City of Houston is Bankrupt

Mish's Global Economic Trend, October 27, 2009

City of Houston is Bankrupt (So are California, Oregon, and Pension Plans in General)

Houston, we have a problem. We are bankrupt.

That is the finding of Bob Lemer, CPA, Retired Partner at Ernst & Young; Aubrey M. Farb, CPA, Retired Partner at Grant Thornton; and Tom Roberts, CPA, Retired Partner at Fitts Roberts.

Cover Letter

October 22, 2009
Name, Title and Address [see list below]
Subject: Finances of the City of Houston
Dear : [see list below]

Enclosed is our partial analysis of the very serious financial situation at the City of Houston. We would be derelict if we failed to share this financial analysis with you. This financial heads up will assist you in meeting your fiduciary responsibilities to Houston voters, taxpayers, readers, viewers or investors---as the case may be.

We feel a public discussion of the City’s financial situation is necessary and firmly believe that addressing the City’s financial condition is in the best interest of the Houston economy and Houston taxpayers. We believe the sooner the City of Houston addresses the financial shortfall the better.

Please bear in mind that the Houston City elections are on November 3, 2009, with early voting having commenced on October 19, 2009. Recent history has shown a large portion of voting occurs during early voting.

We trust that the attached article is of significant assistance to you.
We may be reached at boblemer@sbcglobal.net.

The above was sent to:

City of Houston---Incumbent Mayor, City Controller, and City Council Members
City of Houston—Non-Incumbent City Candidates
Greater Houston Partnership---Board Members
Houston Chronicle---Editorial Board Members
Houston TV Stations---CEOs
Houston Business Journal---Editor
Houston Community Newspapers-Editor
Houston Press-Editor
Municipal Bond Rating Agencies---CEOs
Wall Street Journal---Editor
Barron’s-Editor
Investor’s Business Daily-Editor
USA Today-Editor
Texas Monthly---Executive Editor
Deloitte & Touche LLP---Houston and New York

Executive Summary

City of Houston
Disturbing Financial Facts---October 2009
By: Bob Lemer, Aubrey M. Farb and Tom Roberts

The City of Houston is financially broke and it appears that the mayor who takes office in January 2010 may have to captain the City through bankruptcy procedures.
The City’s unrestricted assets were $1.2 billion short of the already recorded
corresponding liabilities these assets were needed to pay as of fiscal year end June 30, 2008,according to the City’s latest publicly available audited Comprehensive Annual Financial Report (CAFR). The $1.2 billion shortfall was a result of operating losses totaling $1.5 billion for fiscal years 2004-2008, applying the full accrual basis of accounting used in the private sector.

Apparently the City has no idea as to what has transpired financially since June 30, 2008 or will transpire this fiscal year ending June 30, 2010, on the full accrual basis of accounting. But even on the modified accrual basis of accounting (essentially cash basis) followed by the City and all other municipalities, the $236.8 million fund balance in the City’s general fund as of July 1, 2009 (the beginning of this current fiscal year) would not exist except for the City having deposited the proceeds of pension obligation bonds into the City’s general fund instead of depositing them in their legally required immediate destination, the pension plans’ bank accounts.

The City is in this dangerous financial position because its total spending since fiscal year 2003 has greatly outstripped its total revenues in that period. And the rate of growth in the City’s total revenues since 2003 has, in turn, greatly outstripped the City’s rate of growth in population plus inflation.

Thus the City’s problems are a result of greatly overspending and not a result of
insufficient revenues. All of this occurred before the current severe recession. Now the City has the added burden of the recession.

The City is in a real financial dilemma, because now its two principal sources of general fund revenues are in trouble---sales taxes and property taxes. Sales tax revenues already are dropping significantly and property tax revenues will commence dropping at an even more rapid rate after the next annual appraisal and assessment process. And the City will have to go to the voters for any contemplated rate increases in either the sales tax rate or the portion of the property tax rate allocable to operations.

It appears to us that there may be no viable alternative to bankruptcy proceedings and thereby positioning the City to regain control over its overspending, through addressing structural spending problems such as overstaffing and overly generous employee benefits.

Pension Plans and Government Salaries To Blame

According to the report, pension plans and government salaries are at the heart of the matter. Here are a few select details.

Detailed Findings and Observations

1. The City incurred operating losses (“Change In Net Assets”) totaling approximately $1.5 billion for the five fiscal years ended 6/30/08--- per the latest (fiscal year 2008) publicly available audited Comprehensive Annual Financial Report (CAFR), page 199:

In Thousands
a. (312,790)
b. (531,465)
c. (131,893)
d. (221,452)
e. (281,556)
TOTAL (1,479,156) ---or--- $1.5 BILLION

2. The City’s deficiency in unrestricted assets [“Unrestricted (deficit)”] was $1.2 BILLION ($1,174,429 thousands) at June 30, 2008--- per 2008 CAFR, page 15. In other words, the City’s unrestricted assets were approximately $1.2 billion less than the already recorded liabilities that they will be required to satisfy.

3. The $1.2 billion deficiency in unrestricted assets as of June 30, 2008 (which was created essentially during fiscal years 2004-2008-see item 1) was basically financed, per page 15 of the 2008 CAFR, by:
(a) the $347,728,000 collateralized note payable to the municipal employees’
pension trust;
(b) the $643,413,000 combined accrued liabilities to the employees’ pension
trusts (municipal-$285,462,000, police officers’-$318,567,000, and firefighters’-$39,384,000);
(c) the $219,755,000 pension obligation bonds payable;
(d) the $272,941,000 accrued liability for other post employment benefits-----less, per pages 17 and 74 of the 2003 CAFR,
(d) the $54,395,000 net accrued liabilities to the employees’ pension trusts at June 30, 2003 (municipal-$92,386,000, police officers’-$19,221,000, and firefighters’-asset of $57,212,000).

