Officials gamble with the public’s money, and sometimes lose big

Dan Walters
Columnist, CALmatters

Voice of San Diego, a journalistic website that covers local politics, published a remarkable article late last month about financial shenanigans in the San Diego Association of Governments, a regional planning and transportation agency.

Twelve years ago, the article said, SANDAG, as it’s known, decided to invest – or wager – millions of dollars from a newly enacted sales tax in a complex financial scheme. The result was a financial disaster.

“SANDAG bet big that interest rates would go up,” the website reported. “Instead rates went down and stayed down – and they’re still down. That unforeseen event – persistent and historically low interest rates – cost the agency millions.

“As a result, SANDAG now has a roughly $100 million liability hanging over its head. It’s already spent $3.5 million out of pocket that it didn’t anticipate. And it spent $22 million to get out of a portion of its bad bet using borrowed money that will wind up costing $42.5 million to repay.”

Five days after the article was published, Orange County officials made the last payment on a $1 billion bond the county had issued to cover losses from a similar scheme that its county treasurer, Robert Citron, had floated in 1994. Citron invested county funds, those of other local governments and borrowed money in speculative instruments that counted on interest rates remaining low.

When interest rates rose, the investments tanked, the county had to declare bankruptcy and Citron went to jail for financial fraud.

The bond that was finally repaid on July 1 cost taxpayers $1.6 billion with interest – money that otherwise would have paid for public services and facilities.

One would think that the Orange County debacle would have been a powerful warning to avoid gambling with public funds. Unfortunately, it wasn’t, as the SANDAG disaster shows. Nor is SANDAG the only example.

Many California cities have issued “pension obligation bonds” to cover rising retiree benefit costs with borrowing rather than tax money, based on the same assumption that arbitrage – betting that the difference between loan interest rates and investment earnings – can be a net winner.

However, like Orange County and SANDAG, some learned that trying to predict global markets is dangerous. The largest single debt owed by the city of Stockton when it declared bankruptcy was a pension obligation bond.

Hundreds of school districts issued “capital appreciation bonds” that postpone repayments for decades while the accumulated interest magnifies debt. Poway Unified in rural San Diego County became a poster child for financial irresponsibility when it was revealed that its $105 million bond would cost $1 billion to repay.

In 2013, the Legislature passed and Gov. Jerry Brown signed legislation to curb the issuance of such bonds, but it didn’t outlaw them, and after spending some time in the political doghouse, they’ve been expanding in recent years. Local school officials like them because they can promise to build new schools, or repair old ones, without immediately raising taxes – shifting that burden to future generations of taxpayers.

Brown, however, is not immune to the lure of easy money himself. His new state budget includes borrowing $6 billion from an obscure state reserve fund to pay down the state’s pension obligations. It assumes that borrowing costs will be more than offset by pension fund earnings – very similar to what SANDAG, Orange County and numerous other local governments have assumed to their everlasting regret.

 

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