Category Archives: Finance (government)

When Balanced Budgets Aren’t Really Balanced

hide_the_peaby James A. Bacon

The politics of fiscal implosion are ugly. Just look at what’s going on in Petersburg and Richmond.

  • Confronted with a massive budget deficit last year in contravention of the state constitution and the prospect of a deficit in the year ahead, Petersburg City Council bravely agreed to cut the compensation of the city’s 600 employees — but carved out exemptions for senior city officials and themselves.
  • Another trustee has resigned from the board of the city of Richmond’s severely under-funded retirement fund, which has been embroiled in governance issues over who calls the shots over investment decisions.
  • City of Richmond officials say they have nearly completed their comprehensive annual financial report for 2015 — seven months late! The city has not completed the required report on time since 2014. City officials blame IT issues.

That’s just in the Richmond region, which I am familiar with because I read the Richmond Times-Dispatch as my daily newspaper. Who knows what’s happening elsewhere? While Virginians pride themselves for their fiscal rectitude, it is increasingly clear that some jurisdictions don’t hew to standards much higher than Chicago, Cleveland or Detroit.

In theory, the state constitutions requires the state government and each political jurisdiction to balance its budget each year. Virginians should be concerned that Petersburg failed to do so in fiscal 2016, that it shows every sign of failing to do so again in fiscal 2017, and that there appears to be no sanction or penalty in sight. Likewise, we should be concerned of the various tricks the state and its localities can use, if so inclined, to hide long-term structural budget deficits. Here are three:

  • Under-fund employee pensions. The Commonwealth drastically under-funded the Virginia Retirement System in the last recession, although it is now doing penance by accelerating repayments. The City of Richmond has under-funded its government-employees pension, which it operates independently of the VRS.
  • Slow pay creditors. This tactic comes straight out of the Illinois Fiscal Irresponsibility Playbook. Petersburg, it has been revealed, delayed payments of millions of dollars not only to the VRS but schools and the regional jail.
  • Defer maintenance. Rather than properly maintain roads, streets, buses, water systems, sewer systems, school buildings and the like, save money by scrimping on maintenance, even if it means even higher costs down the road.

To what extent do local governments rely upon these and other budgetary sleights of hand to balance their budgets? Nobody knows. Let me rephrase that: The public doesn’t know.

The bottom line here is that citizens cannot take at face value that their local governments are truly balancing their budgets. Some might be. I have faith that my home county of Henrico, whatever its other failings, runs a tight fiscal ship and doesn’t play bookkeeping games. But I don’t know it for a fact. Speaking generally, not specifically about Henrico County, government administrators are subject to the temptation of hiding bad news. And in most cases, local elected officials are either too timid or too untutored to ask tough, probing questions about how money is being spent.

Citizens unite! There are active taxpayer groups in Arlington, Fairfax County and Virginia Beach that I know of. I hope and pray that there are others of which I remain ignorant. Rather than fight lonely fights, they need to pool resources and expertise. I invite like-minded citizens to join Bacon’s Rebellion to create a platform to share knowledge and hold state and local governments more accountable than our elected officials seem able to do on their own. If anyone is interested in such a collaboration, please contact me at jabacon[at]dev.baconsrebellion.com.

Detroit on the Appomattox

Downtown Petersburg is rich in historical architecture, not much else.

Downtown Petersburg is rich in historical architecture, not much else.

by James A. Bacon

For its 2016 fiscal year, which closed June 30, the Petersburg City Council enacted a $75 million General Fund budget. Somehow, the city managed to close the year with a $17 million deficit.

Last week, council members knew the situation was dire. Staring at what they thought was a measly, $7.5 million deficit, they unanimously approved a 20% cut in personnel costs. Then, as reported by the Richmond Times-Dispatch, they learned that the deficit was actually $17 million.

Holy moly! In a state that constitutionally requires a balanced budget, how can a government body be 20% off? How can things go so far wrong?

Mayor W. Howard Myers sounded clueless. “I had no idea. I’m like, wow, where is this coming from,” he told the Times-Dispatch. Vice Mayor Samuel Parham only hinted at the problem: “This is a problem that has compounded over many years, so the  balloon has blown up and it has popped here on us.”

