A Remarkable Comparison: Affordable Student Loans vs. Affordable Housing

Here is an email from Eugene Holloway, a Maryland Attorney, on the rising cost of college education.

Eugene writes:

When I attended law school at George Washington U in 1969, the tuition was $1,900 a semester. I worked my way through and had no debts when I began to practice law.

Later, student loans became the norm. The loans were subsidized, encouraging students to become indebted rather than build sweat equity in themselves. Student loans also took parents off the hook for saving to pay for their childrens� education. The result was still more government dependency.

Screwing up the marketplace with subsidies, drove up the price of education, encouraged institutions to grow based on government support, and placed undue emphasis (economically) on higher and frequently useless education.

We should expect the higher education market to suffer a similar fate to the real estate market, where subsidies, encouraging people to buy what they could not afford (and did not need) led them to a result that, when compared to their investment in time and treasure, was uneconomical.

Eugene Holloway

I spoke briefly with Mr. Holloway on the phone. He is from the Austrian economist school, and spoke of the "education malinvestment".

Over time that is certainly what has happened. The cost of education has spiraled out of control with the cost of higher education far exceeding the payback unless one gets lucky in the jobs lotto process.

Many college graduates will be paying back student loans for 20 years or more. This is what happens when government tries to make things affordable. The same thing happened with affordable housing.

Fannie Mae Freddie Mac Mission

Has anyone even bothered to look up the Mission Statement of Fannie Mae?

We are a shareholder-owned company with a public mission. We exist to expand affordable housing and bring global capital to local communities in order to serve the U.S. housing market.

Fannie Mae Limits



Fannie Mae exists to expand affordable housing.

Fannie now offers loans as high as $938,250.

By what stretch of the imagination is that affordable? That such loans are deemed necessary is proof Fannie Mae has failed its core mission.

Fannie at least has a mission statement that one can understand. They failed, but the mission is clear. Compare an contrast to the Federal Student Aid program.

Federal Student Aid Mission

Inquiring minds are investigating the Federal Student Aid Program.

Organization and Core Mission

Federal Student Aid, an office of the U.S. Department of Education, ensures that all eligible individuals benefit from federally funded or federally guaranteed financial assistance for education beyond high school. Located in Washington, D.C., and ten regional offices, its 1,000-person staff consistently champions the promise of postsecondary education and its value to American society.

Federal Student Aid was formed as a result of the 1998 Amendments to the Higher Education Act of 1965. To face the challenge of modernizing the delivery of student financial aid, this legislation named Federal Student Aid the government�s first Performance-Based Organization (PBO).

Federal Student Aid�s five core objectives are to integrate systems, to improve program integrity, to reduce program costs, to improve human capital management, and to improve products and services.

Excuse me for asking but where exactly is the mission statement? Is this it? To consistently champion the promise of postsecondary education and its value to American society.

The objectives are clear however.

Federal Student Aid Core Objectives

1) integrate systems
2) improve program integrity
3) reduce program costs
4) improve human capital management
5) improve products and services

While the core objectives are clearly stated, it certainly is not clear what any of them have to do with helping students.

Integrating systems is the #1 core objective of the student aid program. Pray tell what the hell does that even mean?

Program "Success"

One way to measure success is by dollars spent. By that measure the student loan program is a rousing success.

• $21.8 billion in Direct Loans were awarded to 2.9 million recipients in FY 2008, excluding consolidation loans. Funds were borrowed from the US Treasury.
• FFEL funds are provided by private and non-profit lenders, insured by loan guaranty agencies and reinsured by the federal government. $52.9 billion in loans were delivered to approximately 6 million FFEL recipients in FY2008.
• Perkins loans are made through participating schools to undergraduate, graduate and professional students. These loans are offered to students demonstrating the greatest financial need. Undergraduates may receive up to $4,000 a year and graduate students may receive up to $6,000 a year based on a student�s need and a school�s available funding.

The document states the student loan portfolio is now up to a whopping $556 billion.

Is it any wonder with success like that, that cost of education is spiraling out of control?

Nowhere along the line are there any incentives by anyone (either the colleges or those administering the program) to reduce costs.

