PERA’s Pension Obligation Bonds Are a Bad Idea


This is an extended version of the OpEd that appeared in the Greeley Tribune.

Last week, Colorado legislators considered – and rejected – a plan of dubious legality to shore up the state’s public pensions.

The result of a difficult three-way negotiation among Governor Hickenlooper, Treasurer Stapleton, and PERA, the plan would have circumvented the state Constitution’s limits against issuing general obligation debt without a vote of the people, for gains that would have been largely illusory.

Worse, the changes could have encouraged future legislatures to repeat mistakes that put teachers’ and state employees’ retirements at risk in the first place, while making real reforms more difficult.

HB15-1388 would have authorized the State Treasurer to direct the Colorado Housing and Finance Authority (CHFA) to issue up to $10 billion in bonds on the state’s credit. The proceeds would have been deposited into PERA’s State and School funds, and invested with the rest of PERA’s assets. The investment returns theoretically would shorten PERA’s time to full funding.

The bonds’ interest was to be funded by the supplemental payments that the state and school districts pay into PERA (the AED and SAED), with PERA paying back the principal when the bonds matured.  The AED and SAED payments are taxpayer contributions established in 2004 and 2006 to stabilize PERA’s finances.  They are escalating percentages of employee salaries.

The complex web of relationships was needed to avoid state constitutional limits on issuing debt. The bill’s language laid out the legal arguments for why the restrictions didn’t apply. Supporters claimed they were revenue bonds that would not obligate general tax dollars, and purported that CHFA is not a state agency.

Passing the buck to the courts, HB 1388 would have required a binding judicial ruling certifying the scheme’s legality before the bonds could have been issued.

Make no mistake: The debt would have been on the state’s credit, and shown up on the state’s balance sheet. These are not revenue bonds; they would have been funded only by general tax revenue.

Whether or not the game of hide-the-pea satisfied the courts, it violated the spirit and purpose of constitutional provisions designed to prevent the legislature from indebting citizens into a long-term fiscal bind. The many state bankruptcies of the 1840s were still fresh in the people’s minds in 1876, when the Constitution was drafted. Those concerns are no less valid now.

The bonds wouldn’t have shown up in PERA’s financial report, except in the footnotes. With no single, authoritative document laying out the full financial picture associated with funding the state’s public pensions, PERA would look better-funded than it was.

Risk-averse legislators could have justified avoiding the difficult decisions needed to provide real retirement security for Colorado’s teachers and state employees. Future legislatures might have been tempted to repeat the mistakes that put that security at risk in the first place. While a full legal analysis awaits, tying the AED and the SAED explicitly to a bonded debt might have complicated any attempts at more sustainable reform.

A comprehensive study by the Center for Retirement Research found that the misuse and mistiming of pension obligation bonds have punished numerous states and municipalities over the last 20 years. The Government Finance Officers Association recommends against their use.

To their credit, the bill’s architects studied past failures and tried to mitigate the risks to Colorado and its schools. The annual interest on the bonds could have been no larger than two-thirds of each year’s anticipated AED and SAED, with a minimum 2 percent spread between the bond interest rate and PERA’s anticipated rate of return. Statutory contributions to PERA – inadequate though they are – would have remained intact, and bond proceeds would have been unavailable for diversion to other spending.

Still, the deal entailed significant risk. Proponents misleadingly argued that it refinanced 7.5 percent debt at 4.5 percent. In an actual refinance, the original obligation is paid off. Here, the pension obligation would have remained, with Colorado taking on additional debt.

Even PERA’s claim that its current debt should be discounted at 7.5 percent is based on an accounting gimmick only available to US public pensions – and no other pensions in the world.  (Not coincidentally, without the discipline of correct accounting, US public pensions are also the worst-funded public pensions in the world.)

As contractual promises, they should be discounted at the same interest rate as the bonds.  PERA would just be adding 4.5 percent debt to the true 4.5 percent debt of its current contractual obligations, improving its situation only marginally.

The proposal’s safeguards would not have changed the fact that proponents were seeking to close the funding gap by taking on additional debt and risk.

While the governor and the treasurer are to be credited for taking PERA’s underfunding seriously, HB 1388 was the wrong answer to the problem.