all owed pension obligations with interest, damages, and legal fees. You might as well just default on the bond interest payments if you’re going to do all that.

    It is one thing if the city isn’t able to afford as much police or fire coverage as citizens claim they want but quite another thing to try and break a contract backed by state and federal law. If the city needs to cut employees or start negotiating with them to lower future benefits, that is okay but I doubt many employees or the courts will consider the various frills the city always manages to afford at the expense of pensions.

    Considering the city helped finance the new soccer stadium, a drunk tank, a new crime lab rather than partner up with the county (which could have led to the long desired combined jail facility), extra Council seats, and so much corporate welfare that the tea party people should be taking to the streets, the pension obligations are minor by comparison.

  4. John,

    I’m not saying the city will never have to address the pension issue. I am saying that as Joseph notes it’s still a small part of the overall budget, and I remain deeply suspicious of the apocalyptic scenarios and cynical concern trolling put forth by those with obvious political agendas. Putting all that aside, my point here is that taking action by defaulting on your contractual obligations, especially when you clearly have the resources to cover them, in the hope of eventually winning a favorable court ruling, has got to be the absolute worst way to go about doing it.

  5. John says:

    Kuff

    definitely not a fan of Brown and was not trying to say I support her. I agree this is not the right solution, but I think it is better than what the mayor and other CM have put forward (which is nada)

    You just look at the math (and I know your math skills are better than mine) and it just does not add up the returns don’t meet the assumptions the payouts make the unfunded portion larger and larger.

    My point was I just think the San Jose and San Diego results are interesting and you will probably (my guess) see more cities go this route. The numbers in that Economist article are pretty worrisome and given no solutions are being offered the clock is running down

  6. Joseph Houston says:

    John, locally the three pensions have made well above average returns in the past 25 years. As such, their long term stability is more a factor of city contributions since the employee amount is taken rain or shine. Through financial shenanigans, former mayor White played fast and loose in terms of underfunding two of the pensions, the municipal and police pensions, a historic look at the numbers showing that is where most of the problem is with regard to the short term figures. The other portion has been the Wall Street meltdown and the dot.com crash but neither is likely to last for the next 30 years (the amount of time pension liabilities are based on).

    Locally, the current mayor is taking advantage of national news stories about runaway pensions in cities and states where employees get far, far greater benefits at much, much lower costs. Those pensions have little to do with our own because we pay more to get less, two of our systems taking huge cuts and requiring employees stay much longer than previously 8 years ago (and additional cuts since then). The mayor wants the third system, HFD’s, to take similar cuts for whatever reasons, be it fairness to the others, political payback for not supporting her, or just to save the money to spend elsewhere.

    Since those benefits are part of their total compensation package, a benefit package that is far lower than most other big cities here and elsewhere, the employees are prepared to fight her every step of the way. The pension spiking that is allowed in HFD’s pension does not even come close to what systems elsewhere allow and major steps have been taken to water them down (less overtime, less assignment pay, etc.). Because Parker is a democrat, she could not previously find a sympathetic ear in Austin on one side and her fellow party members are loathe to attack such a popular group of employees so she is trying to create a wave of public sentiment to force them to do so.

    I suggest people calm down and refuse to buy into the rhetoric coming out of the Bill Kings, John Arnolds, Josh McGees, and assorted anti-government types. Look at the employee cost using a life cycle approach to costing. If you do so, you will find that even if HFD lived as long as the national average (they don’t), their cost per year of service is substantially lower than all these places where drastic cuts are being made. They are not cheap but they are truly among the best so you’re going to have to pay for their services up front or once they leave, enough able to retire right now that political gamesmanship is not in the best interest of the city.

    As a side note, a friend of mine pointed out that all this saber rattling is akin to what mayor White did back in his early years in office. By cutting benefits and raising costs, he ran off hundreds of extra city employees into retirement before they were ready. The public safety employees that left saved his budgets but only at a cost of longer response times and less services offered. As the city physically grew, it had fewer police and fire staff to cover the increased population, perhaps Parker is deploying the same approach now. By losing 400 or so additional fire/police of retirement age, funding will be safe for years since there is no means of hiring close to that many and training them, even if doing so the new people are much cheaper and for PD, have fewer costs attached.