As long as government is willing to "help out" with student loans, universities and colleges will keep raising prices, and the total cost of an education will keep soaring until one day it blows sky high, just as happened with mortgages.

Note that the loans are guaranteed by the government. Also note that student loans are not discharged in bankruptcy. Those two facts are all you need to understand why the financial industry as a whole consistently champions the promise of postsecondary education and its value to American society. No one really gives a damn about the students. Worse yet, were funding cut off, there would be student outrage over it when stopping funding is exactly what is needed to bring costs down.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Market Cheers Over Ugly GDP Report

The stock market and commodities are giddy today on the Third Quarter Advance GDP Estimate which increased at an annualized rate of 3.5%.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.5 percent in the third quarter of 2009, (that is, from the second quarter to the third quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP decreased 0.7 percent.

Motor vehicle output added 1.66 percentage points to the third-quarter change in real GDP after adding 0.19 percentage point to the second-quarter change. Final sales of computers subtracted 0.11 percentage point from the third-quarter change in real GDP after subtracting 0.04 percentage point from the second-quarter change.

Real personal consumption expenditures increased 3.4 percent in the third quarter, in contrast to a decrease of 0.9 percent in the second. Durable goods increased 22.3 percent, in contrast to a decrease of 5.6 percent. The third-quarter increase largely reflected motor vehicle purchases under the Consumer Assistance to Recycle and Save Act of 2009 (popularly called, �Cash for Clunkers� Program).

Real exports of goods and services increased 14.7 percent in the third quarter, in contrast to a decrease of 4.1 percent in the second. Real imports of goods and services increased 16.4 percent, in contrast to a decrease of 14.7 percent.

Nondurable goods increased 2.0 percent in the third quarter, in contrast to a decrease of 1.9 percent in the second. Services increased 1.2 percent, compared with an increase of 0.2 percent.

Real exports of goods and services increased 14.7 percent in the third quarter, in contrast to a decrease of 4.1 percent in the second. Real imports of goods and services increased 16.4 percent, in contrast to a decrease of 14.7 percent.

Real federal government consumption expenditures and gross investment increased 7.9 percent in the third quarter, compared with an increase of 11.4 percent in the second. National defense increased 8.4 percent, compared with an increase of 14.0 percent. Nondefense increased 6.8 percent, compared with an increase of 6.1 percent. Real state and local government consumption expenditures and gross investment decreased 1.1 percent, in contrast to an increase of 3.9 percent.

The change in real private inventories added 0.94 percentage point to the third-quarter change in real GDP after subtracting 1.42 percentage points from the second-quarter change. Private businesses decreased inventories $130.8 billion in the third quarter, following decreases of $160.2 billion in the second quarter and $113.9 billion in the first.

Real final sales of domestic product -- GDP less change in private inventories -- increased 2.5 percent in the third quarter, compared with an increase of 0.7 percent in the second.

Disposition of personal income

Current-dollar personal income decreased $15.5 billion (0.5 percent) in the third quarter, in contrast to an increase of $19.1 billion (0.6 percent) in the second.

Personal current taxes increased $4.8 billion in the third quarter, in contrast to a decrease of $119.1 billion in the second. The quarterly pattern of taxes reflected a much smaller decrease in federal withheld income taxes in the third quarter, based on the quarterly pattern of wages and salaries and a leveling off of the effects on withholding rates from the Making Work Pay Credit provision of the American Recovery and Reinvestment Act of 2009. (For more information, see the Technical Note.)

Disposable personal income decreased $20.4 billion (0.7 percent) in the third quarter, in contrast to an increase of $138.2 billion (5.2 percent) in the second. Real disposable personal income decreased 3.4 percent, in contrast to an increase of 3.8 percent.

Personal outlays increased $148.2 billion (5.8 percent) in the third quarter, compared with an increase of $8.2 billion (0.3 percent) in the second. Personal saving -- disposable personal income less personal outlays -- was $364.6 billion in the third quarter, compared with $533.1 billion in the second.

The personal saving rate -- saving as a percentage of disposable personal income -- was 3.3 percent in the third quarter, compared with 4.9 percent in the second.

Cheering Over Ugly Report

Today the market is cheering over what is actually an ugly report.

