Bonds are a risky way to deal with pension woes

Recently, this column exposed the foolishness of two proposed statewide bond measures: A $15 billion school bond, which will be on the March 3 ballot, as well as a “climate resiliency” bond.

Both are horribly flawed for several reasons, not the least of which that it makes no sense for California to go further into debt when we have a large surplus.

But at the local level, taxpayers need to be aware of a recent resurgence in the use of pension obligation bonds, a risky financing method that fell out of favor during the recession but is now making a comeback.

Fortunately, there is more scrutiny on this form of debt financing than in years past, which may help to dissuade our elected leaders from making ill-advised decisions.

There is a technical definition of POBs set forth below but we prefer a definition that most people can understand: A POB is basically paying your Visa bill with your MasterCard.

Here’s the technical definition: Pension obligation bonds (POBs) are bonds issued to fund, in whole or in part, the unfunded portion of public pension liabilities by the creation of new debt.

The use of POBs relies on an assumption that the bond proceeds, when invested with pension assets in higher-yielding assets, will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds.

Back in 2003, the state of California attempted to float a statewide pension obligation bond without voter approval.

The Howard Jarvis Taxpayers Association sued to invalidate the bonds and prevailed in court.

For HJTA, the assumption of any long-term financial obligation by a government entity should be approved by those financially obligated for the repayment. That means the taxpayers.

More recently, others have questioned the return of POBs as a strategy to deal with unfunded pension obligations. State Sen. John Moorlach, R-Costa Mesa, and Orange County Treasurer-Tax Collector Shari Freidenrich, in an op-ed for the Los Angeles Times, sharply criticized a plan by the city of Huntington Beach to use POBs to paper over that city’s growing obligations to CalPERS.

While many try to paint CalPERS as the bad actor — probably deserved in some cases — Huntington Beach’s wounds are mostly self-inflicted: It made promises to the public employee unions that are not sustainable over the long term.

As Moorlach and Freidenrich argue, “converting a soft debt into a hard debt, with bondholders unwilling to make payment schedule adjustments, may come to haunt POB issuers in the future.”

And it’s not just fiscal watchdogs who are worried about the resurgence of POBs.

The Government Finance Officers Association (GFOA), an association of officials employed by government entities, has issued a stern warning: “POBs involve considerable investment risk. Failing to achieve the targeted rate of return burdens the issuer with both the debt service requirements of the taxable bonds and the unfunded pension liabilities that remain unmet because the investment portfolio did not perform as anticipated. In recent years, local jurisdictions across the country have faced increased financial stress as a result of their reliance on POBs, demonstrating the significant risks associated with these instruments for both small and large governments.”

The GFOA unequivocally states that local governments should not issue POBs.

The reasons for this recommendation include the fact that “the invested POB proceeds might fail to earn more than the interest rate owed over the term of the bonds, leading to increased overall liabilities for the government,” and “issuing taxable debt to fund the pension liability increases the jurisdiction’s bonded debt burden and potentially uses up debt capacity that could be used for other purposes.”

Unfortunately, some municipalities are ignoring these warnings.

In addition to Huntington Beach, the city of Simi Valley is likewise pursuing a POB issuance and has filed a “validation action” in the courts to insulate the bond against future legal challenge.

Californians face enough risks from fires, floods, droughts and earthquakes.

There is no reason we should assume the man-made threat of risky bonds, especially at a time when we are being told that a recession is just around the corner.

If local elected leaders believe that pension obligation bonds are a good deal, they need to convince their citizens and get voter approval.

Jon Coupal is president of the Howard Jarvis Taxpayers Association (hjta.org).