  7. John says:

    Joseph

    have you seen the returns?

    HPOPS- annualized
    5.9%- 5 yr
    6.9%- 10 yr

    Fire
    6.6%- 5 yr
    8.7%- 10 yr

    their actuarial assumptions are 8.5% annualized- not sure in what investment universe you call that “well above average”

    But you can’t use 2008 as an excuse just like you can’t use dot com, because every 7 yrs or so there will be a bust in the market
    1987- Black Monday
    1997- Asia crisis
    2001- dot com
    2008- subprime etc

    You combine that with a zero interest rate world and the performance will not be there. to claim you should throw out the bad years is simply incorrect. Stocks are not the place to be for the long term.

    The problem will come and maybe some don’t care about 20 yrs from now (see Greece) but it will come. My point is public sentiment is not on the side of the unions and votes etc (like in CA) will start coming and they will all shift to 401K style retirement and see benefits changed.

  8. joshua bullard says:

    wait minute-kuffner is correct,i dont always agree with him and in those cases i am right and he is wrong-but not this time,calling a spade a spade kuffner is hitting the nail on its head,cm brown should come up with other ways that are actually possible,not in such a way that its sole purpose is poiltical grandstanding,council member brown needs to infuse ideas that are workable and are invited to the round table,i suspect with a little time she will discover this also,other wise she could simply find herself “shouting into a void”…………………………………

    respectfully submitted
    “joshua”ben bullard

  9. Peter Jacobson says:

    I’ve seen the numbers and I think he is suggesting that if you take the 25 or 30 year past averages, their pensions had better returns than the 8.5%. The last two years included double digit returns, a regular occurence given the charts on their websites.

  10. Joseph Houston says:

    John, from 1985 to 2011, HPOPS has had an average return of ~11%. HFD has done even better. These numbers include every year, not cherry picking good or bad years. The doom & gloom crowd are projecting the numbers available from a few years ago (the big bust) as the basis for the liabilities rather than a long term approach that incorporates both sides of the market (and there are always opportunities available in bear or bull markets). As such, it skews public perception to think the worst.

    The use of figures from communities that are far worse off then our own is also problematic, growing numbers falling under the “we eat our young” reductions in benefit plans. The fear many have these days is not that the city is going to lower future employee benefits, that has happened several times in recent years, but reductions in already earned benefits. That, I believe, is unlawful yet part and parcel on the agenda for some of the haters out there.

    Rather than join the crowd that blames employees, many of you need to focus on those doing the spending. You keep electing them to office and they keep spending on things that really are not high priority items to most people. Whenever the mayor wants something, the money is found, be it sport stadiums, drunk tanks, corporate handouts, or whatever else.

  11. John says:

    Joseph

    where are your sources for the 11% returns?

    I looked at their 2011 report and on page 57 I got my numbers for HPOPS. I don’t see any 20, 25 or 30 yr annualized returns.

    Fire has annualized numbers on their website up to 10 yrs. I looked through their annual report and could not find anything past 10 yrs.

    I just want to see where these returns you speak of are actually in print

    I blame the politicians none of them will deal with this issue. This will be a slow death and 15 yrs from now I guarantee the Houston pensions won’t look that great.

    Also the only opportunities now in this market exist for the risk takers who really add leverage, if not go look at every big hedge fund and nobody can find any returns.

  12. Jj says:

    “3. Again, as a reminder, over two-thirds of the General Fund budget is devoted to public safety. That’s way more than what we spend on pension contributions.”

    Yeah, but THIS year is not the issue. You need to look at how pensions overwhelm the budget in 10 years’ time. They start taking something like 50%.

