Our Enron-Style Scandal

— The City of San Diego has admitted in official filings what its critics have been saying for months: unless it raises taxes or cuts city worker pension benefits, it will have to slash city services.

Bond market specialists who read the voluminous, deliberately obfuscated documents may well reach a stark conclusion: the city is admitting it is on or nearing the financial brink. The city has admitted to cooking the books since 1996.

The multiple admissions were made in filings on January 27 to the Municipal Securities Rulemaking Board, an obscure quasi-governmental body, and other repositories of information on municipal bonds.

The filings, signed by deputy city manager Patricia T. Frazier, correct so-called facts and interpretations that the city put in bond prospectuses beginning back in 1996, the year the city began deliberately underfunding pension contributions while raising workers' benefits. The current filings attempt to atone for sins committed in prospectuses for sewer and ballpark bonds and a host of others.

"Such filings are very rare and usually indicate financial difficulties," says Zane Mann, publisher of Palm Springs-based California Municipal Bond Advisor.

On Monday, the bond- rating agency Moody's Investors Service downgraded the city's financial outlook to negative from stable, saying, with a typical rating agency sugar pill, that it was only "somewhat" perturbed by the city's post-1996 finagling. Moody's also complained of San Diego's "modest-sized and declining reserves" -- a danger that the mayor's Blue Ribbon Committee earlier addressed in vain.

In the middle of one filing is a chart revealing that if the city contributed, on average, a staggering $199 million a year to its pension system between 2004 and 2011, the funded ratio would barely move up from a miserable 66.1 percent to 66.2 percent, while the actuarial liability would soar from $1.3 billion to $2.4 billion.

And amazingly, the footnotes indicate that these numbers are too optimistic. That horrific $2.4 billion number should be even higher.

Confesses the city on the following page, "As can be seen from the foregoing table, the magnitude of the annual pension plan payments to be made by the city may be increasing in the near future and, without new city revenues, or a reduction in the pension benefits payable by the city or other actions to enhance the funding ratio or reduce the (unfunded actuarial accrued liability), these payments may become difficult for the city to fund without reductions in other services."

The city took the voluntary filing step in response to a complaint by the pension fund whistle-blower, Diann Shipione, that the September prospectus for half a billion dollars in sewer bonds, since put on hold, used incorrect actuarial information and did not sufficiently recognize the massive retiree healthcare deficit. Both the pension and healthcare liabilities now exceed $1 billion.

"What this says is even if the city increases pension contributions by 400 percent in the next seven years, the system will still be well over 30 percent underfunded. and the debt will be $2.4 billion, and that isn't even including the healthcare liabilities," says Shipione. "It is hard to imagine a financial picture more bleak. The good news is the financial mischief is oozing out into the public view."

Michael Conger, the attorney handling a case against the city over pension matters, points out that in the past several years San Diego has been saying in bond prospectuses that the state requires the city to contribute to the pension system at rates determined by actuarial valuations. "They have been saying that to the investment community, but they haven't been doing that," says Conger, referring to the deliberate underfunding and concomitant boosts in benefits.

Why did the city suddenly 'fess up in the January 27 filings? "I think some lawyer told them they'd better come clean or get ready to go to jail," says Conger. "This is an Enron-style municipal scandal."

Indeed, some people see similarities between the recent, sudden retirement of city auditor Ed Ryan with the earlier swift retirement of then-Enron chief executive Jeffrey Skilling.

"This is extremely serious," says councilmember Donna Frye, who has been warning her constituents of possible service cuts because the city does not have the money to fulfill its many promises. "A lot of things are not being disclosed to the public" -- or even to councilmembers such as herself.

The deliberate underfunding started when Jack McGrory was city manager in 1996 and was looking for ways to finance the Republican convention, among other things. The practice continued as councilmembers approved corporate-welfare schemes such as the ballpark and Naval Training Center conversion, promoted by nabobs lining the politicians' pockets. Despite the billowing deficit, the council agreed to continue the underfunding in 2002, Frye points out.

Says securities attorney Michael Aguirre, who is running for city attorney, "The investors who purchased the city's bonds have been quietly told more about the financial condition of the city of San Diego than the people of the city have been told."

The filing of opaque documents with a semicloistered regulatory body was clearly an attempt to make a mea maxima culpa into an abstruse and nearly inaudible mea minima culpa. But as in all inscrutable documents, the devil is in the details -- showing that city bureaucrats have horns, tails, and forked tongues.

Examples of deceit abound. The unfunded actuarial liability is being amortized over a 30-year period, with 19 years remaining. But in calculating its net pension obligation, the city used a 40-year amortization, thus understating that obligation, the documents confess.

As Shipione complained, past prospectuses have been saying that the city's actuary, in effect, approved of the underfunding. The city confesses that this was true in 1997, but not in 2002, when it was trumpeted in bond prospectuses.

The filings admit that, under the post-1996 underfunding plan, specified contribution rates "were below the rates of more conventional pension-funding-plan methods, which calculate annual contributions in accordance with the rates determined by a reporting actuary."

Says Shipione, "This is a clear acknowledgment that nobody manipulates their pension plan like San Diego."

Interestingly, one filing indicates that the city's wastewater system stopped the underfunding strategy in the middle of last year and is now funding its pension program in accordance with actuarial requirements. Several questions are obvious, but one stands out: was the city edging into honest funding because Wall Street was looking over its shoulders?

The city has an insurance benefit account for health benefits. It admits that if there are no further contributions to the account, it will be exhausted by the middle of next year.

Time and again in its January 27 filings, the city refers to "errors" made in previous prospectuses. Verily, if these can be defined as "errors," then "murder" can be defined as "overzealous application of zero population growth beliefs."

"Some of the errors are small things, and some are large things," says Shipione. "They suggest intentional perversion of the truth."

So what were some of the purported "errors"? Well, they include such things as misstating the actuary's position on underfunding; understating the net pension obligation by using a longer amortization period; incorrectly stating such things as interest rates, bond maturities, interest payable on bonds, and the amount of a line of credit; and violating conventional accounting standards.

The city admits it understated the total amount payable on operating leases for a 24-year period by $127.2 million.

Hardly surprisingly, "Most of the errors are in favor of inflating the assets and diminishing the liabilities," notes Shipione. "It is not comforting to look at a financial statement and see this level of problems. People say, 'How can we trust anything they say?' "

Throughout the documents, the city sheepishly admits to making a purported "error," and then adds, "Bah, humbug." The words, "This did not affect the actual financial statements, as such," are ubiquitous.

For example, the city admits to a net overstatement on prospective interest income of $26.2 million. But it "did not affect the financial statements, as such." Hmmm. The $127.2 million understatement of amount payable on operating leases (of which the general fund has responsibility for $72 million) "did not affect the financial statements, as such." Oh?

I confess I can't figure why these sums do not affect the financial statements. Maybe the "as such" verbiage is a hedge. I have consulted others, and they scratch their heads, too. The city's disingenuousness on its pension crisis requires the convening of a special grand jury.

Alas, my attempt to reach the city for explanation was, as usual, in vain.

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