Bond sales to cover shortfalls leave governments worse off

Strategy can backfire when bids don't pay for growing pension pledges


Many state and local governments, facing ballooning pension promises to police officers, firefighters, teachers and other public employees, are rushing to sell bonds to cover the shortfalls. That strategy has sometimes backfired in recent years, leaving taxpayers on the hook for even more debt.

States and municipalities are drawn to bond sales because they bring instant cash, easing budget pressures without further tax increases or reductions in retirement benefits.

But critics say the bonds could prove costly for officials using them - and for the local taxpayers. The cities and states have to pay a fixed rate of interest on the bonds, and are essentially betting they can earn a higher rate of return by investing the proceeds in their pension funds.

But recent investment losses have left cities and states on the hook for a mounting debt, covering not just the retirement money for their workers but also the interest on the bonds. New Orleans, Pittsburgh and New Jersey have all placed losing bets in recent years.

Almost all pension funds have suffered sizable losses during the past three years. Government pension plans can dig themselves into deeper holes because, unlike corporate pension plans, they are not bound by federal requirements to maintain a certain level of funding. Some have no reserves: They just pay as they go, out of revenues.

With money tight, municipalities are desperately looking for financial help. This year, pension bonds will account for nearly 5 percent of all new municipal bonds, up from less than 1 percent in each of the past five years.

In the first nine months of this year, Illinois, Oregon's school boards, New Jersey's economic development authority and more than a dozen towns and counties sold $13.3 billion in bonds for pension purposes, almost as much as the total sold for pensions throughout the 1990s, according to Thomson Financial.

More sales are coming. Wisconsin and Oregon each plan one before the end of this year, and Kansas has authorized a sale. West Virginia, home of the nation's weakest public pension plan - the state teachers' plan has only $1 for every $5 it owes, according to a study by Wilshire Associates - is fighting a court battle to sell $3.9 billion of the bonds without holding a referendum. In California, a planned $1.9 billion bond sale for state employees' pensions contributed to the fiscal uproar that led to the recall of Gov. Gray Davis.

Other officials have weighed the risk and declined. "It's really tough to justify," said Robert C. North, the chief actuary for New York City's five employee pension plans. For years, North said, investment bankers have been urging the city to sell bonds to pay for its pension promises, and every time, he argues against it because he says there are sounder and cheaper ways of financing pensions.

"On a risk-adjusted basis, the only people who can make money on this are the investment bankers," North said.

This risk, critics say, is not always made sufficiently clear by financial consultants who stand to make money from the bond sales.

New Orleans issued bonds worth $171 million in December 2000, and almost immediately the stock market tanked. Instead of returning 10.7 percent a year, the investments have suffered losses of about 3 percent a year.

By June, only $98 million was left - enough to pay the firefighters' pensions for just a few more years. When the money runs out, the city will still have to pay their pensions - about $17 million a year - and it will also have to pay interest on the bonds of $16 million a year.

Pittsburgh sold $294 million of bonds in 1996 and 1998 to buttress a skimpy pension plan for its workers. Before that, the city was spending about $21 million a year from its operating budget to keep the plan afloat.

After an initial spurt, the pension plan slumped again when stock prices fell. Today, Pittsburgh is paying $26 million a year to shore up the plan and pay its bondholders. Two major credit-rating agencies recently said they were reviewing Pittsburgh and might lower its rating because of its heavy indebtedness.

Officials might look past unhappy outcomes like these in part because market conditions have improved. Stocks are rising. Interest rates are low, and officials see an opportunity to lock in debt at historically attractive rates. They can also allay workers' fears that no money has been set aside to cover their promised benefits.

Depending on market conditions, the current crop of bonds could pay off handsomely for the governments issuing them.

An Illinois official says that the state's $10 billion bond issue was based on an assumption that the money would earn 8 percent to 8.5 percent annually. Illinois will pay 5.07 percent interest on the bonds. "As long as the actuaries are right," said a spokeswoman for the state budget bureau, "we should be safe."

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