Kersten Institute Warns Hundreds of Cal Agencies at Brink of Insolvency 

Newport Beach, CA

The Kersten Institute just published a warning that a fiscal storm will arrive in the next few months as new Government Accounting Standards Board (GASB) pension and benefit accounting standards push “potentially hundreds of California agencies to the brink of balance sheet insolvency,” causing Moody’s credit rating service to issue a massive number of “junk” downgrades and threaten “another wave of municipal bankruptcies in California.”

The Kersten Institute for Governance & Public Policy is considered one of the top independent experts in public policy budget, tax, labor, and fiscal issues. They have been conducting in-depth examinations of California public agency finances for the past several years regarding the sustainability of public agencies being able to pay for public employee contracted pay and benefits.

The Institute suggests that despite public employee unions “commonly labeling every attempt to reel in their escalating wage and benefit costs as anti-labor or anti-union,” all parties now generally accept that California public entities have over a $1 trillion dollars in liabilities for pension and debt obligations. They credit this acknowledgement as the reason spiking of public employee wages and pensions have becoming less egregious, especially after a number of high profile Chapter 9 municipal bankruptcies, such as Stockton and San Bernardino.

But California agencies granting higher life-time health and welfare benefits have “gone unmitigated for so long that public agencies are now at a major cross-roads where they either need to bring them in-line or face the decimation of all other public programs and services, and even municipal bankruptcy.” Hundreds of California agencies also issued tens of billions of dollars in pension obligation bonds at about a 4 percent interest cost, but “assumed” they would earn a profit by reinvesting the money at a 7.5 percent return.

Kersten warns that this game is about to come to a shocking end with the GASB that controls government financial reporting now requiring government entities to account for the entire future cost for health and welfare benefits as liabilities on their balance sheet. Those public entities that also issued OPEB bonds will be forced to now “assume” an invest return of only 2 percent, immediately. Overnight, pension obligation bonds will go from “profit centers” to huge “losers.”

With California agencies’ fiscal year having ended on June 30, 2015, about a thousand entities for the first time will be forced to incorporate GASB accounting changes for OPEB and pension obligation bond liabilities into their Comprehensive Annual Financial Report (CAFR), which serve as independent financial audits.

Kersten refers to the respected study in 2013, which found the seven counties of Alameda, Contra Costa, Marin, Mendocino, Orange, San Mateo, and Sonoma reported a combined balance sheet net worth of $10 billion in assets over their debt and liabilities. But when OPEB and pension bonds and OPEB liabilities were added, the seven counties were technically insolvent with a combined negative net worth of -$7.4 billion. Only Marin County would have a positive net worth.

When the Kersten Institute applied the same methodology to hundreds of public agencies in California, they found that “many other agencies are likely to be on the brink or past the brink of balance sheet insolvency” when these accounting changes hit public balance sheets this fall.

Los Angeles County already faces an unfunded pension actuarial liability of -$13.3 billion. But the GASB accounting changes will add “a whopping $25.7 billion in unfunded liabilities for other-post employment benefits, primarily retiree health care.” With only a declared +$9.3 billion net worth in 2014, the county’s balance sheet is expected to officially show a negative -$28.7 billion net worth for the 2015 fiscal year.

The old GASB rules allowed government to obfuscate OPEB and pension obligation liabilities, encouraging government irresponsibility. The Kersten Institute suggests:

It may just take another wave of municipal bankruptcies in California before state and local governments get serious about addressing the pension issue and the root causes of unsustainable public employee wage and benefit costs, which are jeopardizing the effectiveness and long-term sustainability of our public agencies.