MMWD; Marinites Meet Your Master

“Tip” O’Neill once said “All politics are local.” I have reported in the past on national and state issues. When I received a notice in the mail of a proposed increase in my water rates I decided to do some research at the local level. If you are a regular reader of this blog you will not be surprised at what I found.

The Marin Municipal Water District (“MMWD”) recently issued a public notice for a proposed increase of 9.8% in the average water rate and service charge to go into effect March 1, 2010.[1] The previous increases in 2008 of 9.7% and 2009 of 7.3% were effective May 1 of their respective years, not in the following fiscal year.[2] MMWD’s fiscal year ends on June 30. The effect of this is to accelerate revenue from the rate increase into the ending year increasing revenue that was not budgeted. The process is gathering speed. This proposed increase reduces the interval between rate raises to less than twelve months (in this case from the earlier implementation date of May 1 to a new date of March 1 so on an annual basis the magnitude of last year’s increase is misrepresented. In this case the increase implemented for FY 2009 actually becomes 8.93% [(12x7.3+2x9.8)/12=8.93]. If MMWD returns to an annual cycle and there is not another increase prior to May 1, 2011 (I wouldn’t bank on it) this is an average increase of 9.5% per year. Over this same time the annual increase in the Consumer Price Index has been 1.47%.[3]

In calling for the increase the first reason cited was increased cost of purchased water, increased cost of treatment chemicals and new capital projects to increase supply.[4]

In the next paragraph the letter reads, “Water consumption continues to drop. While this decrease helps our supply picture, it hurts our financial picture. We had planned for a 5% reduction in water use due to conservation, but water use dropped 8.5% in fiscal year 2008-09, resulting in inadequate revenue to cover operating expenses. To complicate matters, most of the costs of providing water are fixed and do not fluctuate with the sale of water. Even so, we cut operating expenses by $5.3 million in 2009-10 and will eliminate at least $2 million in 2010-11.”

In the Preliminary Budget for 2009-11 actual 2008 operating expenses were $60,583,391 and the revised (upwards) operating expenses forecast for 2009 are $70,754,312, an increase of 16.7%. The preliminary budget for 2010 is up 1.97% at $70,768,416 and increases in 2011 by 5.15% to $74,414,772.[5] I am struggling to find the $5.3 million cut in operating expenses and taking $2 million out of 2011 still increases the budget by 3.4%. If “most of the costs of providing water are fixed” why do our bills keep going up even as water sales revenue continues to increase?

Here’s one reason. On August 8, 2005 the Government Accounting Standards Board (“GASB”) published its Implementation Guide to Statements 43 and 45 on Post Employment Benefits Other Than Pensions.[6] GASB establishes accounting standards for the preparation of audited financials for government entities. The implications of changes in accounting standards can be quite profound as in the example of General Motors seen in an earlier blog. These changes are designed to better inform management and stakeholders of their future liabilities and the funding status of those liabilities. In this particular case it is to clarify the obligations made by MMWD to its employees for retirement benefits not included in their pension plan also known as Other Post Employment Benefits (“OPEB”). For MMWD it required an increase of almost $2.3 million or 167% in the line item “Retiree Benefits”. Note 10 of the audited financials, which discusses OPEB at MMWD, is worth a read. In part it states, “As of January 1, 2007, the most recent actuarial valuation date, the plan was not funded. The actuarial accrued liability for benefits was $33,973,000, and the actuarial value of assets was $0. The covered payroll (annual payroll of active employees covered by the plan) was $18,850,000, and the ratio of the Unfunded Actuarial Accrued Liability (“UAAL”) to the covered payroll was 180%.” 2009 is the first year in which a contribution to this UAAL was ever made.

While this may come as a surprise to its customers, the MMWD Board was well informed. In a Grand Jury report entitled, “Retiree Health Care Costs, I Think I’m Gonna Be Sick” released March 19, 2007 finding F8 states, “Unless government employers prudently manage the liability for retiree health care benefits, they will be forced to cut services, reduce benefits, and/or raise taxes to satisfy credit agencies.”

To which MMWD responded, “MMWD believes that public agencies should always be prudent when managing public funds. However, MMWD does not think it is beneficial to speculate on what might occur in the future (emphasis added).”[7] We are now clear on what that future holds.

But this is only the tip of the iceberg. Note 8 of these same audited financials discusses the contributions made to the employee pension plan. Like most public plans this is a defined benefits plan, meaning that no matter what the performance of the assets of the plan or the contributions made by the plan sponsor, that plan sponsor is on the hook for the promised benefits. Like the OPEB this plan is managed by CalPERS. The actuarial methods and assumptions used are those adopted by the CalPERS Board of Administration. Employees are required to pay 8% of their covered salary into the Plan. Beginning January 1, 1999 the District began paying 1.5% of the covered salary for all employees and at January 1, 2001 an additional 1.5% bringing the total to 3% of covered salary. Employees now only pay 5%. The District pays the entire 8% requirement for senior managers. CalPERS assumes they will earn 7.75% on contributed funds. What unfolds next is not a pretty picture.

At the end of the financials under the title of “Required Supplementary Information” is the unaudited “Funded Status of Plan” or what I would re-title the “Unfunded Status of Plan”. At the end of FY 2008 the Actuarial Value of the Plan was $116,111,118 with an Actuarial Accrued Liability of $133,294,684 leaving an unfunded liability of $17,183,556 and a funded ratio of 87.1%. It is interesting to note that over the reported five years, a period when all investments were making superior returns, the funded ratio remained roughly the same. Of greater concern, the Unfunded Liability as a Percentage of Payroll grew. In other words those taking out are beginning to overwhelm those paying in.

And it gets worse. Between June 30, 2008 and June 30, 2009 CalPERS lost 23.4%[8] of the value of its co-mingled portfolio. According to the MMWD 2009 financials the Covered Payroll for the plan was $20,400,000. There is no valuation yet for the fund at June 30, 2009 but if we apply the known percentage loss to the 2008 balance and assume the contributions made in 2008-09 neither lost nor gained we can come up with a rough approximation. The results of these calculations appear below.

