To fill a pension gap, this city has rented its streets. To himself.


The city of Tucson, Arizona, last year decided to pay the rent for five golf courses and a zoo – to itself. In California, West Covina has agreed to pay rent on its own streets. And in Flagstaff, Arizona, a new lease covers libraries, fire stations, and even city hall.

These are risky financial arrangements born out of desperation, adopted to pay for inflated retirement pensions that cities can no longer afford. Deprived of cash by the pandemic, cities are essentially using their own assets as collateral of some sort to raise funds to pay their workers’ pensions.

It works like this: the city creates a shell company to hold assets and then leases them. The company then issues bonds and returns the proceeds to the city, which sends the money to its pension fund to cover its deficit. These bonds attract investors – who are desperate for a return in a world where interest rates are close to zero – by offering a slightly higher rate of return than similar financial assets. In turn, the pension fund invests the money raised by these bonds in other assets that should generate a higher return over time.

If they can implement the strategy, cities issuing these bonds can reduce their pension bills by an amount equal to the difference between what they earn and what they pay. But as with any strategy based on long-term assumptions, there is a risk.

Taxpayers may still owe money to the pension fund if the investments do not get the return they expect. And while most municipal debt is considered bulletproof because a government is committed to making its creditors free in the event of default, bonds like those issued by West Covina lack that guarantee.

“It puzzles me that anyone would buy these bonds,” said Jessica Shewmaker, who was a member of West Covina City Council when an investment banker pitched the idea last year as a way to hedge. a monthly bill of $ 1.2 million from California public employees. ‘Retirement System, or CalPERS. “These are streets that have not been paved for 20 years.

Across the country, cities are increasingly adopting more aggressive investment strategies as they struggle to fill funding gaps in their retirement programs. The total public pension deficit nationwide is around $ 4.7 trillion, according to Retirement monitoring, a project of the Public Policy Program at Stanford University.

Many states have tried to strengthen their pension systems, which often means telling local governments to send a lot more money. Few cities have cash these days, but they can borrow it long term from investors, with maturities so long it looks like free money. West Covina bonds, for example, do not need to be redeemed for 24 years.

When a municipality borrows money for a public project, such as a new road or bridge, it usually issues a blanket bond, often after obtaining voter approval. These are the backbone of municipal finances and come with strong guarantees – courts can make borrowers pay, even if it means raising taxes.

But it’s different when a municipality borrows to cover a pension deficit. Usually this is done with a retirement obligation. These also require voter approval in some states, but usually come with fewer guarantees for their buyers.

It gets more murky when municipalities use the West Covina approach. Because the bond is issued by the shell company, it’s often referred to as something else – a “rental income bond,” in West Covina’s case – and doesn’t necessarily need voter approval.

The consequences of this approach became clear after Detroit declared bankruptcy in 2013 and was unable to pay its creditors in full.

Like West Covina, Detroit had used shell companies to borrow money after being ordered to fund his pension. A few years later, in bankruptcy, Detroit tried to repudiate the $ 1.4 billion pension loan, calling it a sham transaction that used shell companies to bypass a legal debt limit. Once the dust settles, the bondholders got around 14 cents on the dollar. Retirees in the city have also had their hair cut.

The website of the Government Finance Officers Association, which has 20,000 members and whose stated mission is to “advance excellence in public finance”, shouts enough: “The state and local communities should not issue POB “

This has not deterred governments. Nationally, cities and states issued $ 6.1 billion in pension bonds in 2020, more than any other year since 2008, according to data compiled by Municipal Market Analytics, a research firm. The states that took out large new pension loans last year were Arizona, Florida, Illinois, Michigan and Texas. In California, cities borrowed more than $ 3.7 billion to retire into various public pension funds, breaking the state’s previous record of $ 3.5 billion, set in 1994.

That’s a major comeback for this type of debt, said Matt Fabian, a partner at Municipal Market Analytics who has been writing about deals for years. “They borrow money and basically put it on the market and gamble,” he said.

Mr Fabian said his company’s tally almost certainly missed borrowing from municipalities that have taken the West Covina approach because those bonds used different names. Flagstaff rented out its town hall, libraries and fire stations last year to support a boarding arrangement marketed as “Certificates of Participation.” In January, Tucson followed suit, renting two police helicopters, a zoo conservation center, five golf courses, and bleachers at its rodeo grounds, among other things. And a Chicago suburb of Berwyn has used “forwarded tax securitization bonds” to help fund police pensions.

The street rent that West Covina, a former citrus growing outpost about 20 miles east of Los Angeles now engulfed by urban sprawl, pays the shell company is essentially the money to pay back debt. By issuing this debt, the city was able to make a lump sum payment of approximately $ 200 million to CalPERS.

Like many municipal pension plans managed by CalPERS, West Covina’s is only partially funded. CalPERS treats the shortfall of around $ 200 million as a loan it made to West Covina, at 7% interest. It’s an extraordinary rate in today’s environment, but CalPERS uses it because it’s the return the pension system expects it will earn, on average, on its investments.

By paying off the bulk of its “loan” to CalPERS, West Covina doesn’t have to worry about the 7% interest, at least for now. The risk: If CalPERS misses its investment target, West Covina’s plan will again be underfunded, CalPERS will treat the shortfall as a new loan and the whole process will start over.

When West Covina reviewed its deal, the city’s investment banker Brian Whitworth of Hilltop Securities estimated the city would pay 4% to borrow. Because CalPERS was targeting 7% returns, he said, the city would save around $ 45 million.

“On a bond of around $ 200 million, that’s a very good saving,” he said.

No one asked for a projection of what might happen if CalPERS didn’t hit 7 percent. Instead, Mayor Tony Wu asked Mr Whitworth why he thought West Covina should pay 4% while El Monte next door only paid 3.8%.

The proposal was passed 4 to 1, with Ms Shewmaker voting against because she saw the plan as a gimmick to avoid putting the issue to voters, who she said were unlikely to approve a deal that would multiply by six West Covina debt.

Mr Wu, now a city councilor, said the city had to borrow because it was stuck in unsustainable pension plans and CalPERS refused to negotiate easier terms. A longtime owner of a mortgage company, he said it was “crazy” for CalPERS to base everything on 7% when real interest rates were much lower. But he said challenging CalPERS would be a waste of time.

“It seems very logical, but it will not happen, because those with the power do not want to lose it,” he said. “They’re going to beat us in heavy weather. They are going to chase us to hell. Their lawyers will laugh at the bank.

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