Last year, crippling pension and benefits costs caused the city of Vallejo, California to declare bankruptcy. In this year of compounded economic crisis, more towns and cities may follow Vallejo’s lead, pushed over the edge by an accounting and financial-reporting provision known as GASB (pronounced “gaz-bee”) 45. “It’s a perfect storm of pension liabilities hitting us at a time when the economy is tanking and revenues are tanking,” says David Edwards, the senior policy advisor to Atlanta’s mayor. “It’s unprecedented.”

Unprecedented, perhaps, but not unexpected. In 2004, the Government Accounting Standards Board (GASB) issued its Statement 45, which required cities, towns, and states to account for their outstanding health-care and benefits costs on an accrual basis by the time five years were up. In the past, cities could accumulate massive long-term debt—the result of the lifetime benefits that came with public-sector union pension deals—but not disclose it on their balance sheets beyond their immediate fiscal-year costs. This lack of transparency encouraged irresponsibility in negotiations by kicking costs to the next generation and obscuring true obligations from banks and lenders. Now, local governments have to produce balance sheets that account for the full projected costs of these unfunded mandates over a 30-year period.

GASB has no power to enforce Statement 45, but as the arbiter of generally accepted accounting principles, it has a lot of influence. If the governments fail to comply by the end of the 2009 fiscal year, there will be a cost: cities’ bond ratings will suffer, which will increase their debt expenses, further complicating the already strained cycle of borrowing and spending on which they have become dependent. “You spend years cultivating a good bond rating and you don’t want to throw it out the window,” Edwards explains.

Localities that have already complied with GASB 45 have had to disclose the compromising long-term costs of lifetime health care and other retiree benefits. In New York City, which began compliance in 2007, the accounting measure has placed a new $63 billion liability on the books. Atlanta’s pension- and benefit-related expenses exploded from $44.5 million in 2005 to $118 million today, even while the city cut its personnel headcount by 8.6 percent. In Vallejo’s case, the city’s declaration of bankruptcy last May was due to the fact that it was spending 74 percent of its $80 million general-fund budget on public-sector salaries and benefits. Police captains were entitled to receive $306,000 annually in pay and benefits, while 21 firefighters earned more than $200,000 a year, including overtime. After five years on the job, all were entitled to lifetime health benefits.

Confronting the reality of unfunded pension and benefit obligations is deepening the crisis of confidence already shaking municipal finances. Last week, the chairman of the budget and finance committee of Stockton, California’s city council said that the city should consider filing for bankruptcy protection in the face of an $18.5 million budget deficit. Two smaller towns north of San Francisco, Isleton and Rio Vista, also appear on the brink of bankruptcy.

The culprit, of course, isn’t GASB 45 itself but the ugly reality that it exposes. There are 22.5 million public-sector employees in the United States. The average state and local government employee now makes 46 percent more in combined salary and benefits than his private-sector counterpart does, according to the Employee Benefit Research Institute—including 128 percent more on health care and 162 percent more on retirement benefits. Four out of five public-sector workers have lifetime pensions. Paying for such lavish treatment is difficult; in 2007, Credit Suisse estimated that state and local governments owed more than $1.5 trillion in unfunded health-care and non-pension benefits. Further, the market meltdown has erased $1 trillion from municipal pension funds, according to Boston College’s Center for Retirement Research.

New York City now spends an average of $107,000 for each of its 281,000 current employees—a whopping 63 percent increase since 2000. At the same time, its direct pension expenses each year have increased from $615 million to $5.6 billion. And New York isn’t alone. Forty states estimate that their liabilities for public-sector health-care and other benefits exceed $400 billion—more than their entire public debt, according to Standard and Poor’s. New Jersey has dug a particularly deep hole for itself. Its state pension fund lost half its value in 2008 but pays out $5.2 billion each year in benefits. “The state of New Jersey is insolvent,” writes bond analyst Mike Shedlock. “Bankrupt might be a better word.”

The good news is that the increased transparency may lead to increased accountability. The bad news is that the bill is coming due, accelerated by the aging of the Baby Boomers. And unlike benefits in the private sector, where businesses can adjust their expenses to survive tough times, public-sector pension and benefit packages cannot be renegotiated. Cities and towns may declare bankruptcy to get out from under their debts, but states don’t have that option; their taxpayers will have to pay for irresponsible decisions made decades ago. You don’t need a crystal ball to understand that the municipal budget crunch is going to get much worse this year. All you need is an accountant.


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