More Municipalities Betting on Pension Bonds to Cover Obligations
Struggling to pay employee pensions, local governments are increasingly borrowing money to cover their obligations — exploiting a loophole in federal law that allows them to issue taxable bonds without seeking voter approval.
Oakland took a bet on its pension fund that ended up costing the city an estimated $245 million — nearly a quarter of its annual budget. That hasn’t stopped the city from looking to try its luck one more time.
The bets are being made using an exotic but increasingly popular financial instrument known as a pension obligation bond. Cities, counties and states use the bonds to take out high-interest loans from private investors to plug shortfalls in their employee pension funds.
If the pension funds make smart investments with the borrowed money, the returns can help pay the interest due to borrowers and sometimes even spin off some extra cash to pay pension costs. If they don’t, the bonds can create additional costs for taxpayers, put the retirement funds of teachers and firefighters in jeopardy, and, in the worst case scenario, force municipalities into bankruptcy.
Municipal finance experts are sounding alarms about the practice, saying that local elected officials are taking unnecessary risk because they are afraid to anger voters by raising taxes. There is also the risk of instigating powerful public employee unions if pensions are cut.
“There are communities that just do not want to make the hard choices, even though it means the choices in the future will be worse,” said Robert Doty, a municipal finance consultant in Sacramento. “They are just going to dig themselves deeper and deeper into a hole.”
Oakland provides the clearest example of the risks and the allure of these bonds.
The city is credited with issuing the first pension obligation bonds in the 1980s. Another set of pension bonds the city issued in 1997 have lost Oakland $245 million, according to analysis by the city auditor. Those losses have helped push the city administration to propose more than $200 million of new pension bonds in the coming months.
“One would think they would have learned,” said John Russo, the former city attorney who voted against the 1997 bonds when he was a City Council member and resigned last year because of disagreements over the city’s budgeting. “This is a risk that may go horribly wrong.”