The city’s financial woes became apparent early this year when an audit found overspending in the General Fund by $1.8 million and anticipated a budget shortfall of $6 million. City Council fired City Manager William E. Johnson III, and appointed Dironna Moore Belton in his place on an interim basis. With Belton at the helm, a team of state auditors dug deeper into the books and found that about $4.5 million had been depleted from some “internal accounts” without the city’s knowledge.

Petersburg is a case study in how a municipal government can run up deficits without calling them deficits. The Times-Dispatch article refers to $2.5 million in financial obligations to the city school system, the regional jail and the Virginia Retirement System carried over from the 2016 budget to the 2017 budget.

“When you have a deficit, it just keeps rolling forward, Belton said. “We are working very diligently to do long-term finance restructuring, and we’re still trying to break down exactly the causation (of the deficit), but we do know the number of delinquent accounts that we have.”

Bacon’s bottom line: Fiscal negligence of this magnitude is just extraordinary for Virginia, and it raises all sorts of questions.

First, is this incompetence unique to Petersburg, or is it widespread and Petersburg is just the first to “blow up,” as Vice Mayor Parham put it? The situation calls to mind the chronic inability of the city of Richmond to complete its Comprehensive Annual Financial Report, which suggests that at least one other jurisdiction’s finances are in disarray. If I were a resident of the City of Richmond, I would be very concerned.

Second, Petersburg apparently used a number of tricks to hide the deficit, which allowed liabilities to build up unbeknownst to elected officials. Stretching out payments to vendors is a classic — Illinois is notorious for the late payment of its bills, incurring more than $900 million in late payment interest over six years. Petersburg apparently did the same thing on a smaller scale. How many other Virginia jurisdictions are slow-paying their vendors?

Third, what can be done when a deficit this large has built up? Petersburg, a jurisdiction of about 32,500 people, is already down on its luck. The city has a hollowed out economy, a large population of poor minorities, and one of the worst-performing school systems in the state. Its challenges are immense. Going into drastic budget-cutting mode can only make matters worse. For now, city officials seem determined to take drastic action to get their fiscal affairs in order. But the task will be painful. Which brings us to the fourth question…

Fourth, what happens from a constitutional perspective if a jurisdiction runs a deficit? Are there any sanctions? Or is the requirement to balance budgets every year merely aspirational — desirable but not mandated? What provisions are there for the state to step in? Who initiates the process — the governor or the General Assembly? We’d better get answers because my guess is that the problem is not going to go away.

The Hidden Risk in Money Market Funds, and What It Means for Virginia

Cranky old man... or seer of the future?

Cranky old man… or seer of the future?

by James A. Bacon

I’m sure many readers are tired of hearing my jeremiads about excess debt, fiscal unsustainability, and the necessity of re-engineering Virginia institutions to survive the inevitable reckoning. Well, too bad. The global economy is severely out of balance, Virginia is part of that economy, and we will suffer the consequences when the world’s 21st century experiment with fiscal and monetary perpetual motion machines collapses. State and local polities that prepare for the inevitable storm will be in a better position to ride it out.

Bacon’s Rebellion has explored the unintended consequences of the Federal Reserve Bank’s policy of monetary easing, which has been magnified by comparable policies of monetary easing and reckless credit creation in the European Union, China and Japan. While near-zero interest rates benefit the world’s largest debtor, the United States federal government, it punishes savers and the institutions that serve them. Thus, the Social Security and Medicare trust funds are generating lower income from their surpluses, leading to premature depletion. Insurance companies are earning less on their capital, causing them to increase premiums. The rate of return for pension funds are earning less money, compelling corporations and governments to bolster their contributions.

Even money market fund are affected. A new study published by the National Bureau of Economic Research, “The Unintended Consequences of the Zero Lower Bound Policy,” has found that zero-interest rate policies create problems for savers who park their cash in seemingly safe money market funds. In an effort to deliver non-negative net returns to their investors, portfolio managers have not only reduced expenses charged to investors but chased higher yields by taking bigger risks.

That money market fund you think is a safe and stable repository for your cash? It may not be as safe and stable as you think. Not only is the yield approaching zero, but you may be shouldering risks you didn’t know existed. What’s worse:

Although our empirical results speak mostly to one part of financial markets, we want to emphasize that the effects we document are not necessarily limited to [the] money fund industry only. The reaching-for-yield phenomenon has been observed in other markets: for example, an average insurance company has shifted its assets toward riskier equity holdings, reaching the level of equity exposure of almost 20% in 2014. Similarly, pension funds expanded their holdings into more than 60% equity, away from typically held bonds. More work is needed to better understand the transmission mechanisms underlying the effects of the zero lower bound monetary policy on the stability of financial markets.