A misguided Cash-for-Clunkers added a one-time contribution of 1.66 percentage points to GDP. Auto sales have since collapsed so all the program did is move some demand forward.

Government spending increased at 7.9 percent in the third quarter which is certainly nothing to cheer about.

Personal income decreased $15.5 billion (0.5 percent), while real disposable personal income decreased 3.4 percent, in contrast to an increase of 3.8 percent last quarter. Those are horrible numbers.

The savings rate is down, which no doubt has misguided economists cheering, but people spending more than they make is one of the things that got us into trouble.

The only bright spot I can find is exports. However, even there we must not get too excited as imports rose much more.

Markets advance on surprising GDP growth

Reuters is reporting Markets advance on surprising GDP growth

U.S. stocks rallied on Thursday following four losing sessions as data showed the U.S. economy grew faster than expected in the third quarter after more than a year of contraction.

The first estimate of U.S. gross domestic product showed the economy expanded at a 3.5 percent annual rate, unofficially ending the worst recession in 70 years. A Reuters poll last week found economists looking for a 3.3 percent gain, although some recent data led many to trim forecasts this week.

"The data suggests that we're going to see very positive GDP for at least the next two or three quarters," said Hank Smith, chief investment officer at Haverford Trust Company in Philadelphia. "I don't see much chance for negative territory for at least a year."

I am struggling to understand what is surprising other than how bad this all looks once you break down the numbers. The government sloshed trillions around and yet disposable income is down, jobs are horrendously weak, and the only reason GDP rose is wasteful government spending, cash-for-clunkers and extremely unaffordable housing tax credits whose effect is soon going to start diminishing even though the program was just extended.

I see plenty of chances for negative territory or at least extremely anemic growth starting in the second quarter of 2010, if indeed not the first quarter.

Let's see what Christmas brings. I am expecting far weaker numbers than most. In the meantime, let's party even if only for a day or two. Reality is likely to return soon.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Budget Bloodbath In Utah

Hard decisions are in store for state and local governments in Utah as Government budgets worse than anticipated.

The state's bleak finances appear to be even worse than previously thought. The revenue figures for the last three months show the economy is hammering government budgets.

Bob Springmeyer is the president of Bonneville Research. He has been doing economic analysis and planning for local government since 1976. When he saw the quarterly tax revenue numbers for the first three months -- July through September of this fiscal year -- he was stunned.

He said, "This is the first time I've seen this kind of dramatic drop across the board."

No one expected good news, but the real numbers were worse than projected. Taxes in numerous broad categories, for both state and local governments, were down. Springmeyer said, "I think we're going to have a budget bloodbath this next legislative session."

Overall, revenues fell 16 percent, totaling $275 million. Sales and use taxes, which fund general government and higher education, slumped 23 percent, nearly $100 million. Income taxes, which pay for public schools, slid downward $40 million.
Taxes on corporations, the franchise tax, were in free fall, plummeting 73 percent.

He said, "That's one that I think is probably the most scary. That means that businesses are way down, that means employment is going to be down."

It was the same story for local governments. Revenues from public transit, for instance, dipped $11 million. The transient room tax, which supports the Salt Palace and Convention and Visitors Bureau, was off 25 percent.

"Local governments and state government are going to have to make some really hard decisions," he said. "Are we going to raise taxes, or are we going to cut services?

The scary thing is not that tax revenues are plunging but rather the attitudes over what to do about it.

Springmeyer asks "Are we going to bond and do some of the capital improvements, build some of the schools, rebuild some of the capital things we need to get people back to work and get the economy churning again?"

The economy is NOT going to get churning again by spending more money than cities have. Building schools is not the answer when the cost of education is too high already. Building a school creates jobs one time. Everyone has to pay through the nose for it for years to come in staffing and administration costs in addition to paying back the bondholders with interest for the upfront money to build the schools.

Such proposals are economic madness. So are tax increases. Yet .....

Salt Lake City Mayor Corroon proposes property tax increase.

Salt Lake County's mayor is now asking for a $13.4 million property tax increase, despite nixing a similar proposal from the county council months ago. Peter Corroon said the county simply can't cut anymore after trimming jobs, wages, 401(k) contributions, open days at county outdoor pools and Sundays at 10 county recreation centers.

