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Sunday, August 31, 2003 || Contact Us || Terms of Service

Pittsburgh Tribune-Review
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Guest column

Pittsburgh's pickle

 


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By Robert P. Strauss
Sunday, August 31, 2003

Pittsburgh's current financial situation is very different from that of New York City's in the 1970s in several important respects. First, New York's debt was not insured, so the New York banks that helped finance the run-up in debt could argue with some legitimacy that New York's pending bankruptcy could cause them balance sheet problems.

Pittsburgh's debt is insured, so the risk of bankruptcy lies on the insurers. Of course, if the insurance is used, the city will not be able to credibly borrow again within the foreseeable future, and the bond market will then not only look askance at Pittsburgh's financial ingenuity that got them to use their bond insurance, but at all the other indebtedness that local governments, public authorities, and nonprofits have taken on to determine what may or may not be sustainable.

Using the bond insurance will mean the region gets a black eye in the bond market. Off-balance-sheet borrowing by other local governments and nonprofits, as they have with the Enron and World Com situations, and associated issues with accounting and financial reporting, will simply force a lot more attention from those who facilitate the lending of money in the bond market. That attention could easily reach others, including many prominent nonprofits, that have shown an affinity for off-balance sheet activities and raise borrowing costs.

Second, concerns that New York's bankruptcy would disrupt the national municipal bond market in the 1970s, and thereby justified public (i.e., federal) intervention, were somewhat plausible. Here, while Pittsburgh's direct debt and the indirect debt of its authorities and subsidiaries are not peanuts, their default is hardly going to disrupt Wall Street. The numbers are simply small, and the bond insurance will mitigate the immediate risk to others in the bond market.

This is not to say that local financial institutions are indifferent to what transpires. While I doubt Mellon and PNC hold much Pittsburgh debt, they pay city taxes and have a safe haven from paying other city taxes. Like all corporations, the local banks have a fiduciary obligation to their shareholders to pay as little tax as is legally permitted in order to make more profits for the shareholders. If they can't demonstrate that they do this diligence, they and their boards of directors can be sued by their shareholders, and this sort of thing happens. Why do you think the CEO of Mellon Bank was, at one point, running around Harrisburg trying to get an increase in the per-capita tax that would hit all workers in the city?

Third, the federal Securities and Exchange Commission was, upon New York's quasi default (the so-called 'moratorium' on payment of debt service), involved in determining whether or not the city's bond offer statements knowingly misled investors, and thus violated SEC Rule 10B-5b. So far as I know, the SEC has not made an investigation into the $14 million bond offering made this past May that was signed off on by Pittsburgh Controller Tom Flaherty and city Finance Director Ellen McLean.

Should Pittsburgh default, or the SEC take a pre-emptive interest in this offering, it might find that the offering and subsequent admissions by the controller that the city could run out of cash in November require some serious adult supervision of Pittsburgh's frolics in the national bond market. Whether this turn of events might affect the dynamics in Harrisburg is hard to predict.

Fourth, New York City did, and still has enormous political influence in Albany; New York's 7 million-plus people is easily a dominant force out of the state's 18 million population -- 38 percent to 40 percent between 1970 and 2000. Pittsburgh doesn't have such influence. Compare Pittsburgh's population of 310,000 out of 12 million statewide -- not even 5 percent. Even Philadelphia doesn't have New York's raw political leverage with its 1.3 million population, although both the governor and Speaker of the House from Philadelphia.

Further, New York's absolute and share of New York State's population has been growing over time, while Pittsburgh and Philadelphia's absolute and share of state population have been falling over time. New York was far better positioned to extract things from its state Legislature. Also, Pennsylvania has a more severe prohibition on the state taking on the indebtedness of its local governments than was the case in New York.

ACT 47 NO PANACEA

Unfortunately, the framework for state involvement in Pennsylvania's distressed municipalities (Act 47) doesn't inspire confidence that things will get turned around here quickly, let alone get turned around at all. It's not easy to be optimistic if one looks at Scranton or Philadelphia, both under receivership for over a decade, mired in debt, and operating under forms of receivership that seem to be high on politics and low on results.