With an unfunded liability between the defined benefit pension plan and other post employment benefits standing at an estimated $92,000,000 or 450% of covered payroll and 131% of the entire operating budget is there any hope?

On September 24, 2009 the Marin Managers Association released Draft Version #7 of a report with the "Subject: Proposal for Regional City and County Pension Standard".[9] It highlights the chronic problem with funding defined benefit plans, explaining why they are becoming increasingly rare in the private sector. It goes on to say “There exists an increasing opinion amongst the public at large, and opinion leaders, that State and local government workers should be forced solely into defined contribution plans.

“We feel this would be mistaken for several reasons. First and foremost, defined benefit plans have proven to be more efficient than defined contribution plans for delivering pension benefits…” It goes on to describe all the benefits paid by defined benefit plans and concludes… “Defined benefit plans are funded from three sources. (First) employees are required under law to contribute rates established for each plan tier…The second level of funding comes from investment returns. These are established by the MCERA and CalPERS Boards, with extensive input from actuarial firms. These investment rates have always taken a long view-and are currently expected to generate 7.75% to 8.0% annual rates of return. To the extent these rates are not achieved, the final funding comes into play - employer contributions.” Please read “TAXPAYER CONTRIBUTIONS”

It is easy to see why recipients would like defined benefits. It is much more difficult to understand why taxpayers would tolerate them. But if the taxpayers are willing to assume this liability, what exactly are these benefits?

Let’s start with the General Manager. His monthly salary is $15,813.[10] This doesn’t include perks. As a member of the California Public Employees Retirement System (CalPERS) the program is mandatory for all full-time employees. The current retirement formula is 2.7% at 55. What this means is for each year of service the employee vests 2.7% of salary and at 55 with 37 years of service he/she would receive 100% of ending salary for life adjusted for inflation. The employee contribution rate is 8% of monthly salary but for all Senior Managers the District makes the entire contribution. Early retirement is possible at age 50 if an individual has five years’ service credit in CalPERS.[11]

What about mid level managers? The current retirement formula is the same, 2.7% at 55. The employee’s contribution rate is 8% of monthly salary. District employees currently pay 5% on a pre-tax basis and the District contributes 3%. Early retirement is possible at age 50 if an individual has five years of service credit in CalPERS, credit that can come from any other agency that is enrolled with CalPERS.[12]

All of the remaining full time employees at MMWD are members of the Service Employee’s International Union (“SEIU”). The pension benefits afforded to these employees are identical to those of mid level managers.[13]

And what about the unfunded OPEB? The District provides medical and dental benefits to employees if they retire from the District on or after age 50. The medical benefits cover the employee and their one dependent from retirement date for life. Medicare Supplemental insurance coverage is used when a plan participant reaches age 65. The employee and their one dependent receive dental coverage from retirement until the employee reaches age 65. Employees are not obligated to contribute unless plan costs exceed the District’s maximum contribution. For dental coverage, the District pays the entire cost of the dental insurance until the retiree reaches age 65. The retiree at age 65 may elect to continue coverage for themselves plus a dependent at their own cost.

In exchange for this lavish retirement package, particularly when most American’s are working longer, in many cases extending retirement well past 65, and often struggling with medical bills and simply forgoing dental care, are the employees somehow giving up something along the way? Far, far from it.

Salaries are at or above comparable private sector jobs with the security of union termination policies. And the list of perks is extensive at an average cost to taxpayers of over $30,000 per employee per year.[14]

In addition to retirement benefits they include[15] :

• Vacation of 80 hours after 6 months employment rising incrementally to 200 hours after 20 years (assuming an 8 hour day, that equates to two weeks, increasing to five weeks)
• 13 paid holidays
• 15 days annual sick leave (which can be accumulated and sold back at retirement)
• Health insurance
• Family dental insurance including orthodontia
• Group life insurance
• Long term disability insurance
• Vision care
• Tuition reimbursement

But is there just a glimmer of hope? On June 24, 2009 the MMWD Board approved a "Proposal for Classification and Compensation Study Contract".[16] The contract was awarded to Koff & Assoc. The list of Koff’s clients reads like a who’s who of municipal districts. Absent were the rest of us who are neither represented by unions nor have taxpayers to fall back on when revenue projections fall short. By establishing job classifications and compensation levels within only the heavily unionized public sector, where unions hold a monopoly on the labor force, control will move farther and farther away from those who will pay; the taxpayers, who these public servants are supposed to serve.

MMWD is looking more and more like a benefits plan funded by a water district. Bottled water anyone?
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Suggested reading:
Dick Spotswood: The Militant Centrist http://blogs.marinij.com/spotswood/
Steven Greenhut; Plunder: How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation

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[1] http://www.marinwater.org/documents/Rate_Increase_Mailing_Notice_Dec_2009.pdf
[2] http://www.marinwater.org/controller?action=opennews&id=171
[3] http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&[4] series_id=CUUR0000SA0&output_view=pct_1mth
[4] http://www.marinwater.org/documents/Rate_Increase_Mailing_Notice_Dec_2009.pdf
[5] http://www.marinwater.org/documents/MMWD_Budget_2009_11_compressed.pdf
[6] http://www.gasb.org/news/nr080805.html
[7] http://www.co.marin.ca.us/depts/GJ/main/cvgrjr/2006gj/responses/Retiree_Costs/response_to_retiree_health_mmwd.pdf
[8] http://www.calpers.ca.gov/index.jsp?bc=/about/press/pr-2009/july/2008-09-fiscal-performance.xml
[9] http://www.docstoc.com/docs/12736953/MMA-Draft-Proposal-for-Marin-Pensions-v7-clean
[10] http://www.marinwater.org/documents/Managers_Web.pdf#Top
[11] http://www.marinwater.org/documents/Senior_Managers_Summary_Update.pdf
[12] http://www.marinwater.org/documents/Mid_ManagersSummary.pdf
[13] http://www.marinwater.org/documents/SEIU_Summary_Update.pdf
[14] http://www.marinwater.org/documents/MMWD_Budget_2009_11_compressed.pdf
[15] http://www.marinwater.org/controller?action=menuclick&id=498
[16] http://www.marinwater.org/documents/Item_06_Board_Report_re_Class_Study_0617.pdf

The Coming Class War; an Essay

Over the last few months my blog has focused on unfunded liabilities and how government creates them, often with the complicity of unions. On Wednesday January 13, a shot was fired by President Obama in the coming class war. The looming battle between the members of society who benefit from unfunded entitlements and those who will be expected to pay for them is escalating.

