No More Detroits: The Philadelphia Public Bank Solution

Saturday, October 12 / 8:30 AMThe Arch Street United Methodist Church

50 North Broad St.Philadelphia, PA

Using Existing Government Funding to create a Public Bank in Philadelphia

Presented By: Scott Baker

SSBAKER305@YAHOO.COM

What is a Comprehensive Annual Financial Report (CAFR)?

It is not the “Budget.” A "Budget Report" is a selective funding of x accounts from y resources - set up to be primarily

funded with taxation and done for the year. An ”Comprehensive Annual Financial Report" is the showing of all income: Investment,

Taxation, and Enterprise, plus the accumulated wealth over decades. Budgets are for the year, a CAFR is for it all since creation of the government entity.

There is a big difference between the two. A correct analogy would be: The annual budget to operate your house vs. your statement of net worth.

Every Government entity has a CAFR – there are ~184,000* of them, totaling 10s of trillions of dollars, almost all online.

CAFRs describe the assets of government agencies and pensions. Note, due to GAAP, and especially due to some recent “standardizing” rule changes, CAFRs tend to project future liabilities years, even decades, out, while offsetting them only with current assets and revenue projections based on current receipts. This leads to a false deficit projection. It’s as if you were expected to pay your entire 30-year mortgage with only the assets you have now and the income you will have based on your current level of income (…and sometimes not even that!)

• CAFR sources: http://www.phila.gov/investor/CAFR.html and http://www.phila.gov/investor/Financial_Reports.html

* As of 2007: http://cafr1.com

How is money raised for Philadelphia currently, besides taxes and investments? The city issues Bonds.

Types of City Issued Debt (http://www.phila.gov/investor/Homepage.html)

The debt program managed by the City includes general obligation debt, lease and contract debt issued by related authorities,* debt of the Water and Sewer and Aviation Departments, and debt of the Philadelphia Gas Works (PGW). Debt of the Pennsylvania Intergovernmental Cooperation Authority (PICA), School District of Philadelphia (SDP), and the Philadelphia Parking Authority (PPA) is managed independently. Types of debt managed by the City include the following:

General Obligation DebtThe City can issue general obligation debt, backed by the full faith, credit and taxing power of the City, subject to voter approval and subject to adherence to the Commonwealth Constitution…. 

Contract and Lease DebtIn addition to general obligation debt, the City issues tax-supported obligations through the use of its related authorities….

Revenue BondsThe City oversees the issuance of revenue bonds for the Water and Sewer Department, the Aviation Department, and Philadelphia Gas Works (PGW).

* Related authorities include 8 separate entities we will discuss later

Philadelphia Bonds, rated by Moody’s, Standard & Poor’s, and Fitch (page 23):

The City is subject to a statutory limitation established by the Commonwealth of Pennsylvania as to the amount of tax supported general obligation debt it may issue. The limitation is equal to 13% of the average assessed valuations of properties over the past ten years. As of June 30, 2012 the legal debt limit was $1.622b. There is $1.543b of outstanding tax supported debt leaving a legal debt margin of $79.8m.

Philadelphia is paying 2% to 5% interest on bonds for credit it could create itself from a Public Bank that pays the city dividends.

If the city can issue debt (bonds), why can’t it deposit tax dollars in a public bank?

Bond Type Moody’s Investor Service

Standard & Poor’s

Corporation Fitch IBCA

General Obligation Bonds

A2 BBB+ A-

Water Revenue Bonds A1 A A+

Aviation Revenue Bonds A2 A+ A

We are NOT interested in changing fund uses, we are interested in changing fund investments.

In fact, we are trying to preserve the ability for government agencies and pensions to cover their

expenses in the future.

Can investments in a Public Bank be more:Prudent and safe?Counter-cyclical?Able to provide consistent returns?Supportive of the local community/job-creation?Fiduciarily responsible?

Note: Although money will be used throughout the year, this usage is predictable and the remainder can form the deposit base for making loans from a Public Bank until then. (this is how North Dakota does it with the Bank of North Dakota).

The real question is: Is this strategy safer and better, for reasons listed above, than current investment strategies?