"At some point you have to say there are things we won't sacrifice," Corroon told KSL Newsradio in an interview Wednesday. "I said I won't sacrifice public safety and I won't sacrifice programs for our seniors and our children, so that's where we drew the line."

In prepared remarks to the county council on the budget, Corroon said Salt lake County is now "in the eye of the storm" when it comes to the economic downturn. The 2009 county budget was $801 million. The proposed 2010 budget stands at $638 million.

Corroon said he did not believe the county can cut any further "without harming the essential services" the county has to provide.

Nearly four months ago, Corroon said no to a $5 million tax "shift" proposed by the county council. Corroon says this is also considered a tax "shift" -- switching revenue sources from declining sales tax revenues to a property tax increase voters have already approved.

Mayor Corroon voted against a $5 million property tax increase earlier now wants a $13.4 million increase. Before anyone votes for any tax hikes the city (and its citizens) need to know where the money is going and what they are getting for their tax dollars.

How much in the hole is Salt Lake City anyway? After all, close analysis shows that City of Houston is Bankrupt (So are California, Oregon, and Pension Plans in General).

Could Salt Lake City be in a similar predicament? What about the state? If so, raising taxes sure is not the answer.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Boeing Expands Operations In South Carolina

A well deserved victory celebration goes to the workers at Boeing Co.'s 787 Dreamliner factory who on September 10 voted 199-68 to decertify representation by the International Association of Machinists.

Today the seeds of desertification bore fruit as Boeing picks Charleston for new 787 line.

Boeing's board has voted unanimously to build a second 787 final assembly plant in Charleston.

"We're taking prudent steps to protect the interests of our customers as we introduce the 787-9 and ramp up overall production to 10 twin-aisle 787 jets per month," said Jim Albaugh, president and CEO of Boeing Commercial Airplanes, in a prepared statement.

South Carolina offered the company $170 million in upfront grants for startup costs, plus multiple tax breaks that would be worth tens of millions of dollars more.

The legislation assumes the company will invest $750 million and create 3,800 new jobs in South Carolina within seven years � if it doesn't create that many jobs, it doesn't get any of the money.

Local economist Dick Conway, who has studied Boeing's impact on the regional economy for decades, estimates that each Boeing job generates spending that supports 1.7 other local jobs � one of the highest "multipliers" of any private-sector employer.

10-Year No-Strike Provision At Heart Of Issue

What killed the deal for Washington was refusal of the union to agree to a no-strike provision sought by Boeing as noted in Boeing talks fall apart; S.C. likely to get 787 line.

Discussions between the Machinists union and Boeing over the second 787 production line for Everett are effectively dead, according to a person familiar with the negotiations.

Last week, company negotiators asked for a "best and final offer" from the International Association of Machinists (IAM). The company wasn't satisfied with the union proposal and talks stalled.

U.S. Sen. Patty Murray, D-Wash., intervened over the weekend, talking to each side separately and acting as a go-between, her office confirmed. Gov. Chris Gregoire and Aaron Reardon, Snohomish County executive, also made calls to both sides and tried to encourage compromise.

It's not known exactly how far the union had moved in its offer to the company since last week, when it sought an extended series of predetermined wage increases as part of a no-strike agreement.

Whatever the union offered it was too-little too late.

By the time the union was willing to negotiate, South Carolina upped the ante with $170 million in upfront grants for startup costs plus multiple tax breaks that would be worth tens of millions of dollars more. In return Boeing needs to invest $750 million and create 3,800 new jobs.

The article notes "That surprisingly large number suggests that if Charleston does win the second 787 line, Boeing will expand there quickly and add substantial work beyond the 787."

For another take at why the Washington talks failed, please consider Boeing, Union Urged to Meet in �Last-Ditch� 787 Talks.

Boeing Co. and its machinists union have been asked to meet in U.S. Senator Patty Murray�s office today in a �last-ditch attempt� at reaching an agreement to keep 787 Dreamliner assembly jobs in Washington state.