“Many originally feared that most of the $700 billion in TARP money would be lost. But because of the management of this program by Secretary Geithner and my economic team, we’ve now recovered the majority of the funds provided to banks.

“As far as I’m concerned, however, that’s not good enough. My commitment is to the taxpayer. My commitment is to recover every single dime the American people are owed.”

“We want our money back, and we’re going to get it. And that’s why I’m proposing a Financial Crisis Responsibility Fee to be imposed on major financial firms until the American people are fully compensated for the extraordinary assistance they provided to Wall Street. If these companies are in good enough shape to afford massive bonuses, they are surely in good enough shape to afford paying back every penny to taxpayers.”

President Obama continued, “Now, our estimate is that the TARP program will end up costing taxpayers around $117 billion -- obviously a lot less than the $700 billion that people had feared, but still a lot of money. The fee will be in place for 10 years, or as long as it takes to raise the full amount necessary to cover all taxpayer losses.”1

A quick examination of the latest TARP Transaction History updated on January 13, 20102 shows that most of the banks subjected to President Obama’s diatribe have already returned the money lent them with interest. A notable exception is CitiBank. In that case the Treasury decided not to include its stock, (preferred stock that has been converted to common by Secretary Geithner), in a secondary offering by the bank but rather chose to speculate on the future price of Citi shares and sell them at a later time. (A side question is who votes those shares, Mr. Obama?). In the mean time the Treasury has become the majority shareholder in the automobile industry’s major financing arm, GMAC, taking on an additional $3.8 billion in an announcement on December 30, 2009.3 GMAC can now be added to Fannie, Freddie and the FHA as government owned banking businesses.


So the banking industry, which has returned its bailout funds is now responsible for paying back all of TARP. Absent from the discussion was the TARP money that has not been paid back owed by the two auto companies, General Motors and Chrysler; their combined financing subsidiary, GMAC; or by AIG. Nor was there a discussion of the open ended spigots at Fannie Mae and Freddie Mac and the bailout of underwater and overleveraged homeowners to the tune of $23.5 billion, many of whom defrauded their respective lenders on their loan applications.

Bank shareholders have suffered mightily in the dilution that has occurred in their banks, all of whom issued common stock to repay the TARP as did the shareholders in General Motors, Chrysler and GMAC. But in the case of the employees of the banks, now lambasted for the bonuses they have received, and the union employees of the auto companies who scored a major victory on Thursday in the health care debate by preventing taxation of their Cadillac health plans, and the employees at AIG; someone else is picking up the tab. Each case is different but they are all benefiting from a single government policy and most notably the banks. The enormous profits the banks are reporting today are in large part due to the zero federal funds rate imposed on the market by the Federal Reserve. “Even bankers can make money borrowing at zero and lending at 3 ½%.”

So who does pay? Savers. If you worked all your life and set aside savings to take care of yourself in your retirement you are the one paying for the miscreants in government and business who precipitated this crisis. Not only are you going to pay increased taxes on the meager returns you might squeeze out of a 1.25% CD, the artificial rate the banks (and, for that matter all borrowers) are paying is subsidizing their bottom line at your expense. So, on the one hand as Obama gesticulates against the banks for taking risk, his sidekick Ben Bernanke is forcing those who saved, didn’t over-leverage and invested prudently, now anticipating a decent return on that savings, to move out the speculation curve and take enormous risk to generate any income so the profligate can recover and prosper. The fees the banks pay will be socialized, spread across all of banking’s customers, and will mean virtually nothing to the banks’ bottom lines, passed on to their customers who are expected to be mollified by the tongue lashing meted out in their public scolding.

What is now clearer is the dividing line in the class war. As the Obama administration moves its pro union agenda forward it needs the help of the banking system. In this Faustian bargain he will continue to pursue his dance with the financiers who borrow at zero from the Fed to float record federal deficits lending those funds back to the government to finance its social experiment. Every dollar of deficit is a dollar redistributed as it will be paid back only by those who pay taxes, a shrinking percentage of the earning population.4
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1. http://www.ft.com/cms/s/0/70884e62-014c-11df-8c54-00144feabdc0.html
2. http://www.financialstability.gov/latest/reportsanddocs.html
3. http://www.treas.gov/press/releases/tg501.htm
4. http://www.urban.org/UploadedPDF/1001289_who_pays.pdf

Health Care III, A Christmas Present?

On Saturday, December 19 Senator Harry Reid released legislative language for the Patient Protection and Affordable Care Act (PPACA) as Senate Amendment 2786. These are the changes proposed by the Senate to H.R. 3592. It is expected to pass in the Senate before Christmas. Included in the amended bill is a brand new government sponsored health insurance program that provides a perfect example of how Congress creates unfunded liabilities.

Introduced in March of 2009 by Senator Ted Kennedy it is known as the CLASS Act (Community Living Assistance Services and Supports Act)[1] and is designed to provide insurance for long term care. This program creates a new government entitlement supported by a brand new trust fund. In the beginning there are more people paying in than taking out but as more participants vest and begin receiving benefits, payments increase and eventually swamp the income. If it sounds familiar it’s because it is very similar to the scheme that bankrupted Bernie Madoff and General Motors and it operates just like Social Security, Medicare and the entitlement programs of the State of California. Consider this, an individual pays an average premium of about $65 per month for five years (a total of $3,900) and then becomes eligible for benefits. Participants are eligible for $50 per day towards their long term care or ten times the rate at which they paid in. That is $1,500 per month as long as they are alive! For the first five years there will be no beneficiaries only premium payers. Early in the program as the beneficiaries come on line there is still positive cash flow because there are more payers than recipients but eventually beneficiaries exceed the payers, the trust fund is exhausted and the program will begin contributing to the deficit. We know this today! Yet Senator Reid would have us believe that this program will contribute $72 billion towards “paying for health care.” Here are the Congressional Budget Office (CBO) figures.