Philadelphia CAFR Investment holdings – as of June, 2012

(not including 8 separately reporting agencies)

Breakdown by investment type on CAFR – page 47: (amounts in thousands)                                                                                                                                                                      

Classifications  Fair Value % of Total

Corporate Equities 1,745,706 27.29%

Corporate Bonds 900,314 14.07%

U.S. Government Agency Securities 863,478 13.50%

Miscellaneous - Limited Partnership 739,073 11.55%

U.S. Government Securities    720,264 11.26%

Other Bonds and Investments 421,599 6.59%

Mutual Funds  361,789 5.66%

Commercial Paper  309,068 4.83%

Short-Term Investment Pools 257,360 4.02%

Collateralized Mortgage Obligations 52,973 0.83%

Financial Agreement 21,047 0.33%

Certificate of Deposit 5,000 0.08%

Total    $6,397,670 100.00%

Partial Breakdown of Pension Fund Investments. What kinds of risks are there?

2 Examples:

• Equity Securities subject to Foreign Currency Risk (in thousands of USD) – page 49

Currency Fair ValueEuro Currency 135,856 22.14%Japanese Yen 87,656 14.28%Pound Sterling 97,963 15.96%Australian Dollar 22,324 3.64%All Others 269,861 43.98%Total: $613,660 100.00%

• Broker-Dealer Repayment Risk: “Statutes permit the Municipal Pension Fund to lend its securities to broker-dealers and other entities with a simultaneous agreement to return the collateral for the same securities in the future. The Pension Fund has contracted with a third-party securities lending agent to lend the Pension fund’s securities portfolio. The agent lends securities of the type on loan at June 30, 2012 for collateral in the form of cash or other securities at 102% of the loaned securities market value plus accrued interest. The collateral for the loans is maintained at greater than 100%. Securities on loan as of June 30 are unclassified with regards to custodial credit risk.” Securities of securities – it’s risk, squared!

What about hedge funds? Is investing in hedge funds safe and prudent?

Discussion from the minutes of a June 27, 2013 meeting of the Board of Pensions and Retirement Investment Committee (emphasis added):

Agenda Item #2 – Additional Capital Recommendation – Mason Capital Management (the pension's chief investment officer) Mr. Handa stated that Staff and Cliffwater are recommending additional allocation to Mason Capital, to bring the total allocation up to $50,000,000. Mr. Handa said they believe it is between $26,000,000 and $27,000,000 million will be added but are not sure and that is why the recommendation is up to $50,000,000. They have invested with Mason Capital almost four years and the returns over that period of time have been very good. The performance from 2013 has been extraordinary. The hedge fund has made money on both sides, long and short. At the end of May they were up 13%. In 2012 they were down when the market went up.(Chairman & Director of Finance) Mr. Dubow asked Mr. Handa how they were doing this month.Mr. Handa said he spoke with Michael Martino on Tuesday. Mr. Martino said they were doing fine and would not give specific numbers. Over a four year period they’ve done very well for us. Over the last six plus months the results have been fairly consistent.Mr. Dubow asked Mr. Handa how does this fit in our asset allocation.

Mr. Dubow wanted to know where the funding would come from.Mr. Handa said the funding would come from domestic equity, where we are currently over allocated at 28%. Mr. Handa said it would come from the S & P 500. We have approximately a little fewer than 6.9% of our portfolio in the S & P 500. One of the reasons why the plan has done well is because of our over allocation to domestic equity.

Mr. Albert made a motion to allocate up to $50 million to Mason Capital. (Trustee) Mr. Stagliano seconded it. There was no discussion. All were in favor. There were no oppositions or abstentions. The motion passed.

To Recap:1. Invest in funds based on past performance, even though this is no guarantee of future

performance.

2. Invest in hedge funds that go both long and short, even though most of them never beat the S&P, and they charge high fees. (During the FY 2012 being discussed, the pension fund returned 12.8%, while the S&P was up over 20%).

3. Assent to motions without discussion to remain “team players.” (Groupthink)

4. Above all, don’t invest in anything that might help the local community!

Swell.  I feel safer already, don't you?