Just as generals are said to fight the last war, economic policy makers fight the last recession. Just as the masters of the universe in Washington, D.C. pursue policies to prevent a repeat of what they failed to foresee in 2007, they are blind to the extraordinary leverage built into the global economy, the linkages between sectors, and the mechanisms by which defaults in one corner of the globe will spread panic and chaos to other parts of the globe.

The best way for state and local lawmakers to insulate Virginia and its communities is (a) to curtail borrowing and (b) stop creating new long-term obligations that cannot be readily pared back. That’s not to say that we should cease borrowing altogether or refuse to launch any new programs, but it is to say that we live in times of great volatility and unpredictability and we should set higher standards for incurring any new liability.

Chicago on the James?

richmond_skylineby James A. Bacon

As if the City of Richmond didn’t have enough problems, now tensions are erupting between the executive director, board of trustees, and members of the city pension fund’s investment advisory committee. Based on the account by Michael Martz at the Richmond Times-Dispatch, the rancorous relations between pension director Leo F. Griffin and members of the investment advisory committee might have originated over policy but have now gotten personal.

The underlying issue appears to be over who should control the pension’s investment decisions. For years the investment advisory committee set policy in lieu of hiring a high-priced chief investment officer. But Griffin, who took on his post three years ago, allegedly has been working behind the committee’s back to assume control of rebalancing the system’s investment portfolio and making other investment decisions, while blocking the flow of information to committee members. In effect, Griffin is alleged to be changing the governance model of the pension fund without a serious discussion by the board.

Like most Richmonders, I had never heard of the Richmond Retirement System. I assumed that the Virginia Retirement System ran the city’s pensions. But, no, the city’s $540 million fund is responsible for paying the retirement benefits of nearly 10,000 retired and current city employees.

funding_progressThis fracas follows on the heels of a proposal by Richmond Mayor Dwight Jones earlier this week to raise taxes and borrow $580 million over the next ten years to fix the city’s derelict public school buildings and meet other capital needs approaching $1.5 billion. The two sets of issues are linked because, it turns out, city pensions are only 63.5% funded, and the unfunded liability amounts to $310 million. As seen in the “Schedule of Funding Progress,” the city has made only marginal progress during the past seven years of economic expansion to restore the pension to the fully funded position it had in 2000.

In reading the pension fund’s 2015 Comprehensive Annual Financial Report, I see that the pension fund could be even more fragile than it appears from those numbers. When calculating its unfunded liabilities, pension managers assume that the fund’s assets will generate an annualized rate of return of 7.5% over the long run. By contrast, the Virginia Retirement System assumes a “discount rate” of only 7.0%. Some pension observers say that, in an era of persistent, near-zero interest rates, the discount rate should be even lower.

The discount rate used by municipal pension funds has political ramifications. A higher rate assumes greater investment returns, which reduces the funds the City of Richmond has to contribute each year to support the pension. But if actual performance falls short, the city will have to increase its annual payout, much as the General Assembly has done in recent years to shore up state pensions.

Fiscally speaking, we live in perilous times. We fantasize that we’ll always be able to muddle along. Then along comes Puerto Rico, which shows how dysfunctional our political system can get when managing long-term debt. Closer to home we can observe the political turmoil created when Illinois and Chicago, a state and city with massive unfunded pension obligations, struggle to avoid becoming the next Puerto Rico.

The City of Richmond is an awesome place and, economically speaking, has more going for it than any time in 30 or 40 years. But weak finances may be its Achilles heel.

Virginia Procurement Process Needs Reform

Complex projects from transportation to IT need risk management.

Complex projects from transportation to IT need risk management.

by James A. Bacon

The Commonwealth of Virginia needs to reform its procedures for contracting and administering billions of dollars of contracts, the Joint Legislative Audit and Review Commission (JLARC) has found in a new study.

In 2015 Virginia spent more than $6 billion through contracts, including for transportation projects, information technology, and building construction, noted JLARC. The process for managing the contracts is decentralized, with each agency handling its own work. State procurement staff are insufficiently schooled in risk management, and the state pays insufficient attention to monitoring and enforcing the contracts.