This program’s contribution to paying for health care peaks in 2015 and begins declining as payments out begin to exceed premiums in. The CBO’s scoring of Senate Amendment 2786 states, “As noted earlier, the CLASS program included in the bill would generate net receipts for the government in the initial years when total premiums would exceed total benefit payments, but it would eventually lead to net outlays when benefits exceed premiums…in the decade following 2029, the CLASS program would begin to increase budget deficits.” Zingo, a brand new unfunded liability.

This sums up the problem with government, it is accounted for like a classic Ponzi scheme[3], in other words on a cash basis. Corporations are not allowed to use this accounting method. Unlike corporations which have to bring future liabilities onto their balance sheets our government is presumed to be perpetual and simply reports cash in and cash out. If accounted for on a GAAP basis (“Generally Accepted Accounting Principles”)[4] one analysis puts the real 2008 federal budget deficit at a staggering $5.1 trillion[5], not the $455 billion reported by the Congressional Budget Office.

Now let’s look at the rest of the CBO’s scorecard on the Senate amendment.


The total cost of the program has increased 20% from the Chairman’s Mark discussed in an earlier blog[6] or $100 billion above previous estimates. So again we ask, “How does this contribute to reducing the deficit?”

The single biggest savings comes from reductions in Medicare, Medicaid, and other programs in the amount of $483 billion. They are:

• Permanent reductions in Medicare payment rates in the fee-for-service sector saving $186 billion

• Adjustments to the Medicare Advantage program saving $118 billion

• Reducing Medicaid and Medicare payments to hospitals serving large populations of low-income patients by about $43 billion

• $28 billion comes from reductions in subsidies for non-Medicare Advantage plans and changes to payment rates recommended by an Independent Payment Advisory Board established by the legislation. These recommendations are non-binding.

• CLASS (our afore mentioned Ponzi scheme) for $72 billion.

• Improvements in disbursements by adopting and regularly updating standards for electronic administrative transactions which enable electronic funds transfers saving $11 billion.

The CBO offers this caveat, “These longer-term calculations assume that the provisions are enacted and remain unchanged throughout the next two decades, which is often not the case for major legislation. For example, the sustainable growth rate (SGR) mechanism governing Medicare’s payments to physicians has frequently been modified (either through legislation or administrative action) to avoid reductions in those payments, and legislation to do so again is currently under consideration in the Congress.” Readers will recall this as H.R. 3961, the Medicare Physician Payment Reform Act that reverses reductions in payments established by SGR. CBO estimates the cost of H. R. 3961 at $210 billion over the next 10 years[7] and this is not considered in the national debate as part of the cost of health care.

Hot off the press, the CBO today released a correction to the score it published on December 19 to wit, “Correcting that error has no impact on the estimated effects of the legislation during the 2010–2019 period. However, the correction reduces the degree to which the legislation would lower federal deficits in the decade after 2019.”[8] Oooops!

Have a Merry Christmas and caveat emptor.
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[1] http://thomas.loc.gov/cgi-bin/bdquery/z?d111:SN00697:
[2] http://www.cbo.gov/ftpdocs/108xx/doc10868/12-19-Reid_Letter_Managers.pdf
[3] http://en.wikipedia.org/wiki/Ponzi_scheme
[4] http://en.wikipedia.org/wiki/Generally_Accepted_Accounting_Principles
[5] http://www.wnd.com/index.php?fa=PAGE.view&pageId=113366
[6] https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHBfbQYEF29qDLGEC6IH9Z_CzLM364QR6NBQXitr389IZmSnzE1ucHm3jC7joRfBX45rnMUbFWtS39GCjYTDAjxNujGKbJtKhSJNYNt9JEknVbr3Ntx7sh-Wuh8un8hUV_mHUvwKP-tYQ/s1600-h/Chairman's+Mark+chart8.jpg
[7] http://www.cbo.gov/ftpdocs/107xx/doc10732/HR3961_HonRyan.pdf
[8] http://www.cbo.gov/ftpdocs/108xx/doc10870/12-20-Reid_Letter_Managers_Correction1.pdf

The California Debt Crisis, Sinking in Quicksand

As California seemingly sinks deeper and deeper into debt we have to ask the question, “How did we get here and can we fix it?” What follows is a discussion on the symbiotic relationship between elected government officials and public employee unions.

On May 23, 2008 the City of Vallejo filed a case seeking bankruptcy protection under Chapter 9 of the United States Bankruptcy Code.[1] In its filing it disclosed that the cost of public safety salaries represented 74% of its $80 million budget.[2] The average fireman in Vallejo takes home $170,000 while City Manager Joseph Tanner’s total annual compensation is more than $400,000.[3] And the response is to cut services not salaries.

Not far behind is the city of Bakersfield with its “3 at 50” retirement benefit. In 2001 Bakersfield’s city council voted to allow police officers and firefighters retirement pay equal to 3 percent of their best year’s salary for every year they worked, to a maximum of 90 percent. Their retirement eligibility begins at age 50.[4]

In 1999, in the transition between governors Pete Wilson and Gray Davis, California SB 400 was passed. Sponsored by the California Public Employees Retirement System and proposed by the Senate Public Employees and Retirement Committee it cleared that committee by a vote of 4-0. It cleared the Senate Appropriations Committee 11-0 and passed on the Senate floor 35-0. In the Assembly it garnered only 7 nays to pass and become law on September 10, 1999 by a vote of 70 ayes to 7 nays. This bill established a new level of survivor benefits for state and school employee participants comparable with Social Security and made significant increases to the benefits of state and school employees. Among others it provided for retirement at age 50 and cost of living adjustments. Benefits were increased even more for “safety” employees, that is state police and firefighters.[5] It became a mammoth unfunded liability and the model for municipalities around the state.

Hit by the twin financial downturns caused by the dot-com bust and 9/11, Governor Gray Davis struggled with mounting deficits and a dysfunctional budgetary system. Finally, blamed for the electricity crisis that hit California, Davis was recalled in 2003. He was replaced by Arnold Schwarzenegger who ran on a campaign of fiscal responsibility. When the state legislature rejected his spending limit proposal a compromise was struck and Proposition 58 requiring a balanced budget appeared on the March 2004 primary ballot and was approved by the voters. Still the deficits persisted and the pessimistic forecasts became reality.