Murray, a Washington Democrat, �believes the union has put a very good offer on the table, and Boeing shouldn�t pass up on this opportunity,� Alex Glass, a spokeswoman for the senator, said in a telephone interview.

Boeing is considering building a new 787 Dreamliner assembly plant in South Carolina in what would be the first time the world�s second-biggest commercial-jet builder has set up a new factory outside its historic Seattle manufacturing hub. The company hasn�t yet been able to reach the no-strike agreement it�s seeking with the union, whose four walkouts in the past 20 years have delayed plane deliveries and cost billions.

Chief Executive Officer Jim McNerney said on an Oct. 21 conference call that the upfront costs and inefficiencies of building a plant in South Carolina, adjacent to a Dreamliner parts factory the company bought in July, would be overcome by additional strikes at Puget Sound sites.

A new plant in Charleston, added to the one Boeing just bought that makes sections of the Dreamliner�s fuselage, would give Boeing its first assembly center outside Seattle and could siphon more jobs away from Washington as Boeing considers other new aircraft models.

Facing 4 walkouts and $billions worth of delays in Washington vs. moving operations to non-union shop where workers are happy to be employed, Boeing made the rational choice. Boeing would be wise to move as much production as it can to South Carolina.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Is a Home an Investment?

Here is an interesting video by Pete Schiff that discusses in what instances homes are investments vs. speculation vs. just a place to live.



I agree with Schiff that for most people who own and live in their own home, the best way to think about homes is as shelter. The mistake many made was thinking that home prices would rise forever, and somehow those rising home prices would support retirement. We have since seen how fatally flawed that idea is.

Schiff labels as speculators, those buying multiple homes hoping for price appreciation. Again I concur. Some who got out at the right time made fortunes, other who held on too long and could not sell or make their mortgage payments went bankrupt.

Those buying homes to rent, (assuming they know what they are doing, where lease rates will support the mortgage payment - conditions I added), can reasonably be called investors. Those needing huge price appreciation to cover interim losses and those not having a clue as to what they are doing, can also be labeled as speculators.

Homes As Consumables

I strongly agree with Schiff that a home is a consumable. It has to be maintained or its worth will head to zero. In fact, homes can be worth less than zero as has happened recently in Detroit.

Please consider In Detroit, a housing auction of last resort.

On the auction block in Detroit: almost 9,000 homes and lots in various states of abandonment and decay from the tidy owner-occupied to the burned-out shell claimed by squatters.

Despite a minimum bid of $500, less than a fifth of the Detroit land was sold after four days.

Out of 9,000 homes for bid, there was no bid for over 7,200. The homes that did not sell are worth less than zero because it will cost $10,000 or more just to tear them down.

Those were 2006 tax sales. 2007, 2008, and 2009 tax sales are likely to be as bad if not worse.

Value of the land itself may not go to zero (except in instances of excess taxation), but over time, the value of the structure always goes to zero unless it is maintained.

On the rationale that housing is indeed a consumable, housing prices should be included in the CPI. I have discussed this many times, most recently in Case Shiller CPI At Negative 5.1%.

Substituting the Case-Shiller housing index for Owners' Equivalent Rent, I have the year-over-year CPI at -5.1%. By that measure real interest rates are huge.

BLS Owner's Equivalent Rent Numbers From Twilight Zone

By the way, even rental prices are overstated in the CPI given that rental prices are falling nearly everywhere. Please see BLS Owner's Equivalent Rent Numbers From Twilight Zone for details.

Thus, unless one is very careful, the idea of buying homes to rent them out is fraught with danger as Schiff points out.

However, the idea of falling rents and falling property prices is hardly what one would expect to see in the hyperinflationary or high inflation environment that Schiff espouses.

In such conditions, one should expect rising prices to bail out otherwise bad investment decisions. There has never been a hyperinflation in history where real estate prices have fallen. That means some of Schiff's overall logic on inflation, the dollar, and home prices is flawed.