4. Thus, as of June 30, 2008, the City’s elected officials essentially had transferred financial ownership of the City from the taxpayers to the City’s employees, about 43.7% of who do not live in the City, according to documentation we have received from the City’s human resources department. Very troubling, 63.3% of first responders (police officers and firefighters) do not live in the City, versus just 30.0% of civilian employees, according to the City’s human resources department.

5. The City’s deficiency in unrestricted assets is so severe that in their yet to be completed audit for fiscal year 2009 the City’s independent auditors apparently will have to address the audit reporting issue as to whether the City was a “going concern” as of June 30, 2009.

6. Apparently the City has no idea yet as to what its operating loss (“change in net assets”) was for the fiscal year just ended June 30, 2009 or what its deficiency in unrestricted assets was at June 30, 2009, and has no idea as to what is in store fiscally for fiscal year 2010. That is because the City does not keep its books on the full accrual basis of accounting (fully accruing its assets and liabilities) but once a year, via the audited Comprehensive Annual Financial Report (CAFR). And the CAFR cannot be completed until the (nearly always very substantial) annual audit adjustments are booked.

....

17. For example, Exhibit B demonstrates how it was possible for the City to actually show an audited surplus of $19,891,000 from operations in the general fund (which is the focus of the annual budget and the MFOR) for fiscal year 2008 when, in reality, the City had an audited Citywide operations deficit of $281,556,000 for fiscal year 2008.

18. Exhibit B is difficult to comprehend for a person not trained in governmental accounting, even for a CPA. But the two most significant reasons for the difference between the $19,891,000 general fund surplus from 2008 operations and the $281,556,000 deficit from 2008 Citywide operations are: (a) the ever-growing accrued liabilities to employees for pension plans and other post retirement benefits; and (b) the commenced practice of financing current pension plan expenses with backend loaded pension obligation long-term bonds.

19. Once one understands Exhibit B, or at least items 18(a) and 18(b), it becomes obvious that the City’s fiscal 2010 general fund budget is an illusion, for two reasons. First, it is calculated on the modified accrual basis of accounting (essentially cash basis) and therefore ignores the ever-growing and enormous accrued liabilities for employee pensions and other post retirement benefits. Secondly, it is dependent upon continued payment of some of the pension expenses with issuance of long-term backend loaded pension obligation bonds.

23. At June 30, 2008 (date of the City’s last audited financial statements), the City’s total Citywide debt per capita of $5,338 was over twice the $2,528 debt per capita of the now bankrupt State of California.

Inquiring minds may wish to download the entire Lemer/Farb/Roberts assessment of City of Houston Finances document from Scribd.

I agree with the findings of Bob Lemer, Aubrey M. Farb, and Tom Roberts. Any attempts to balance this on the backs of taxpayers is not viable. Houston should declare bankruptcy and seek to null and void the contracts of city workers including police and fireman.

California Is Bankrupt Too

Interesting, I note in point 23 that the authors of this report have concluded California is bankrupt. Of course I agree with that assessment as well. Unfortunately there is no provisions for states to declare bankruptcy.

What About Oregon?

Inquiring minds are reading Climbing PERS expenses face Oregon pension board, agency budget writers.

The cost of Oregon's Public Employees Retirement System is about to skyrocket to budget-busting levels.

As a result of PERS' $17 billion investment loss in 2008, every state agency, municipality and school district that participates in the system is staring at an average 50 percent increase in the base rates PERS charges to fund their employees' retirement benefits in 2011 and 2012.

That's not a doomsday scenario. Unless the pension fund's board changes its rate-setting rules, or its investment portfolio generates a 26 percent return in 2009, these rate increases are guaranteed. What does that mean to you? Fewer teachers, cops and firefighters. Less of every service that government provides. Higher fees and taxes. Perhaps all of the above.

The base rate that public agencies pay to support employees' retirement benefits could double in the next five years, according to the PERS actuary, Mercer Inc. If rates reach that level, the retirement system will gobble one quarter of every tax dollar that goes into a public agency to support payrolls.

Oregon isn't alone.

Public pensions nationwide are in crisis mode, and state Treasurer Ben Westlund points out that Oregon's pension system is still better funded than most. PERS officials also note that a major recovery in the stock market could alleviate, or even eliminate, the pain. Indeed, the system's investment portfolio has already bounced back 14 percent this year.

But here's the rub: Even if the pension system's investments return an average 10.5 percent annually for the next three years - their historical average - PERS rates will still increase to 21 percent of payroll in July 2013, according to Mercer's modeling.

If, in a slower growth scenario, investment returns are closer to their 10-year average of 4.5 percent, all bets are off. PERS' executive director, Paul Cleary, recently told the citizens board that oversees investment of the $50 billion pension fund that if 4.5 percent is the new normal, "our business model doesn't work."

Pension System Busted Country Wide

It is highly likely that nearly every pension plan in the country is busted. The solution is for every city and municipality in a predicament to "pull a Vallejo" and declare bankruptcy. Please see Judge Rules Vallejo Can Void Union Contracts for details.

Deficiencies cannot be met on the backs of taxpayers. Enough is enough. It's time to end every massively underfunded public defined benefit plan in the country, by force if necessary (bankruptcy), unless unions agree to major concessions that would make the plans viable without raising taxes one cent.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com