Spurned by the state legislature but emboldened by his election victory Schwarzenegger turned to the voters. In 2005 he backed four initiatives designed to restrain some of the leverage public unions held under current law. Proposition 74 extended the probationary period for new teachers from 2 years to 5 and made it easier to dismiss teachers with unsatisfactory performance. Proposition 75 prohibited public employee unions from using union dues for political purposes without the consent of the union members. Proposition 76 limited the growth of state spending to the growth in revenues and gave the Governor certain veto powers. Proposition 77 changed the way California draws boundaries for congressional and legislative districts giving the power to a panel of retired judges approved by the voters. Opposed by the California State Teachers Union and aggressively financed, all four initiatives went down to defeat.[6]

Public employee unions hold a unique position in society. Unlike unions in the private sector where demands are constrained by the ability of a business to finance wage and benefits packages or go out of business, municipalities are monopolies. Public unions are well financed. Unlike private unions where dues collection is a cost, public union dues are deducted from pay and the cost of administration and collection is paid for by taxpayers. Because of the monopolistic nature of public services (if the local policeman doesn’t show up you can’t call a competing police station) unions hold a gun to the head of the public that pays them. With the potential for disruption in services from municipal transportation to schools, firefighting services to police protection, voters put enormous pressure on their elected representatives to settle public sector labor disputes.

But the root of the problem is the ability of public unions to influence the outcome of elections. As noted above the unions are highly organized and well financed. When legislation is proposed the union and union members are well versed on the effect, often involved in writing the legislation as in SB 400. Union leaders lobby on behalf of their constituency, and unions are well represented at the ballot box. Often, legislation is targeted and very specific in its desired effect and misses the scrutiny of the public. Set against this specialized and skilled lobbying machine is the typical voter. So far in 2009 there have been 1,589 bills introduced in the California Assembly and 833 bills introduced in the Senate.[7] The time and energy to simply understand and track a mere handful of legislation is daunting. The prospect of over 2,000 pieces of legislation each year leads to what is called “rational ignorance”, a condition that occurs when the cost of educating oneself on an issue exceeds the potential benefit that the knowledge would provide.[8] And with this power in place the unions are in a position to elect their bosses, the very individuals the public relies on to manage the finances of government and negotiate union contracts. It is pretty easy to see who wins and who loses in this proposition.

And unions now have the strong backing of the White House. When Governor Schwarzenegger attempted to reduce wages for unionized home care workers President Obama threatened to withhold billions of dollars in federal stimulus funds if the salaries weren’t reinstated[9] placing the federal government squarely in the middle of the fiscal problems of the State.

On January 30, 2009 the newly inaugurated president signed three executive orders,[10] 13494, 13495 and 13496 strengthening the union’s position in any projects funded under ARRA (the American Recovery and Reinvestment Act) and overriding state labor rules.[11] According to The Kansas City Star, “President Barack Obama …issued an executive order backing the use of union labor for large-scale federal construction projects.

“The order encourages federal agencies to have construction contractors and subcontractors enter project labor agreements. Those agreements require contractors to negotiate with union officials, recognize union wages and benefits and generally abide by collective-bargaining agreements…”[12]

And on the same day as those executive orders were signed a group of union leaders was welcomed to the White House. “I do not view the labor movement as part of the problem. To me, it’s part of the solution,” Mr. Obama told the group.[13]

On November 18, 2009 the California Legislative Analyst’s Office released its report on California’s fiscal outlook projecting a deficit $20.728 billion[14] for fiscal year 2010.



There is an unsettled debate over whether higher taxes and regulation are causing wealthy individuals and businesses to leave the state. What is not open for debate is that the cost of staying is rising while the quality of services provided by local and state government is declining. The poor are disproportionally impacted and that is the exact opposite of the goal of the so-called socially responsible. When a county employee recently told me about how tough it is to cut benefits for the poor, as the county has been doing repeatedly while grappling with their budget issues I suggested, “Why don’t the county employees take a pay or benefits cut and ease the burden for the poor?” The answer was immediate and unequivocal, “Are you kidding? We wouldn’t do that!” No doubt.

The best analysis I have seen of the power of public sector unionism was published by the Cato Institute on September 28, 2009.[15] It ends:

“As keepers of the public purse, legislators and local council members have an obligation to protect taxpayers’ interests. By granting monopoly power over their governments’ supply of labor to labor unions, elected officials undermine their duty to taxpayers, since this puts unions in a privileged position to extract political goods in the form of high pay and benefits that are way above anything comparable in the private sector. Under such an arrangement, government, being itself a monopoly, leaves the citizens whose money it squanders with no options.”
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[1] http://www.ci.vallejo.ca.us/GovSite/default.asp?serviceID1=712&Frame=L1
[2] http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/05/06/BACH10HUK6.DTL
[3] http://www.bondbuyer.com/issues/117_87/-288275-1.html
[4] http://www.kget.com/news/local/story/3-at-50-retirement-debate/msXwaOs5k0eCtPms3hnh6g.cspx
[5] http://info.sen.ca.gov/pub/99-00/bill/sen/sb_0351-0400/sb_400_cfa_19990928_142123_sen_floor.html
[6] http://en.wikipedia.org/wiki/California_special_election,_2005#Results_2
[7] http://www.sen.ca.gov/~newsen/senate.htm
[8] http://en.wikipedia.org/wiki/Rational_ignorance
[9] http://www.kget.com/news/local/story/President-Obama-threatens-to-withold-billions/6bQ0EuJLlkq3mzJ0_q3dOA.cspx
[10] http://www.archives.gov/federal-register/executive-orders/2009-obama.html
[11] http://www.flemploymentlawblog.com/articles/government-contracts/
[12] http://artfularticulations.blogspot.com/2009/02/president-obama-executive-order-favors.html
[13] http://www.telegraph.co.uk/news/worldnews/northamerica/usa/barackobama/4401782/Barack-Obama-welcomes-union-leaders-to-the-White-House.html
[14] http://www.lao.ca.gov/handouts/education/2009/California%E2%80%99s_Fiscal_Outlook_Proposition_98_Briefing_111809.pdf
[15] http://www.cato.org/pub_display.php?pub_id=10569

