California pension Death Star approaching

Death Star Darth Vader Star Wars - wikipediaJan. 18, 2013

By Chriss Street

When Moody’s Investors Services issued a “Request for Comment” last July about their plan to begin recalculating the effect of massive state and local unfunded pension liabilities on credit quality, I warned that this would eventually result in the across-the-board slashing of municipal bond credit ratings and numerous municipal bankruptcies in California.

It now appears that I may have understated the risk for California.  The California Public Policy Center released a report analyzing of the impact of the new Moody’s policy on six Northern California counties: Alameda, Contra Costa, Marin, Mendocino, San Mateo and Sonoma.  Their conclusion is that, when the new rules are applied, the annual cost of pensions will increase from the equivalent of about 50 percent to 100 percent of these counties’ net property tax income.

With the state is running new deficits after already raising state income taxes to the highest level in the nation, California homeowners should be prepared for their politicians to try to overturn Proposition 13, which for 35 years has limited California property tax rate increases to 2 percent per year of the assessed value, and reappraisals occurring only with the sale of the property.

Given that California has only 11 percent of the U.S. population, but issues 20 percent of all of the nationwide municipal bond volume, Moody’s warned it would be re-assessing the financial condition of all California counties and cities “to reflect the new fiscal realities and the governmental practices.”

More bankruptcies

Moody’s  said that a greater share of municipal bankruptcies are expected to come from California.  California Treasurer Bill Lockyer’s office tried to reassure the public by calling the Moody’s warning “a little hyperbolic” and stating, “No city’s going to blithely skip into bankruptcy court to avoid its obligations.”  But today, more than 50 of 482 California cities have declared a “Financial Crisis” and have considered filing for Chapter 9 municipal bankruptcy.

CPPC’s analysis used data from the most recent county Actuarial Valuations to produce four core restatements of solvency: total pension debt, unfunded pension debt, government normal yearly contributions and amortization payments of unfunded pension.  CPPC determined that, for the four adjustments Moody’s is expected to make, two would have very significant impact on county solvency:

* “First, pension debt would be adjusted using a high-grade long term corporate bond rate (5.5% for 2010-2011) instead of a Pension Fund’s target rate of return (7.75% more or less).

* “Second, government payments to Pension Funds would be adjusted to reflect the lower discount rate, the need to fully fund pensions by the time employees retire, and a 17 year level-dollar amortization of unfunded pensions.”

In their Actuarial Valuations, the counties claim they have conservatively banked 78 percent of their pension liabilities in cash and securities, leaving only $4 billion in under-funding.  But the Moody’s adjustments will increase the unfunded pension obligations by $6 billion, balloon the unfunded liability to $10.2 billion and the cash and securities funding down to a speculative level of 58 percent.

At a 78 percent funding level, the six counties are only required to contribute 29 percent of their payroll, or about $640 million, to fund their pension plans each year.  But under the new Moody’s formula that will drive down their funding level to 58 percent, the counties’ required annual pension cost will skyrocket to 63 percent of payroll, or $1.4 billion per year!


California has run huge budget deficits for the last decade.  Recently voters passed Proposition 30 as a $6 billion state income tax increase on top earners in hopes of rescuing schools by balancing the state budget.  But, according to the California State Controller’s just released December financial statement, state spending is $900 million over budget and state tax revenue is at least $360 million under budget.

For the last 35 years, California politicians have been forbidden from jacking up property taxes by the because of Prop. 13.  The initiative has been so popular with homeowners that it has been referred to as the third rail of California politics.

But as the CPPC study demonstrates, the annual cost of pensions will soon increase from the equivalent of about 50 percent to 100 percent of these counties’ net property tax income.  With the state already running new deficits on top of the highest income taxes in the nation, it is my belief that California politicians will soon try to overturn Prop 13. 

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