From the Philadelphia Inquirer: Philly Deals: Hedge fund loses money for Pa.*

“A hedge fund based on New York's Park Avenue that failed to deliver the profits that Pennsylvania's state pension system had been counting on has decided to cut its losses and shut down - even after the state begged it to try again.

The Pennsylvania State Employees' Retirement System (SERS) gave New York-based Tiger Management $250 million in 2012, expecting Tiger's genius investors would generate 8 to 12 percent annual profits. That would be $20 million to $30 million a year, without the usual up-and-down volatility of stock investments.

* http://www.philly.com/philly/business/20131006_PhillyDeals__Hedge_fund_loses_money_for_Pa__pension__then_closes.html

But instead of performing to hype, Tiger's custom-built Tiger Keystone Partners portfolio lost $1 million in its first year. One of Tiger's managers bet on gold, which fell, more than wiping out the profits its other managers made from the rising stock market…The system has about $26 billion invested, more than $17 billion short of its target if it is to keep paying all the pensions it owes. It can't afford losses.”

Tiger lost money in a year (2012) when the S&P rose by 13%. Most S&P index funds charge <0.2%

What about the safest kinds of investments?

Breakdown of Non-Pension City Fund Investments (in thousands)

City investments in U.S. Government Securities or Corporate Bonds <1 year: $ 159,819 1-3 years: $1,705,906Total: $1,865,725

“The City’s policy to limit credit risks is to invest in US Government securities (11.26%) or US Government Agency obligations (13.50%). The US Government Agency obligations must be rated AAA by Standard & Poor’s Corp or Aaa by Moody’s Investor Services.” – page 48

Question: Could an investment of some of these funds in a Public Bank meet the city’s ratings policy for safety?

Standard & Poor's (S&P) maintained Bank of North Dakota's (BND) credit ratings in its latest review of the Bank released July 23, 2013. Its long-term issuer credit rating remained "AA-" and its short-term issuer credit rating to "A-1+” - http://banknd.nd.gov/financials_and_compliance/credit_rating.html

Proper risk analysis should include more than that for the BND and should account for the community banks.  North Dakota has not had a bank failure in over 20 years, while nationwide, there have been 517 through the end of Sept, 2013, since 2000, says the cash-strapped FDIC which has to pick up the pieces: http://www.fdic.gov/bank/individual/failed/banklist.html

The 2012 Philadelphia CAFR lists 8 Philadelphia Agencies With Separate Investment Portfolios, reported apart from

the financial information presented for the primary government (page 12), in thousands (page 36):

Government Entity Total assets, excluding capital

Philadelphia Gas Works $708,391

Philadelphia Redevelopment Authority $196,491

Philadelphia Parking Authority $171,747

School District of Philadelphia $635,492

Community College of Philadelphia $63,537

Community Behavioral Health, Inc. $88,792

Delaware River Waterfront Corporation $11,913

Philadelphia Authority for Industrial Development

$125,644

Total $2,001,997

Additional Investment Sources in CAFR 2012In thousands. Capital Assets not listed

Governmental Funds - Page 26

Assets Governmental Activities & Business Type Activities

8 Agency Component Units

Cash on Deposit and on Hand 82,679 310,248

Equity in Pooled Cash and Investments 0 40,022

Equity in Treasurer's Account 927,436 0

Investments 109,377 112,841

Due from Component Units 69,246 0

Due from Primary Government 0 69,617

Amounts Held by Fiscal Agent 56,965 109,544

Notes Receivable - Net 0 34,324

Accounts Receivable - Net 490,998 335,973

Interest and Dividends Receivable 1,440 20,438

Due from Other Governments - Net 459,647 113,670

Inventories 47,316 118,398

Other Assets 4,295 215,406

Deferred Outflow - Derivative Instruments 144,229 0

Restricted Assets: Cash and Cash Equivalents 241,769 211,148

Restricted Assets: Other Assets 862,766 310,368

Totals $3,498,164 $2,001,997

Total of Governmental Activities & Business Type Activities + Component Units = $5,500,161

Additional Investment Pools in CAFR 2012 (continued)

In thousands - Capital Assets not listed

Enterprise Funds + Non-major Gov. Fund + Combining Statement of Fiduciary Net Assets: $6,941,785

Gov’t Activities/Business Type Activities + Component Units (previous page): $5,500,161Grand Total of Governmental/Bus Activities, Enterprise Funds, and Fiduciary Assets: $12,441,946

Note: Asset classes have various restrictions, penalties, and other factors affecting reallocation strategies using a Public Bank. What are these and how easy is it to change them?