Even though contracts account for a significant portion of state spending, the state does not maintain comprehensive information on how contracts are performing. This prevents individual agencies and state-level decision makers from assessing whether their investments in individual contracts have provided value to the state. It also prevents agency staff from avoiding problematic vendors and developing and administering contracts in a way that takes into account previous “lessons learned” at their own agency or other agencies.

JLARC embarked upon the study in 2014 after the maladministration of the U.S. 460 superhighway project resulted in a $250 million loss to the state without any ground being cleared or asphalt laid. The state has been embroiled in other high–profile contractual disputes involving the provision of IT services and the explosion of a rocket at the Wallop’s Island space port.

“Risk management isn’t on the radar,” said Tracey Smith, study project leader, in a presentation to lawmakers Monday. Writes Michael Martz in the Richmond Times-Dispatch:

Legislators on the commission, particularly the lawyers, expressed shock that state agencies routinely enter into big, often risky contracts without legal advice from the Attorney General’s Office.

Del. David B. Albo, R-Fairfax, chairman of the House Courts of Justice Committee, called it “ludicrous” that agencies would draft major contracts without lawyers.

Bacon’s bottom line: State procurement laws reformed corrupt practices of an era in which politicians routinely gave contracts to their friends and supporters. The laws emphasized putting contracts out for competitive bids, procuring the lowest price and making the process transparent. The nature of business has changed over the decades, but with one important exception, the state procurement process has not kept pace.

Unless you’re procuring commodity products like office supplies or janitorial services, the lowest price is almost meaningless. The quality of work is often a critical but hard-to-define variable. Another is the allocation of risk — who pays when something goes wrong? Identifying and allocating risk is why we have lawyers. Sometimes the lawyers get carried away, picking at nits, but they perform a critical business function because things often do go wrong. Accidents occur. Disagreement arise. Unanticipated events throw everyone for a loop.

Government employees are not trained to think about risk. Politicians aren’t inclined to worry about risks that might explode on someone else’s watch.But as contracts grow increasingly complex with the trends to outsourcing and public-private partnerships, the allocation of risk can be as important as the price.

There is one outfit in state government that has been acquiring the competencies to engage in sophisticated risk management — the Office of Public-Private Partnerships (OP3), which oversees contracts for some of the state’s most complex transportation projects. As I recall, OP3 raised red flags relating to the infamous U.S. 460 project but its warnings were overruled for political reasons. The office has developed a network of contacts it can call upon to supplement the skills of its in-house staff. Virginia’s Secretary of Technology and the head of the Department of General Services should have comparable capabilities.

Good management doesn’t excite the electorate like, say, banning guns or restricting bathroom options for transexuals. But billions of taxpayer dollars are at stake. And that makes it a sexy topic for me.

Virginia Ranks 19th for Fiscal Condition

Graphic credit: Mercatus Center

Graphic credit: Mercatus Center

Virginia’s state finances are nothing to brag about, according to data contained in the Mercatus Center’s 2016 edition of “Ranking the States by Fiscal Condition.” The Old Dominion gets below average scores for cash solvency (cash on hand to pay short-term bills), and middle-of-the-road scores for budget solvency and long-run solvency. The state scores above average in trust fund solvency (pension funds and long-term debt), and 5th best in service-level solvency (the ability to raise taxes and increase spending without damaging the economy). Summarizes the Virginia state profile:

Total liabilities are 30 percent of total assets. Total debt is $6.86 billion. Unfunded pension liabilities are $87.66 billion, and other postemployment benefits (OPEB) are $5.19 billion. These three liabilities are equal to 24 percent of total state personal income.

Virginians tend to think that the state’s fiscal condition is fine as long as the Commonwealth maintains a AAA bond rating. Mercatus, which admittedly is funded by the Koch brothers but has no particular ax to grind against Virginia, suggests otherwise.

— JAB

Reader Alert: Another Jeremiad about Debt and Risk

Richmond Fed "Bailout Barometer" -- federal backing of total U.S. debt   increased another 0.7% in 2015 to reach almost 61%.

Richmond Fed “Bailout Barometer” — federal backing of total U.S. debt increased another 0.7% in 2015 to reach almost 61%.

Holman W. Jenkins, Jr., at the Wall Street Journal reminds us how countries around the world, including the United States, are doubling down on debt to stave off recession:

The Richmond Fed’s “bailout barometer” shows that, since the 2008 crisis, 61% of all liabilities in the U.S. financial system are now implicitly or explicitly guaranteed by government, up from 45% in 1999.

