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Thread: weekend commentary - 'moment of truth' for California Gov't finances

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    Default weekend commentary - 'moment of truth' for California Gov't finances

    (snip)"San Diego Isn't the Only City With Pension Troubles: Joe Mysak

    By Joe Mysak

    Nov. 17 (Bloomberg) -- What other municipalities are committing fraud when they sell bonds, by not coming clean about the size of their pension shortfall?

    How many are committing that kind of fraud?

    These are the questions investors have to pose after the city of San Diego settled fraud charges with the Securities and Exchange Commission this week.

    The city sold five bond issues totaling $260 million in 2002 and 2003. ``At the time of these offerings, City officials knew that the City faced severe difficulty funding its future pension and health-care obligations unless new revenues were obtained, pension and health-care benefits were reduced, or City services were cut,'' the SEC said in the settlement with the city.

    San Diego provided some disclosure of the city's pension and health-care obligations. ``It did not reveal the gravity of the City's financial problems,'' the SEC said.

    That's fraud.

    ``The City, through its officials, acted with scienter,'' the SEC said. That is, the city officials knew they weren't providing the whole story in their bond-offering documents, and went ahead with the sale anyway."(snip)


    The bottom line here is that San Diego is now the first major city to be investigated by the Securites and Exchange Commission and subsequently charged with committing fraud in regard to 'deliberately lying' to banks and investors re the city's actual financial condition in order to sell their municipal bonds (or to sell them at favorable interest rates). While the settlement agreement means that nobody at the SD city hall is going to jail, it also means that an important precedent has now been set. That precedent is likely to have PROFOUND future financial implications for SD taxpayers, taxpayers in other parts of California, and indeed taxpayers in other states whose local gov'ts are in financial trouble because of civil service employee benefit promises/obligations.

    Back to financial basics - SD and many other cities spend more money than they actually take in through income, property, sales and other taxes. To prevent bankruptcy, these cities create and sell municipal bonds to investors i.e. they spend the investors' money today and agree to pay back the investors (with interest) out of future tax revenues over a period of many years. The SEC investigation boils down to the fact that SD and very probably many other cities have sold new municipal bonds without reporting the city's already existing obligations to pay retirement and other benefits to civil service employees in the future - and that when those future obligations on city tax revenue are counted in, there is no way that the city can also afford to make the required future payments on its muni bonds at the same time.

    In the long term this basically means that SD and similar cities are doomed to bankruptcy because they simply don't have enough available future tax revenue to meet their obligations re retirement and other benefits to teachers, cops, firemen etc. and at the same time make their required muni bond payments to investors. Thus it is certain that somebody is going to get 'screwed' in the future, and odds are it will be the 'fat cat' investors rather than local teachers, cops, firemen etc.

    In the short term, with the SEC now paying close attention, the SD precedent will probably result in an inability of similar cities to issue new muni bonds, or at the very least will require that similar cities that must issue new muni bonds will have to pay very high interest rates in order to compensate the investors for the high degree of actual financial risk of those bonds actually getting paid off. Without being able to issue new muni bonds to raise additional operating cash, similar cities are now very likely going to have no choice but to implement stiff tax increases.

    Thus potential muni bond investors (and we've recently discussed investing in tax exempt muni bonds here in DD) now need to be extremely diligent before considering the actual risks vs returns that accompany future purchases of new muni bonds. On the other hand, the interest rates which are likely to become available on future muni bond offerings are likely to be pretty damned high in order to try and pursuade investors to accept the additional default risk and still buy very high risk muni bonds.

    In regard to California taxpayers and businesses, given the California state law that limits property tax increases to 3% per year, this will mean that SD and similar California cities will have limited options ... to seriously increase the sales tax rate, to institute an additional city income tax on city residents and businesses, to institute/increase 'sin' and 'nuisance' taxes etc. Of course, the cities could also reduce their spending in other areas - however this is highly unlikely because of both state legal mandates re welfare/medicaid and because of local policies re low income residents.

    Thus middle class California taxpayers and businesses will probably be taking a lesson from the legendary 'Animal House' club scene .....
    "if I was you I'd be ... umm ..." --- " LEAVING - what a GREAT idea !"

    ~
    Last edited by Melonie; 11-18-2006 at 09:52 AM.

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