Act 47 was not intended to be a strong form of state intervention for fiscally broken municipalities, and the Pennsylvania Intergovernmental Cooperation Act of 1991, specifically fashioned for Philadelphia, has not, in my judgment, served Philadelphia very well either. Having one or two major municipalities to play around with through such state-appointed review commissions may constitute a political win for the governor and legislators who get to appoint commission members; however, once 15 or 20 municipalities statewide fall under Act 47 in the next year or so, this kind of political win could turn into every state politician's nightmare. There is such a thing as too many outstretched hands and too much whining.

Anybody who has looked closely at Pittsburgh's financial situation and relevant state and federal laws, has to recognize that the city's debt service in relation to its budget is very high --actually extraordinary. Banks prohibit families from paying more than 25 percent of their income in mortgages, interest, and taxes. "Best practice" debt service for municipalities is supposed to be under 10 percent. Pittsburgh is at least 23 percent, and its per-capita debt is in the stratosphere. By both measures it is among the top 10 nationally, and right where New York City was when it was put under the Emergency Financial Control Board. (Note the title "Control" as contrasted with talk about " Review" board for Pittsburgh.)

Because of IRS restrictions on the frequency of refinancing, and because the City's bonds were issued without call provisions in the admitted $1.3 billion outstanding direct and immediately overlapping debt, the City can not itself take advantage of falling interest rates. Simple refinancing is not an option.

FOUR-PIECE PUZZLE

Pittsburgh's financial puzzle ultimately has four pieces:

  • Establishing and maintaining actual financial transparency

  • Increasing revenues

  • Cutting spending

  • Stretching out debt service or actually defaulting and triggering the insurance.

    Let me discuss the first three. (As yet I haven't figured out how Pittsburgh can do the fourth as it has to pay about $95 million a year in debt service for the next five years, up from $24 million annually in 1979 or 11 percent of the city's $213 million annual operation spending).

    The rush to Harrisburg for more revenue authority in June and July of this year -- before the 2002 audited financial statements come out later in August, and without much implementation of spending restraint or hard choices this year -- may turn out to be the first perceived cry of "Wolf." The political transparency of the first cry of Wolf really could make matters much worse for the city, I'm afraid. If there is a $60 million deficit, where is it? The fiscal admissions now involve using up a piggy bank of perhaps $39 million with no cash to spare for next year -- $39 million is different than $60 million. Unfortunately, the transparency of playing the police layoffs card is matched, in an odd way, by the fiscal opaqueness of the city's accounting procedures, and financial reporting practices.

    In the 1970s Congress insisted that New York get an accounting system that worked, and New York agreed to adhere to Generally Accepted Accounting Principles, or GAAP, in its accounting. Until New York's crisis, it was specifically exempted from New York state's requirement that localities follow GAAP. New York didn't want to do GAAP, but the Congress held firm. Public disclosure is a strong antidote to political and financial malfeasance, although it requires that those in the print and other media notice and make the information available.

    Pittsburgh, like all other municipalities in Pennsylvania, is not obligated by state law to follow GAAP. It just has to turn in a statistical report each year, and an independent audit to the Department of Community and Economic Development in Harrisburg. Its authorities really don't have to do much either. It really would be unfortunate if Pittsburgh were allowed to avoid meaningful financial accounting and disclosure rules the way Philadelphia has been allowed to when Philadelphia was no longer able to sell its notes in 1991.

    Now, Pittsburgh, in its daily operations, uses accrual accounting for revenues, which allows one to be unduly optimistic about what is coming in the door, and uses cash accounting for expenses, which allows it to play around with timing of what goes out the door to make the books look good. Couple that with its seven additional public authorities and their own subsidiary corporations, that function as unobservable checkbooks, the city is readily able to kite money back and forth to not only look good, but hide from financial bad news itself.

    Right now, the public has no effective right to know what is going on. I challenge anybody to get a copy of the most recent debt offering statement from the city finance director. Neither state nor local law obligates her to provide this information in a timely or complete manner.