Enterprise Funds: Water & Sewer, Aviation, Industrial & Commercial Development – page 31 Totals

Current Assets (includes $195,634 in Equity in Treasurer’s Account) $381,811

Deferred Outflow – Derivative Instruments, Non-Current Assets (Restricted) (includes $862,766 in Treasurer’s Account)

$1,104,535

Combining Statement of Fiduciary Assets - Page 126 Totals

Gas Works Retirement Reserve Fund Total $445,868

Municipal Pension Fund Total $4,590,877

Non-major governmental fund (Combined) – page 123 Totals

Debt Service, Capital Improvement, Permanent Funds Total $418,694

Management fees for pension Investments

Standard fund management fees – there are >100 investment managers paid by the pension board! Are there too many cooks?

Broker fees or trading costs

Reporting fees to JP Morgan for “City of Philadelphia Municipal Pension Fund Excess Return Report” that lists pension fund returns.

What other fees are there? Hedge fund 2 and 20? – 2% for “showing up” and 20% of any profits? Fund expenses? Fees states pay for withdrawing from certain hedge funds?

Community banks

Dividends

(Interest)

A typical Megabank like JP Morgan has just a 31% Loan to Asset ratio – less than ½ of what ND’s community banks have. Large banks don’t make many loans!

Learning from the example of the Bank of North Dakota

Standard & Poor's (S&P) maintained Bank of North Dakota's (BND) credit ratings in its latest review of the Bank released July 23, 2013. Its long-term issuer credit rating remained "AA-" and its short-term issuer credit rating to "A-1+” - http://banknd.nd.gov/financials_and_compliance/credit_rating.html

Proper risk analysis should include more than that for the Public Bank itself.  North Dakota has not had a bank failure in over 20 years, while there have been 517 bank failures through the end of Sept, 2013 nationwide since 2000, says the cash-strapped FDIC which has to pick up the pieces: http://www.fdic.gov/bank/individual/failed/banklist.html

What about “key man” risk? What is the risk of key executives leaving and what does that portend for the safety of the bank? Maybe this is an over-rated fear. While Jamie Dimon makes millions running JP Morgan Chase, the president of the Bank of North Dakota – a Civil Servant - makes less than $300 thousand a year. Which is the safer, better-run bank? Well, JP Morgan recently paid over a billion dollars in fines related to multiple government agency Civil violations (not criminal…so far). The BND has never been found guilty of securities or bank fraud.

What are we paying for?

Detroit, MI and Stockton, CA are in bankruptcy proceedings. Funding and outlays from pensions and agencies will be cut, yet their CAFRs contain billions.

See Detroit is Not Broke: http://www.opednews.com/articles/Detroit-is-Not-Broke-by-Scott-Baker-130805-986.html

22 States* are considering some form of State Banking Legislation – and many municipalities are too. Many of these proposals look to fund a Public Bank with CAFR funds.

• By law, all taxes from North Dakota and the Chickasaw Indian Nation Banc2 in Oklahoma, go first to the Public Banks.

Other Municipalities are Investigating alternate CAFR Investment strategies

Existing Public Banks in Green:North Dakota: Bank of North DakotaOklahoma: Chickasaw-owned Bank2 of Oklahoma City.

Is it a better fiscal solution for Philadelphia to reallocate some CAFR Funds into a Public Bank?

* http://www.nytimes.com/roomfordebate/2013/10/01/should-states-operate-public-banks/many-states-see-the-potential-of-public-banking - citing National Conference of State Legislatures

The biggest banks are now even bigger than ever.

Are they still Too Big To Fail…or will they actually Fail next time?

The operations of the TBTF banks have been compared to a Casino, but this is unfair…to Casinos! In a Casino, you have consistent rules, and if you go bust, you don’t get bailed out, you get thrown out.