By Joshua Sharf | Watchdog Arena
UPDATE 4/30/15 2:19PM ET:
Sen. Chris Holbert, the Republican Senate sponsor of HB15-1388, has announced that he is in the process of withdrawing himself as a sponsor of the bill.
As its legislative session nears its end, Colorado is considering a bill that would authorize the state to issue up to $10 billion in bonds to shore up the state’s severely under-funded public pensions. The bill has the backing of Republican State Treasurer Walker Stapleton, as well as a number of Republicans in the closely-divided state Legislature.
The Public Employee Retirement System, or PERA, promises a traditional defined benefit pension plan for the state’s government employees as well as nearly all of its public school teachers. It acknowledges an unfunded liability of $23 billion, with some estimates running as high as $93 billion.
HB15-1388 would authorize the state treasurer to have the Colorado Housing Finance Authority (CHFA) issue bonds whose proceeds would go to the PERA State and School funds. The supplemental stabilization payments (AED and SAED) that the state government and school districts make would be set aside for bond repayment.
The treasurer would control the timing of the issues. The expected annual interest payments could amount to no more than two-thirds of the annual stabilization payments, and the spread between the interest rate and the expected rate of return on PERA’s investments could not be less than 2 percent. Currently, PERA assumes a 7.5 percent return.
According to the Fiscal Note attached to the bill, the issuers envision issuing up to $10 billion in notes, with an interest rate of 4.39 percent. Currently, taxable Colorado State Certificates of Participation, with maturities of 25 years, are trading at 4.9 percent yield.
The bill requires the governor and the treasurer to actively obtain a court opinion as to the legality of the maneuver. The state constitution contains a provision barring state and local governments from issuing multi-year debt without a vote of the people. The provision was a response to the wave of state bankruptcies in the 1840s, which would have been as fresh in people’s minds than as the inflation of the 1970s is in ours.
Nevertheless, the Colorado courts have defined several conditions under which debt is not covered by the provision, and bill authors have laid out their case – in the text of the bill – for why this bond issue would be exempted. They argue that the CHFA is not under the direct control of the state government, although the state government’s credit rating will be used when offering the debt to the markets.
Supporters of the bonds point to historically low interest rates, and that are unlikely to last for long. They argue that governments have a unique, fleeting opportunity to lock in low long-term rates, widening the difference between their cost of borrowing and the return on their investments.
However, a study by the Center for Retirement Research at Boston College, cited by Governing.com, indicates that investment timing is as important as borrowing timing. Higher investment returns come with increased risk. If, early on, returns fail to meet expectations, or worse, yet fail to meet the interest rate on the bond, it can take years for the fund to dig itself out of the hole, if it ever does.
According to the report, “POBs had a negative average real return from 1992-2009, but show a small gain when the time period is extended to 2014.”
For an already-underfunded system, an offering intended to provide flexibility could end up making matters worse. And to quote famed investment advisor Yogi Berra, “Predictions are hard, especially about the future.”
The sudden influx of cash, along with the expectation of annual returns in excess of the debt service, has led legislatures in other states to consider the investment spread a cushion against their own obligations. Legislatures often face budgetary pressure to reduce their contributions when tax revenues are low. Thus pension plans suffer from the double-whammy of shorted contributions and lower returns.
While Colorado has always paid its statutory obligations, it often has contributed less than the Actuarially Required Contribution (ARC), calculated by the Government Accounting Standards Board (GASB), to be the contribution needed to keep the amortization period at 30 years.
Under the new public pension accounting rules, GASB will no longer calculate an ARC, leaving the historically inadequate statutory requirements as the only guidance for the Legislature.
Opponents of the measure have noted that the bill is being dropped at the end of the legislative session, which may prevent lawmakers from fully considering the implications. In addition, PERA is currently the subject of a legislatively-mandated audit, and a task force charged with developing a better “early-warning system” for potential trouble.
Some members also worry that committing the state to a bonded debt might tie the government’s hands, making more substantive policy remedies more difficult to enact in the future, and reducing the financial flexibility to deal with potential future investment shocks.
This article was written by a contributor of Watchdog Arena, Franklin Center’s network of writers, bloggers, and citizen journalists.