Citigroup estimates that the top 20 advanced industrial economies, in addition to their enormous, recognized public debts, also face unrecorded additional debts of $78 trillion for their unfunded pension systems.

Six years after a crisis caused by excessive borrowing, McKinsey estimates that even visible global debt has increased by $57 trillion, while in the U.S., Europe, Japan and China growth to pay back these liabilities has been slowing or absent.

No one likes recessions but they serve a useful purpose — they wring bad investments out of the economy and reallocate resources to more productive uses. But that’s not much consolation to a laid off Intel employee in the U.S. or a laid off cement-plant worker in China. So, politicians and central bankers around the world are doubling down on variations of the same strategy of spending, borrowing and financial repression (driving down interest rates to transfer wealth from savers to debtors) to perpetuate economic growth. When countries start experimenting with negative interest rates, the consequences of which no one can predict, you know that policy makers are desperate.

The global economy is entering a new phase: the end game in which democratic welfare states struggle to maintain massive entitlements in the face of aging populations and slowing economic growth. The United States is not as far down this road as some other countries, but absent major policy changes, deficits and the national debt are heading inexorably higher. Don’t believe me — believe the Congressional Budget Office.

Meanwhile, the four leading contenders for U.S. president are advancing platforms totally disconnected from reality. The cost of Bernie Sanders’ programs, if implemented, would cost $18 trillion over ten years, estimates the Wall Street Journal. Donald Trump’s tax-cut plan would cost $9.5 trillion over 10 years, says the Urban-Brookings Tax Policy Center, while the Ted Cruz tax plan would cost $8.5 trillion, according to the same group. The least fiscally irresponsible candidate, Hillary Clinton, would expand government spending by a mere $1 trillion over ten years, according to the McClatchy news organization

We can argue about the biases of the groups crunching these numbers, but that would miss the point. The odds are overwhelming that the next president of the United State will not be remotely serious about balancing the budget. Liberals argue that bigger spending can be paid for with taxes on the rich with little or no adverse impact on the economy, and conservatives can argue that the “dynamic” effects of tax cuts will stimulate economic growth and bring in more revenue than static models would indicate. Yeah, right.

Hither Virginia? There is little that Virginia can do to buffer its economy from these national and international trends, nor can state and local governments insulate themselves from collapsing tax revenue in the next recession. But they can protect themselves by maintaining AAA bond ratings and putting their public pensions on a sound footing so that when the crunch does come, they will be better positioned to meet long-term obligations without debilitating tax increases.

I am particularly worried about two categories of state-local debt. The first category is university debt backed by revenue from students. The higher ed bubble is unsustainable even during a period of modest economic growth. A recession will leave many institutions destitute, and a Boomergeddon-scale calamity could leave the entire industry in a shambles. A second category is debt taken on for “economic development” projects like sports stadiums, convention centers, golf courses, and other glittering objects that are best paid for by private investors trained in analyzing risk.

You can add a third category of long-term obligation: maintaining transportation services such as Washington-area metro, Virginia Beach light rail, Richmond bus rapid transit, and the like, which will require government subsidies in perpetuity. Could local governments support those services in a severe revenue downturn? Doubtful. Likewise, I am suspicious of toll-backed highway bonds assuming long-term traffic growth even as the evolution to more dense, mixed-use communities scrambles traditional commuting patterns, and as Uber, Lyft, Bridj, transportation-as-a-service enterprises, and self-driving cars seem destined to radically alter Americans’ driving habits.

Nassim Nicholas Taleb writes about building “anti-fragile” enterprises and institutions — entities that are not merely resilient in the face of massive adversity but can thrive in adversity. Virginia can become anti-fragile if state and local governments, in the face of a global economic meltdown, can maintain the ability to provide core government services while other states and metros are falling apart. Talent and capital will migrate to the oases of stability. A handful of states will prosper. Will ours be one of them?

Mala Suerte, Puerto Rico

potential_derelictsby James A. Bacon

The U.S. territory of Puerto Rico, like several American states, has forged a facsimile of prosperity by borrowing and spending beyond its means. Earlier this year, independent bond-issuing authorities began defaulting on their debt. Investors fear the territory will fail to make payments on General Obligation bonds coming due in May and June.