Health Care Part II; Would you Buy an Insurance Policy from this Man?[1]

On October 29, Speaker of the House Nancy Pelosi released the long-awaited House version of health care reform which was crafted partly in Congressman Rangal’s Committee on Ways and Means. Actually, she introduced two bills; H.R. 3961, the Medicare Physician Payment Reform Act[2] and H.R. 3962, the Affordable Health Care for America Act.[3]

Let’s look at H. R. 3961. In my last blog post I discussed the $285 billion budgeted in 2010 for overturning the impending 21% cut in Medicare payments to physicians scheduled to take place on January 1, 2010. That discussion pointed to a budget resolution from the House Finance Committee passed on March 29, 2009[4] which requires enacting legislation. H.R. 3961[5] is that legislation and it seeks to permanently change the way physician reimbursements are calculated through amendments to Section 1848 of the Social Security Act,[6] the section of the Act that sets physician reimbursement rates.

In an effort to be diligent and to supply you, the reader, with a clear picture of how physicians are currently compensated under Medicare, I read Section 1848. It is 40 pages long, contains 14,000 words and 86 footnotes including legislative changes. The complexities of the language make it impossible to do a simple calculation and we can only assume the Mandarins in Washington have it right. But the question is really about the cost of this legislative change. In most of my analysis I consult the Congressional Budget Office report of the fiscal impact of legislation. Unfortunately H. R. 3961 has not been scored by the CBO. I assume this is because it is in the aforementioned budget resolution, which was. I score it as they did then at a cost of $285 billion. There is a silver lining. That is Ms. Pelosi’s claim that this legislation will fall under the new Pay-go rules codified by the house, but that silver lining dims significantly when you consider the Senate has openly rejected that kind of budgetary restraint.[7] Nevertheless this represents somewhere in the neighborhood of a quarter of a trillion dollars that have to come from somewhere.

The other examination is of H. R. 3962, the “Affordable Health Care for America Act.”[8] It is nearly 2,000 pages of legislative language. I again deferred in my analysis to the CBO.[9] Table 2 from their report shows their estimate of the Net Cost at $894 billion. The first thing I noticed is the disparity between the Net Cost and the impact on the budget. In years 2010 through 2012 the cost is minimal. Yet the impact to budget is different with deficit increases of $6.8 billion in



2010 and $16.6 billion in 2011. In 2012 there is a decrease of $15.8 billion. What accounts for this? As part of the American Recovery and Reinvestment Act of 2009 (ARRA) there was a temporary increase in payments to states for Medicaid (FMAP) which apparently is not considered part of health care when it is stimulus.[10] That stimulus expires on December 31, 2010 so the House has included a one-time extension of these payments into 2011 at an estimated cost of $23.5 billion. Payments to Primary Care Practitioners account for the majority of the rest at an average of $5.7 billion per year over the ten-year estimate.[11] This of course is in addition to the $285 billion discussed above from H.R. 3961. The majority of the savings comes from discounts in Part D (Prescription Drug Benefit) and Phase-in of Payment Based on Fee-for-service Costs.
But the best way to analyze the bill is to put it against the Chairman’s Mark of the proposed Senate legislation, which I discussed in my last blog post. Several things stick out. First, the House bill is 30% more costly than the Senate proposal. Interestingly both bills assume half of



the cost will be paid for by savings in Medicare, Medicaid and other programs. Second, the House bill forgoes tax on high premium plans and makes only minimal changes in existing tax expenditures, leaving us with a $598 billion shortfall compared to the Senate plan’s $85 billion. And how does this become deficit negative? The House plan charges significantly higher penalties for non participation (to the tune of $167 billion) and raises taxes on the wealthy by $536 billion! And, if the House is successful in enforcing Pay-go for H. R. 3961 they will either have to raise taxes by an additional $285 billion or cut spending by that amount. If the savings are truly realized the plan will simply be deficit neutral at a cost of $800 billion in potential new taxes.

Once again I will pose the question, “With an unfunded liability of $107 trillion in the current Social Security and Medicare program[12] can we afford to just spin our wheels?” It appears to me the “Affordable Health Care for America Act” will be very unaffordable for someone, possibly everyone.


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[1] http://www.politico.com/news/stories/0609/24167.html
[2] http://www.ssa.gov/OP_Home/ssact/title18/1848.htm
[3] http://docs.house.gov/rules/health/111_ahcaa.pdf
[4] http://budget.house.gov/PRArticle.aspx?NewsID=1677
[5] http://docs.house.gov/rules/health/111_sgr1.pdf
[6] http://www.ssa.gov/OP_Home/ssact/title18/1848.htm
[7] http://thehill.com/homenews/house/63399-senate-move-on-medicare-payments-sets-up-pay-go-showdown-with-house
[8] http://docs.house.gov/rules/health/111_ahcaa.pdf
[9] http://www.cbo.gov/ftpdocs/106xx/doc10688/hr3962Rangel.pdf
[10] http://www.legis.state.ia.us/lsadocs/SC_MaterialsDist/2009/SDDLH031.PDF
[11] http://www.cbo.gov/ftpdocs/106xx/doc10688/hr3962Rangel.pdf, pg. 23, Table 3.
[12] http://www.freerepublic.com/focus/news/2269595/posts

“You Lie!” The American Health Care Debate

In my lifetime no domestic issue has raised more rancor in America than the debate raging over health care. Representative Joe Wilson’s outburst has been repeated over and over by both sides, from the capitol to my own dinner table, as we wrestle with what may be the seminal issue of the Obama presidency’s first year. So, is government-funded health care just one more Unfunded Liability? Let’s take a look.

Support for the Senate version of health care reform got a boost this month when the CBO, in a letter from Director Douglas Elmendorf to Senator Max Baucus, said, “…enacting the Chairman’s mark, as amended, would result in a net reduction in federal budget deficits of $81 billion over the 2010-2019 period.” [1]

The “Chairman’s mark” of the America’s Healthy Future Act is a marked up version of the proposed legislation that came out of the Senate Committee on Finance.[2] It is not the legislation. As Director Elmendorf’s letter states, “…analysis is preliminary in large part because the Chairman’s mark, as amended, has not yet been embodied in legislative language.”