In regards to investment properties outside the US, there may be some select places such as Argentina where property values are still reasonably cheap. However, as a general thesis I disagree with Schiff. Property bubbles are nearly everywhere. Moreover, I think the US dollar is due for a strong bounce even if one could find some otherwise reasonable opportunities.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Multi-Year Stock Market Top Could Be In

Professor David Waggoner posted the following chart yesterday on Minyanville that I think is worth noting.



click on chart for sharper image

Professor Waggoner commented "The next intermediate level pivot down is around 882. It is a 50% retrace of the entire move up from the low and is a possible pivot for an extension of the entire A-B-C pattern off the low. It is also a natural support level as shown on the chart.

These intermediate level targets are based on the interpretation that the move up from the March low is a corrective retrace of a 5 wave set down from October 2007.

I concur with Professor Waggoner's analysis.

The important point in above chart is that the move up from the March low is likely a correction, not the start of a new bull market. That information alone is worth far more than any details as to how the market may decline from here. Many patterns are still in play.

Depending on the index, you can count these moves off the bottom as a simple A-B-C correction as shown, or as an A-B-C-D-E wedge. We'll know which one was correct in hindsight, but both suggest stocks will eventually make new lows - either sooner (in 2010) or later. A multi-year top could be in. Fundamentally, it should be in.

In the short-term, if we have in fact seen the end of the rally, the SPX will likely decline to the 200 day moving average, currently at 916. By the time we get there, it could be in the neighborhood of the 38% retrace line near 933. If things go quickly, it could be down there by the end of the year.

This is not a recommendation to short; this is a notice that risk is tremendously high and a top could be (and in my opinion should be) in. The market may have other ideas.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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City of Houston is Bankrupt (So are California, Oregon, and Pension Plans in General)

Houston, we have a problem. We are bankrupt.

That is the finding of Bob Lemer, CPA, Retired Partner at Ernst & Young; Aubrey M. Farb, CPA, Retired Partner at Grant Thornton; and Tom Roberts, CPA, Retired Partner at Fitts Roberts.

Cover Letter

October 22, 2009
Name, Title and Address [see list below]
Subject: Finances of the City of Houston
Dear : [see list below]

Enclosed is our partial analysis of the very serious financial situation at the City of Houston. We would be derelict if we failed to share this financial analysis with you. This financial heads up will assist you in meeting your fiduciary responsibilities to Houston voters, taxpayers, readers, viewers or investors---as the case may be.

We feel a public discussion of the City�s financial situation is necessary and firmly believe that addressing the City�s financial condition is in the best interest of the Houston economy and Houston taxpayers. We believe the sooner the City of Houston addresses the financial shortfall the better.

Please bear in mind that the Houston City elections are on November 3, 2009, with early voting having commenced on October 19, 2009. Recent history has shown a large portion of voting occurs during early voting.

We trust that the attached article is of significant assistance to you.
We may be reached at boblemer@sbcglobal.net.

The above was sent to:

City of Houston---Incumbent Mayor, City Controller, and City Council Members
City of Houston�Non-Incumbent City Candidates
Greater Houston Partnership---Board Members
Houston Chronicle---Editorial Board Members
Houston TV Stations---CEOs
Houston Business Journal---Editor
Houston Community Newspapers-Editor
Houston Press-Editor
Municipal Bond Rating Agencies---CEOs
Wall Street Journal---Editor
Barron�s-Editor
Investor�s Business Daily-Editor
USA Today-Editor
Texas Monthly---Executive Editor
Deloitte & Touche LLP---Houston and New York

Executive Summary

City of Houston
Disturbing Financial Facts---October 2009
By: Bob Lemer, Aubrey M. Farb and Tom Roberts

The City of Houston is financially broke and it appears that the mayor who takes office in January 2010 may have to captain the City through bankruptcy procedures.
The City�s unrestricted assets were $1.2 billion short of the already recorded
corresponding liabilities these assets were needed to pay as of fiscal year end June 30, 2008,according to the City�s latest publicly available audited Comprehensive Annual Financial Report (CAFR). The $1.2 billion shortfall was a result of operating losses totaling $1.5 billion for fiscal years 2004-2008, applying the full accrual basis of accounting used in the private sector.