Not surprisingly, Senate Democrats called for bankruptcy protection for Puerto Rico. Every Democrat in the Senate signed a letter in January, calling for “appropriate restructuring tools” available under bankruptcy law that would allow the territory “to respond to [its] economic and humanitarian crisis.” Virginia Senators John Warner and Tim Kaine signed the letter.

longer_range_risks2Congressional Republicans have been trying to devise some other means of devising default. One proposal has been to create a “control board,” which, though lacking the broad bankruptcy authority that territorial officials had sought, would facilitate some debt restructuring. (Bearing Drift has an excellent article describing the thinking of Rep. Rob Wittman, R-1st, who serves on the House Committee of Natural Resources, which has oversight of this issue.) Democrats maintain that tough measures usurping local control smack of colonialism.

All sides agree that there is no easy remedy. Either bond holders get stiffed, rattling municipal markets and creating fallout for the 50 states, or Puerto Rico must adopt draconian policies that will cripple the economy and hurt the poor. There is no happy ending here.

Why should Puerto Rico’s financial woes concern a Virginia-centric blog? Because whatever solution is devised for the territory will set a precedent for future bail-outs and, indeed, could accelerate the coming reckoning with reality of states in terrible fiscal shape like Illinois. Inevitably, there will be calls for more forgiveness in which fiscally disciplined states like Virginia will bail out improvident states.

safe_for_nowMichael Thompson, president of the Thomas Jefferson Institute for Public Policy, makes the following observation in his latest column:

Allowing Puerto Rico the unprecedented power of abridging [municipal] debt will come at a direct cost to Virginia and all the other states that rely on the bond market for financing. Once the market sees that ‘full faith and credit’ protections are faulty, borrowing costs will go up for states in accordance with the increase risk. … Likewise, the value of funds holding this debt, which are found in 401ks and other retirement nest eggs across Virginia and the rest of the country, will be severely shaken.

The importance of Thompson’s insight cannot be overstated: Once bond investors realize that the assurances they thought they were guaranteed are rendered null and void by political expediency, they will demand a risk premium on all other municipal debt. That will hurt Virginia, although probably to a lesser degree than states lacking our AAA rating. What the Senate Democrats overlook is that investors will demand the highest risk premium for precisely those states whose finances are in greatest disarray — the blue states of Illinois, New Jersey and California. A higher cost of debt would make Illinois’ currently perilous predicament even worse.

Now, it’s one thing for Congress to take a hard line toward Puerto Rico, a territory that no one quite considers a part of the United States, and a very different thing to take a hard line on Illinois, which has senators and representatives with voting rights in Congress. Should the unimaginable occur and Illinois default on its bonds, bailing out Puerto Rico will create a precedent that will make it harder to deny Illinois, and any other states that might follow it, similar consideration.

The country will immediately polarize between citizens of states that have acted prudently, made hard choices, and husbanded their resources and states that ducked fiscal reforms and borrowed more. Congress will face a terrible decision: whether to bail out the improvident, thus creating a moral hazard for the very behavior that got those states into the fix in the first place, or to hold the line, at the risk of having state governments failing to perform essential responsibilities, as we have seen, for instance, in the Flint, Mich., lead-poisoning crisis.

This is a litmus test issue for me. Having railed against fiscal recklessness for years only to be told by many that I am an alarmist if not an outright right-wing whackjob, I have zero sympathy — no, in this brave new world of negative interest rates, I have negative sympathy — for any Virginia politician who caves on this issue. I will wage relentless blogfare against anyone who buckles. The spenders and borrowers need to get a strong, in-your-face message that states must mend their fiscal their ways because there will be no succor for them in the future. Tough luck, Puerto Rico. But better you than Illinois.

Buena Vista: the Canary in Virginia’s Fiscal Coal Mine

dead_canaryby James A. Bacon

The City of Buena Vista, which defaulted in 2014 on a $9.2 million bond issue to pay for a golf course that was supposed to spur growth in the city, has received some good news. It will be allowed to keep its city hall. For now. The office building, along with the police station and the golf course itself, stands as collateral on the debt.

Although ACA Financial Guaranty Corp., the bond insurer, still could take possession of city buildings, reports the Roanoke Times, it will not do so any time soon. “ACA is not currently interested in pursuing the option of foreclosing on the deeds of trust securing the bonds,” an attorney for the insurer wrote to the Buena Vista city manager.