Payment for reform comes from two sources: new revenue and cost savings in existing government funded programs. So as I thought about how to approach an analysis it occurred to me there are two steps: The first is to look at the line items to see who pays and the second is to ask the question of how likely these items, if passed, will survive and generate the revenue or savings envisioned. At the very least the analysis provides a baseline from which to track the legislation to see what passes and what doesn’t and to monitor its performance over time.

The cost for the proposal is broken down into the following three categories: Medicaid and Children’s Health Insurance Program (CHIP), insurance exchange subsidies, and tax credits for small employers. The total estimated cost is $829 billion. Cost offsets (revenue) in the form of additional taxes amount to $311 billion and are divided into these four categories: a tax on high premium insurance plans, penalty payments by uninsured individuals, penalty payments by non-offering employers, and tax revenue from the expansion of insurance. Two thirds of the revenue (or $201 billion) is tax on premium plans. How likely are those plans, once the rules are set, to be modified to avoid some or all of the tax? Beware the law of unintended consequences. Nevertheless the net result still leaves a half trillion dollar hole.



Now we look at the intangibles

Of the total $420 billion in savings $404 billion comes from reductions in direct spending, or in other words, savings on existing government outlays. There are 19 categories and multiple sub categories. I will focus on the largest.

Excluding the Medicare Improvement Fund, which I will address later, I see these five major categories: (1) savings from reduction in direct benefits under current programs; (2) reductions in payments to health care providers; (3) savings in payments to drug companies; (4) reductions in payments to health care facilities primarily hospitals; (5) and modification of current plans.

Figures in Billions of Dollars
1. Reduced benefits..........................................................$ 18.8
2. Reduced payments to health care providers.....................$ 73.7
3. Reduced payments to drug companies............................$ 28.6
4. Reduced payments to health care facilities.......................$168.4
5. Modification of Medicare Advantage (Part C)..................$117.4

Benefit reductions are accomplished by means testing and raising co-payments on higher earning individuals. Savings pertaining to payments to health care providers are made by reducing and/or capping the growth of payments to doctors and other providers. Reductions in payments to drug companies are accomplished by switching to generics. Reduced payments to facilities come from a significant shift from emergency room use to other facilities, presumably primary care providers. The last savings is a modification of a current program called Medicare Advantage that has resulted in significantly higher delivery costs than Medicare A and B. Medicare Advantage lets a beneficiary shift the administration of Medicare to other plan providers such as Health Maintenance Organizations (HMO), Preferred Provider Organizations (PPO), Private Fee-for-Service Plans (PFFS), Special Needs Plans (SNP) and Medical Savings Account Plans (MSA).

While there is little doubt the expense side of the ledger will survive, one must question the revenue side. As pointed out earlier none of the proposals are in legislative language. We can only imagine the depth of lobbying going on. We can also imagine a world where the legislation actually passes as envisioned. What are the consequences? For example if we drain $168.4 billion of revenue from the hospitals in this country, how many will survive? With shorter patents on drugs and reduced cash flow to drug companies how much capital will flow into innovation? And how likely is sapping doctors, nurses, hospice care providers and homecare providers of $73.7 billion in income to promote better care and service if in fact it happens? As we shall see shortly, for the doctors it won’t.

But the real question in my mind is this: can the government execute? For example, in the past, cuts scheduled in fee-for-service to physicians have been routinely overridden by congress. From the 2009 annual report for the trust funds of Medicare parts A and B, “Congressional overrides of scheduled physician fee reductions…could jeopardize Part B (payments for doctor visits) solvency… Part B costs have been increasing rapidly, having averaged 7.8 percent annual growth over the last 5 years, and are likely to continue doing so. Under current law, an average annual growth rate of 5.5 percent is projected for the next 5 years. This rate is unrealistically constrained due to multiple years of physician fee reductions that would occur under current law, including a scheduled reduction of 21.5 percent for 2010. If Congress continues to override these reductions, as they have for 2003 through 2009, the Part B growth rate would instead average roughly 8.5 to 9.0 percent.”[3] To watch Secretary Giethner’s press conference releasing the report click here.

So what did Congress do? The answer is sleight of hand. $22.2 billion, 5% of the “savings” in the current legislation, are from funds scheduled to be spent between 2014 and 2019 from the Medicare Improvement Fund.[4] They were actually moved to a budget resolution for Fiscal Year 2010 and increased to a whopping $285 billion overriding past and future reductions in one fell swoop. So the way the current bill became “deficit neutral” was to actually authorize a quarter of a trillion dollars of Medicare spending that will occur during the years the bill covers but keep it out of the bill.[5] Where is Joe Wilson when we need him?

The last item I will address is the Medicare Commission. From Director Elmendorf’s letter to Senator Baucus, “The projected longer-term savings for the proposal also assume that the Medicare Commission is relatively effective in reducing costs—beyond the reductions that would be achieved by other aspects of the proposal—to meet the targets specified in the legislation. The long-term budgetary impact could be quite different if those provisions were ultimately changed or not fully implemented. (If those changes arose from future legislation, CBO would estimate their costs when that legislation was being considered by the Congress.)” The Medicare Improvement Fund[6] was created by Congress in 1999 with complete implementation by 2003 with three objectives:

• the design of a premium support system,
• improvements to the current Medicare program, and
• financing and solvency of the Medicare program

So can the government execute? Can we trust Congress to pass the legislation they are proposing without bowing to pressure from lobbies? Even if passed will Congress avoid tinkering either with the level of benefits or the adjustments in compensation? All evidence suggests the answer is no. Each year we continue to add one unfunded liability to another. The most dangerous four words in the English language be it investing or government spending are, “This time is different.” Albert Einstein defined insanity as, “Doing the same thing over and over again expecting different results.”