Apparently the City has no idea as to what has transpired financially since June 30, 2008 or will transpire this fiscal year ending June 30, 2010, on the full accrual basis of accounting. But even on the modified accrual basis of accounting (essentially cash basis) followed by the City and all other municipalities, the $236.8 million fund balance in the City�s general fund as of July 1, 2009 (the beginning of this current fiscal year) would not exist except for the City having deposited the proceeds of pension obligation bonds into the City�s general fund instead of depositing them in their legally required immediate destination, the pension plans� bank accounts.

The City is in this dangerous financial position because its total spending since fiscal year 2003 has greatly outstripped its total revenues in that period. And the rate of growth in the City�s total revenues since 2003 has, in turn, greatly outstripped the City�s rate of growth in population plus inflation.

Thus the City�s problems are a result of greatly overspending and not a result of
insufficient revenues. All of this occurred before the current severe recession. Now the City has the added burden of the recession.

The City is in a real financial dilemma, because now its two principal sources of general fund revenues are in trouble---sales taxes and property taxes. Sales tax revenues already are dropping significantly and property tax revenues will commence dropping at an even more rapid rate after the next annual appraisal and assessment process. And the City will have to go to the voters for any contemplated rate increases in either the sales tax rate or the portion of the property tax rate allocable to operations.

It appears to us that there may be no viable alternative to bankruptcy proceedings and thereby positioning the City to regain control over its overspending, through addressing structural spending problems such as overstaffing and overly generous employee benefits.

Pension Plans and Government Salaries To Blame

According to the report, pension plans and government salaries are at the heart of the matter. Here are a few select details.

Detailed Findings and Observations

1. The City incurred operating losses (�Change In Net Assets�) totaling approximately $1.5 billion for the five fiscal years ended 6/30/08--- per the latest (fiscal year 2008) publicly available audited Comprehensive Annual Financial Report (CAFR), page 199:

In Thousands
a. (312,790)
b. (531,465)
c. (131,893)
d. (221,452)
e. (281,556)
TOTAL (1,479,156) ---or--- $1.5 BILLION

2. The City�s deficiency in unrestricted assets [�Unrestricted (deficit)�] was $1.2 BILLION ($1,174,429 thousands) at June 30, 2008--- per 2008 CAFR, page 15. In other words, the City�s unrestricted assets were approximately $1.2 billion less than the already recorded liabilities that they will be required to satisfy.

3. The $1.2 billion deficiency in unrestricted assets as of June 30, 2008 (which was created essentially during fiscal years 2004-2008-see item 1) was basically financed, per page 15 of the 2008 CAFR, by:
(a) the $347,728,000 collateralized note payable to the municipal employees�
pension trust;
(b) the $643,413,000 combined accrued liabilities to the employees� pension
trusts (municipal-$285,462,000, police officers�-$318,567,000, and firefighters�-$39,384,000);
(c) the $219,755,000 pension obligation bonds payable;
(d) the $272,941,000 accrued liability for other post employment benefits-----less, per pages 17 and 74 of the 2003 CAFR,
(d) the $54,395,000 net accrued liabilities to the employees� pension trusts at June 30, 2003 (municipal-$92,386,000, police officers�-$19,221,000, and firefighters�-asset of $57,212,000).

4. Thus, as of June 30, 2008, the City�s elected officials essentially had transferred financial ownership of the City from the taxpayers to the City�s employees, about 43.7% of who do not live in the City, according to documentation we have received from the City�s human resources department. Very troubling, 63.3% of first responders (police officers and firefighters) do not live in the City, versus just 30.0% of civilian employees, according to the City�s human resources department.

5. The City�s deficiency in unrestricted assets is so severe that in their yet to be completed audit for fiscal year 2009 the City�s independent auditors apparently will have to address the audit reporting issue as to whether the City was a �going concern� as of June 30, 2009.

6. Apparently the City has no idea yet as to what its operating loss (�change in net assets�) was for the fiscal year just ended June 30, 2009 or what its deficiency in unrestricted assets was at June 30, 2009, and has no idea as to what is in store fiscally for fiscal year 2010. That is because the City does not keep its books on the full accrual basis of accounting (fully accruing its assets and liabilities) but once a year, via the audited Comprehensive Annual Financial Report (CAFR). And the CAFR cannot be completed until the (nearly always very substantial) annual audit adjustments are booked.

....