The long-running controversy has harmed the ability of Buena Vista, a city of 6,500 in the Shenandoah Valley, to access credit markets. The Virginia Resources Authority recently rejected a request by the city for a loan to upgrade its public water system.

Maybe someone needs to call in Marc Edwards, the Virginia Tech professor who documented the lead poisoning in the water system of Flint, Mich., to make sure Buena Vista’s water is OK. I say that only partly tongue in cheek. The overlooked part of the Flint tragedy is the decades of fiscal mismanagement preceding the city’s takeover by state authorities that allowed the water system to deteriorate.

In Virginia, there is very much the idea that “it could never happen here.” But, in fact, it could, and Buena Vista is a case study. There are many other fiscally challenged cities, towns and counties in Virginia, where the old tobacco-textiles-furniture-and-coal economy has suffered comparable devastation to the Michigan automobile economy. Who knows what kind of hail-mary “investments” other local governments have pursued in desperate bids to revitalize local economies? Who knows the extent to which localities have deferred maintenance on their municipal water systems?

Buena Vista is so small that its plight has escaped the notice of the usual hand wringers, and I haven’t heard of any requests for bail-outs (although that’s not to say Buena Vista hasn’t been quietly looking for help.) At the national level, Puerto Rico is bordering on insolvency, and the entire state of Illinois is close behind. You can be assured that both will ask for help at some point to relieve them from the consequences of their bad decisions and dysfunctional political cultures.

Inevitably, Americans will face cruel choices — either bail out reckless and improvident governments or let their innocent citizens face more Flint-like calamities — and most likely Virginia will, too. To be sure, the Old Dominion’s finances are sounder than those of most states, but they aren’t as sound as we think, and not every jurisdiction has a AAA bond rating like Fairfax County, Henrico County of the City of Virginia Beach.

Your Federal Monetary Policy at Work

virginia_endowments2
by James A. Bacon

Pension funds and individual savers aren’t the only groups finding it difficult to generate decent investment returns in the current near zero-interest rate environment. Data gathered from 812 colleges and universities show that participating institutions returned an average of only 2.4% (net of fees) in 2015, contributing to a decline in their long-term, 10-year average return from 7.1% to 6.3%.

“This year’s long-term return figure is well below the median 7.5 percent that most endowments report they need to earn in order to maintain their purchasing power after spending, inflation and investment management cost,” states the press release announcing the results of the National Association of College and University Business Officers-Commonfund study of university endowments’ financial performance.

Investment returns were down for all asset classes: domestic equities, alternative strategies, fixed income, international equities, and short-term securities/cash. This is what comes of a Federal Reserve Board policy of quantitative easing that has driven down interest rates to near-zero levels for more than seven years now. There has been too much money chasing too few sound investments, creating asset bubbles around the world that now are deflating — along with financial returns. While Fed policy benefits the world’s largest borrower, the United States federal government ($19 trillion in debt and counting), it punishes savers, which includes state pension funds, private pension funds, insurance companies, and Americans saving for retirement.

For every percentage point shaved off the interest rate curve, Uncle Sam saves about $190 billion a year. (Other borrowers benefit, too, such as buyers of houses and cars.) But savers are punished. That’s a major reason state pension funds are in crisis. They’re always playing catch-up to ever-falling investment yields.

America’s universities are another victim of Fed policy. Collectively, their endowments hold assets valued at $528 billion. A 0.8% decline in return on investment amounts to $4.5 billion. Translated into Virginia terms, an 0.8% decline in return on the $16 billion in Virginia university endowments amounts to almost $130 million. That’s right, Fed policy is costing Virginia universities $130 million a year — and nobody knows about it, and nobody talks about it.

““FY2015’s lower average 10-year return is a great concern,” NACUBO President and Chief Executive Officer John D. Walda said. “On average, institutions derive nearly 10 percent of their operating funds from their endowments. Lower returns may make it even tougher for colleges and universities to adequately fund financial aid, research, and other programs that are very reliant on endowment earnings and are vital to institutions’ missions. ”

Higher ed bears most of the responsibility for runaway costs and tuition, but it isn’t responsible for declining investment returns. Next year is not likely to get any better. The U.S. stock market is down, international stocks are down, commodity prices are down, and interest rates remain depressed. Even hedge fund managers are losing money.  Most likely, Virginia colleges and universities will take another hit, and it doesn’t take a Larry Sabato to predict that they will respond by boosting tuitions and begging the General Assembly for more money.