    REDEFINING ROLES

    Achieving financial transparency will require, among other things, a meaningful redefinition of the city controller's responsibilities. Now, he keeps the books, OK's the writing of checks, and audits. It is axiomatic that one cannot be an independent auditor if one keeps the books and writes the checks. To remedy this requires an amendment to Pittsburgh's Home Rule Charter, and the creation in the city of its own controller, auditing and accounting staffs, and check-writing procedures. The elected city controller can then become truly independent and audit the city both in terms of its finances as well as its performance as a governmental unit.

    Also, the city's accounting system needs to be upgraded and the activities of all of its authorities consolidated properly. So, amending the Home Rule Charter should be positively viewed by Harrisburg, for it would be a positive political statement by the electorate that it wants to know more and participate more completely in the resurrection of the city from its financial ashes.

    Few would dispute that Pittsburgh's revenues are anemic, and that its tax-exempt property and vast number of commuters short-change the city's fisc. Certainly the city's giving up 10 percent of its annual real estate taxes for tax-increment financing deals now looks foolish, and makes this commuter wonder whether the time has yet come for me to help pay for this sort of irresponsibility without having any say in the matter.

    I hope readers still remember that the Pittsburgh wage tax was cut from 2 percent to 1 percent, and the extra 1 percent local sales tax, traded for the elimination of the personal property tax, was supposed to be a regional solution to at least some of Pittsburgh's financial problems caused by tax-exempt property and nonresident use of city services. Instead, those revenues have been devoted to stadium debt service, support of hidden economic development activities in something called the Pittsburgh Economic and Industrial Development Corporation, and some institutional support for the region's cultural assets.

    When our kids want more, I insist that they demonstrate they deserve it and demonstrably do something up front before they get it. I suggest before Harrisburg gives the city the authority to tax commuters -- who don't have the right to vote on how those monies get spent -- that the long list of promised spending cuts and management efficiencies be demonstrably in place.

    Further, I suggest that any new taxes on nonresidents be predicated on effected Home Rule Charter amendments that not only achieve the above financial transparency ideas along with significant budgetary reforms but also require that these new commuter taxes be contingent on the verifiable continuation of such transparency and standing of all taxpayers (including nonresidents) to both see the books and testify openly before City Council about how such monies get spent for operating and capital purposes. I'd go so far to make financial transparency -- the right to look and the right speak to City Council -- to be legislated "triggers" for the commuter tax that would turn off the commuter tax if some adult found that transparency was not occurring and commuters were not allowed to see the books and speak out about how the monies were being used.

    Moving from a strong mayor form of Home Rule to this form of financially transparent form of Home Rule will change the politics of the city and region for the better, and ensure that improved governance will occur. It also would be a better template than Act 47 or some sort of PICA-West for Harrisburg in dealing with what are rumored to be far more distressed municipalities in the next year or so.

    THE UNIONS

    With respect to the expenditure part of the puzzle, I think it's fair to say as a general proposition that Pennsylvania's public sector unions are far more in control of their employers' fates than are their private-sector counterparts. There has been very little public attention devoted to what they have won at the bargaining table and what they do for what they get paid. It's likely that sooner or later these matters, that affect the expenditure part of the puzzle, will have to be addressed in a substantial way.

    Whether or not reform in this area will occur is hard to predict. At the county level, the issue of work rules was never publicly discussed during the county Home Rule Charter debate. The new county government was not allowed to change, modernize, or reform its work rules for historical employees in any substantial way.

    Again, public disclosure is the best way to trade in lousy financial and labor practices and their lousy politics for responsible governance. The voluntary opening up of all current collective bargaining and pension agreements by the city's unions would be an important first step to avoiding constant state interference, and might go a long way toward solving the city's financial mess locally. Then, a simple and effective way to achieve lasting expenditure reform would be to insist that these new and subsequent collective-bargaining and pension agreements be approved by the electorate, and not just agreed to by the mayor behind closed doors.

    Even US Airways' pilots have had to deal with the economic realities of the marketplace. Will anyone start asking our public employees what universe they think they are operating in and make that discussion a truly public one? Or will it take bankruptcy to bring reality to the city and its employees?

    Robert P. Strauss is a professor of economics and public policy at Carnegie Mellon University.


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