But the most frightening result of this is that if it succeeds at all levels it is only deficit-neutral. With an unfunded liability of $107 trillion in the current Social Security and Medicare[7] can we afford to just spin our wheels?
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[1]http://www.cbo.gov/ftpdocs/106xx/doc10642/10-7-Baucus_letter.pdf
[2]http://thehealthcarevalueblog.com/files/2009/09/Health-Care-Reform-Mark-Document-FINAL.pdf
[3]http://www.cms.hhs.gov/ReportsTrustFunds/downloads/tr2009.pdf
[4]http://www.ssa.gov/OP_Home/ssact/title18/1898.htm
[5]http://www.healthreformmusings.com/2009/03/articles/cost-of-health-care/medicare-physician-fix-may-result-in-more-fundamental-reform/
[6]http://www.ssa.gov/OP_Home/ssact/title18/1898.htm
[7]http://www.freerepublic.com/focus/news/2269595/posts

Subsidized Housing; America's Iceberg

Friday’s issue of the New York Times has an article about the pending problems with the Federal Housing Administration (FHA).(1) For those of you who read this blog that is old news. But it is just the tip of the housing iceberg. The real danger lies within the Government Sponsored Enterprises (GSEs).

The Federal National Mortgage Association was part of the FHA until 1968 when, under mounting budget pressures brought on by his policy of “guns and butter,” President Lyndon Johnson privatized Fannie Mae taking it off the federal government’s balance sheet. Unfortunately he didn’t disconnect it from the government’s guarantee. Two years later the Federal Home Loan Mortgage Corporation, later known as Freddie Mac, was formed to “compete” with Fannie Mae. Both became public companies and were two of the largest companies in the Fortune 500.

Initially both GSEs operated like great big savings and loans borrowing from the public and purchasing mortgages for their portfolios. In addition to the implied government guarantee the GSEs were exempt from state and federal income tax and, unlike any other companies in the Fortune 500, were not required to report potential financial difficulties in their annual filings. In the early 1980s Fannie Mae faced bankruptcy because of a mismatch between assets and liabilities and a surge in foreclosures. Losing $1 million a day, by 1983 its net worth had fallen below zero. But the government came to the rescue and under an accounting change sponsored by then President Regan, both Fannie and Freddie were able to capitalize the losses on their portfolio loans, some worth only seventy cents on the dollar, sell the loans as mortgage backed securities and amortize the loss over the next 20 to 30 years. This policy, called “forbearance” allowed the lenders to operate with negative net worth. Fannie president David Maxwell increased lending standards and moved the portfolio into adjustable loans to reduce the sensitivity to short term borrowing costs.(2) The sensitivity between assets and liabilities improved as both GSEs extended the maturities by issuing longer term debt and securitizing and selling many of their loans. As the yield curve steepened Fannie recovered but the same fate that befell Fannie Mae hit the savings and loan industry leading to the failure of over 740 institutions at a cost to the taxpayer of $124 billion.(3)

Not content to let the mere subsidization of housing rest with the benefits already bestowed on Fannie and Freddie successive congresses and administrations pressed their own agendas on the agencies. The profits of Fannie and Freddie were ripe for use as subsidies to the under-served segment of the market, the euphemism for low to moderate income home buyers. The Federal Home Loan Mortgage Corporation Act updated Freddie’s charter in 2005, “to provide ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities)…”(4) Much of this subsidy was provided to bring in the very borrowers who today cannot afford the homes they were encouraged to buy.

And then came the Great Panic of 2008. With the future financing of the GSEs very much in doubt the Bush administration released a proposal that would temporarily authorize the Department of the Treasury to purchase $100 billion each, up from $2.25 billion, of Fannie Mae and Freddie Mac obligations. At the time the CBO estimated the chance of this occurring at less than 50% and “that the expected value of the federal budgetary cost from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.” The CBO assigned only a 5% probability the price tag would reach $100 billion between them. On September 7, 2008 Fannie Mae and Freddie Mac became wards of the U. S Government. At the end of March, 2008 the combined portfolio of mortgage loans and guarantees of the GSEs stood at $5.2 trillion(5) and by July 2009 the bailout was fast approaching that $100 billion mark. Mortgage analyst Bose George of Keefe, Bruyette & Woods said, “We’re assuming they each will cross the $100 billion mark fairly soon.”(6)

Today the picture is only bleaker. Losses continue to mount. Renegotiated loans are re-defaulting at a rate in excess of 50%(7) and the default rate on the current portfolio is approaching 10%. On September 9, 2009 the Congressional Research Service released a report entitled “Options to Restructure Fannie Mae and Freddie Mac”.(8) The table below from that report shows that total taxpayer support for Fannie and Freddie now stands at $1.058 trillion dollars.



In a recent interview Rep. Barney Frank (D-Mass.) responding to a question of becoming Secretary of Housing and Urban Development said, “I want at least two years with President Obama and a solidly Democratic Senate so that we can get the federal government back in the housing business.” With the government insuring 90% of current home loan activity I am having a real tough time finding what’s left for the government to "get...back in..."

And see the debt ticker to the right of this blog? Add the $5.2 trillion of debt guaranteed by the GSEs that isn’t yet shown on the government’s balance sheet. Including the GSEs government debt now stands at a mind-boggling 122% of GDP. There are only three countries in the world with a higher percentage; Lebanon, Japan and Zimbabwe.(9) I wonder which one we are aspiring to?
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(1) http://www.nytimes.com/2009/10/09/business/09fha.html?_r=1&th&emc=th
(2) “Getting Fannie Mae in Shape” NY Times, December 26, 1985
(3) http://en.wikipedia.org/wiki/Savings_and_loan_crisis
(4) Federal Home Loan Mortgage Corporation Act, 12 U.S.C. Sec. 1451 Note. Sec. 301(b)3.
(5) CBO Report to the Committee on the Budget, U. S. House of Representatives by Peter R. Orszag, CBO Director, July 22, 2008
(6) http://money.cnn.com/2009/07/22/news/companies/fannie_freddie_bailout/
(7) http://finance.yahoo.com/news/Homeowners-in-financial-apf-1726904164.html?x=0&sec=topStories&pos=6&asset=&ccode
(8) Options to Restructure Fannie Mae and Freddie Mac, N. Eric Weiss, September 9, 2009
(9) https://www.cia.gov/library/publications/the-world-factbook/rankorder/2186rank.html