Cities borrow to strengthen pension funds

• Cities issue bonds to fill gap between how much money a pension fund has compared with its ability to meet current and future obligations
• Oakland%2C Calif.%2C is believed to have issued the first pension obligation bond in 1985
• Researchers found cities in the greatest fiscal stress turned out to be the ones most likely to issue the bonds

Despite what finance experts say is a significant risk, cities across the nation continue to borrow money to bolster their employee retirement accounts.

Nashville was the latest to consider such a move, but Mayor Karl Dean's administration withdrew the proposal last week after intense criticism.

The city had considered borrowing $200 million to help reduce nearly $400 million of unfunded liability in its pension plan.

Earlier this year, Franklin, Tenn., agreed to issue $10 million in bonds to invest in the city's pension fund.

Elsewhere:

The Connecticut towns of Hamden and Stratford agreed this year to borrow up to $125 million and $220 million, respectively, to shore up pension plans.

Portsmouth, Va., this year borrowed nearly $170 million to help fund pension plans.

Fort Lauderdale issued $337 million in bonds last year to cover $400 million of unfunded liability in two separate retirement funds.

Oakland, the city believed to have issued the first pension obligation bond in 1985, again used them last year to pump more than $200 million into the city's retirement account for police and firefighters.

Critics say borrowing money to invest in pension funds is risky and point to cities where the deals have gone bad and helped contribute to major financial difficulties — including municipal bankruptcy.

Stockton, Calif., is among the most high-profile examples. The city borrowed money to shore up its retirement account, only to see significant investment losses.

Pension funds took a beating in the stock market during the Great Recession, and combined with increasing numbers of retirees — and in some cases, extra benefits given during boom years — have seen their unfunded liabilities grow.

That's the difference between how much money a pension fund has compared with its ability to meet current obligations and future promises to employees.

To reduce that gap, cities from coast to coast have borrowed. But issuing what are called pension obligation bonds carries significant risk, and finance experts warn cities not to enter into the deals lightly. The Chicago-based Government Finance Officers Association has cautioned cities on their use.

"It is a quick fix," said Jeffrey Esser, the association's executive director. "It is viewed as less painful than making the hard choices to fund a pension plan."

Those tough choices include raising taxes and cutting city services to pay more into retirement accounts.

Borrowing money to bolster a pension fund works like this: A city issues bonds, locks in a favorable interest rate, invests the proceeds with the rest of its retirement funds and banks on investment returns exceeding the financing costs.

Plans haven't always worked out. In a 2010 report, the Center for Retirement Research at Boston College found that after the recent financial crisis, most pension obligation bonds issued since 1992 were in the red.

The bonds, researchers found, could prove useful if a city were in a strong financial position and able to shoulder the risk without hurting its fiscal health.

But cities in the greatest fiscal stress turned out to be the ones most likely to issue the bonds, the researchers found.

In 2007, Stockton issued $125 million in bonds to help cover a pension shortfall. It invested them with the California Public Employees Retirement System, the nation's largest public pension fund.

But the system saw big losses during the recession, and the value of Stockton's investment dropped to less than $100 million.

Yet, the city was still on the hook to bondholders for the full amount, plus interest.

The deal and other bond obligations were significant factors in the city's decision to seek Chapter 9 bankruptcy protection.

Pension bonds put "the burden of payoff onto the next generation," said Marcia Fritz, executive director of the California Foundation for Fiscal Responsibility, a group that has tried to rein in lavish pension plans through reforms in a state that has been at the forefront of the issue.

"All of that money is going to go into the stock market, and it is subject to the whims of the stock market," she said. "I thought these pension bonds had gone the way of the dinosaurs."

Gang also reports for The Tennessean in Nashville