    And your commentator who slams John Arnold along with “anti big govt types” needs to look into who John Arnold is. He loves liberal causes and big govt – but he has enough of a brain to be able to see this huge issue that will bring both of those crashing down. Go ahead, do nothing, block any reform. Conservatives and anti-big govt might just get smart and stop trying to take the rope out of your hands, the rope with which you are trying to hang yourselves.

  13. Joseph Houston says:

    Add up the individual years and divide. As I said, you just need to know where to look. I’d cut & paste the charts but they don’t come out right so you might need to send in a request (all three pensions are getting more of these of late).

    Oh, and from the viewpoint of an employee, Houston pensions never looked particularly good. Every other major city in the country has a better set of benefits, even after these taxpayer revolts I keep hearing about (most of them costing the employee less). 🙂

  14. Joseph Houston says:

    Sorry JJ, the reason so many of us have been fussing about pension funding for years now has been because we see all the waste and mismanagement getting tossed in our laps. There is still ample time to fix the problem with minimal benefit cuts but given how elected officials keep putting off funding promised pensions in favor of frills, I suspect drastic cuts to services will be just as likely as all the other proposals made.

  15. John says:

    Joseph

    you can’t even provide a link so i can add up the numbers and do my calculations? Sounds like Madoff/Stanford style returns you are “referencing” You just made up those numbers if you can’t reference anything. If you are going to have an economics/finance discussion it would be helpful to reference data and not just make up statistics like the talking heads on TV do

    As I said I gave REAL numbers you are quoting fantasy, the returns are not there and will not hit the 8.5% threshold.

  16. Joseph Houston says:

    John, the numbers were from the HPOPS website. Sorry that you aren’t allowed to sign in for all the detailed information but if you look at the individual reports that are freely available to the public, you might be able to work the math for yourself. Otherwise, you are just as free to file that information request as anyone else is. Just so you know, you can find it on the “Historical Data” section in the form of a PDF file.

    And upon closer inspection, that was a 25 year average, the 26th year (2011) would have made it even higher since last year’s return was 21.7%. I suspect next year will be 4% or so but considering how many mutual funds were providing negative returns, that’s still pretty good. If you want to dispute anything I’ve written here, by all means chime in but you don’t have to get insulting.

  17. John says:

    I am not insulting. I am just asking for the numbers and I think you are just making them up out of thin air. You could include a link or something, instead you just throw out a number with no factual support

    But my point is that in 0% interest rate world (and it will be that way for at least 2-3 yrs) it will be impossible to hit 8.5% net returns. Every year they fall short will only dig the hole deeper.

    John Arnold and others have provided the math showing they will be bankrupt in 20-25 years. yet nobody from the Unions has shown any math to prove otherwise.

    Plus public sentiment is not on the side of the unions the San Diego and San Jose votes will start happening all over the country

  18. Joseph Houston says:

    John, it should be noted that by law, unions have no say on pension boards. You can review the long standing animosity between them in Houston if you like, they were no secretive about it.

    I’ve told you where to get the numbers and for whatever reason, you choose not to ask the right people for them. While you claim that it is impossible to hit 8.5% returns, both HPD and HFD’s pension systems have done so more often than not over the years, recent years including the aforementioned 21.7% return for PD and around 14% the year before.

    It is important to remember that the pensions are not obligated to invest solely in short term T-Bills, nor bonds, nor the stock market. Their asset balance has been flexible and reaped the rewards over time, the vast majority of underfunding proven to come from the city not paying in what was needed (you claim to have read the reports so you should know this).

    I suspect new employees are going to take another bath or two, police hires since 2004 have to stay until they turn 55 years old and then for a smaller benefit while municipal employees since then must stay until 62 for an even smaller benefit. There really isn’t a lot more you can trim in that sense. The referendums in CA and WI do prove a willingness to force employees to pay into their pensions and for medical but locally, we STILL pay more for less than they get. If Houston were at the top of the pay/benefit ladder, it would have a lot more maneuvering room in that sense but it is near the bottom so good luck when a mass exodus leaves with all their DROP money and benefits intact, the city needing 10 or more years to climb back with the rejects even the constables refused to hire.