17. For example, Exhibit B demonstrates how it was possible for the City to actually show an audited surplus of $19,891,000 from operations in the general fund (which is the focus of the annual budget and the MFOR) for fiscal year 2008 when, in reality, the City had an audited Citywide operations deficit of $281,556,000 for fiscal year 2008.

18. Exhibit B is difficult to comprehend for a person not trained in governmental accounting, even for a CPA. But the two most significant reasons for the difference between the $19,891,000 general fund surplus from 2008 operations and the $281,556,000 deficit from 2008 Citywide operations are: (a) the ever-growing accrued liabilities to employees for pension plans and other post retirement benefits; and (b) the commenced practice of financing current pension plan expenses with backend loaded pension obligation long-term bonds.

19. Once one understands Exhibit B, or at least items 18(a) and 18(b), it becomes obvious that the City�s fiscal 2010 general fund budget is an illusion, for two reasons. First, it is calculated on the modified accrual basis of accounting (essentially cash basis) and therefore ignores the ever-growing and enormous accrued liabilities for employee pensions and other post retirement benefits. Secondly, it is dependent upon continued payment of some of the pension expenses with issuance of long-term backend loaded pension obligation bonds.

23. At June 30, 2008 (date of the City�s last audited financial statements), the City�s total Citywide debt per capita of $5,338 was over twice the $2,528 debt per capita of the now bankrupt State of California.

Inquiring minds may wish to download the entire Lemer/Farb/Roberts assessment of City of Houston Finances document from Scribd.

I agree with the findings of Bob Lemer, Aubrey M. Farb, and Tom Roberts. Any attempts to balance this on the backs of taxpayers is not viable. Houston should declare bankruptcy and seek to null and void the contracts of city workers including police and fireman.

California Is Bankrupt Too

Interesting, I note in point 23 that the authors of this report have concluded California is bankrupt. Of course I agree with that assessment as well. Unfortunately there is no provisions for states to declare bankruptcy.

What About Oregon?

Inquiring minds are reading Climbing PERS expenses face Oregon pension board, agency budget writers.

The cost of Oregon's Public Employees Retirement System is about to skyrocket to budget-busting levels.

As a result of PERS' $17 billion investment loss in 2008, every state agency, municipality and school district that participates in the system is staring at an average 50 percent increase in the base rates PERS charges to fund their employees' retirement benefits in 2011 and 2012.

That's not a doomsday scenario. Unless the pension fund's board changes its rate-setting rules, or its investment portfolio generates a 26 percent return in 2009, these rate increases are guaranteed. What does that mean to you? Fewer teachers, cops and firefighters. Less of every service that government provides. Higher fees and taxes. Perhaps all of the above.

The base rate that public agencies pay to support employees' retirement benefits could double in the next five years, according to the PERS actuary, Mercer Inc. If rates reach that level, the retirement system will gobble one quarter of every tax dollar that goes into a public agency to support payrolls.

Oregon isn't alone.

Public pensions nationwide are in crisis mode, and state Treasurer Ben Westlund points out that Oregon's pension system is still better funded than most. PERS officials also note that a major recovery in the stock market could alleviate, or even eliminate, the pain. Indeed, the system's investment portfolio has already bounced back 14 percent this year.

But here's the rub: Even if the pension system's investments return an average 10.5 percent annually for the next three years - their historical average - PERS rates will still increase to 21 percent of payroll in July 2013, according to Mercer's modeling.

If, in a slower growth scenario, investment returns are closer to their 10-year average of 4.5 percent, all bets are off. PERS' executive director, Paul Cleary, recently told the citizens board that oversees investment of the $50 billion pension fund that if 4.5 percent is the new normal, "our business model doesn't work."

Pension System Busted Country Wide

It is highly likely that nearly every pension plan in the country is busted. The solution is for every city and municipality in a predicament to "pull a Vallejo" and declare bankruptcy. Please see Judge Rules Vallejo Can Void Union Contracts for details.

Deficiencies cannot be met on the backs of taxpayers. Enough is enough. It's time to end every massively underfunded public defined benefit plan in the country, by force if necessary (bankruptcy), unless unions agree to major concessions that would make the plans viable without raising taxes one cent.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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