While Spain is raiding its pension funds to settle its government debt, many cities in America are doing the opposite: borrowing hundreds of millions of dollars to pay short-term pensions costs. As the AP notes (h/t Huffington Post), city governments hope that in the long term, pension investments will make up for the cost of the borrowing.
Unfortunately, this only works if the pension investments live up to expectations, which hasn’t been happening lately. And even in better economic conditions the track record for such borrowing is extremely spotty. The case of Oakland provides a striking example:
Len Raphael, an accountant and former candidate for city council, says officials who approved the bonds last year acted without understanding the risks or crafting a long-term plan to bring the city’s finances in order.
“They were saying, ‘Let’s borrow the money now, and later we’ll figure out how are we going to repay it,’” Raphael said. “That was nuts.”
The struggling city in the San Francisco Bay Area made a similar gamble on pension bonds 15 years ago, and the move ended up costing taxpayers $250 million because the pension fund’s investments didn’t yield as much as the interest owed on the bonds.
So this is a risky proposition. And if it fails, Oakland will find itself in even worse trouble than it is already:
“Issuing such bonds can also hurt a government’s credit rating and increase the cost of borrowing. According to a December report by Moody’s, pension obligation bonds tend to reflect poorly on the quality of management and is viewed as “part of a continuous pattern of reliance on one-time resources.”
This is a desperate gamble that few cities would make if there were better options. Unfortunately, the pension crisis in many cities is so deep that mayors think there’s no better choice. Oakland, Fort Lauderdale, and the entire state of Illinois have all pursued this strategy, and many more cities are likely to follow. A few may get lucky, but more will fail, dragging their credit rating down with them.
But hey, at least Wall Street is making money.