Fall From Frugality Puts San Diego on Fiscal Brink

A city once known for good management has a pension plan more than $1 billion in the red.

By Tony Perry
Times Staff Writer

September 1, 2004

SAN DIEGO — Somewhere in tax-fighting heaven, Howard Jarvis must be spinning.

The city that the late sponsor of Proposition 13 once extolled as nonpareil in its stewardship of public money ("If all cities were run as well as San Diego, we wouldn't need Proposition 13") is now caught in a financial crisis of colossal proportions.

Not one caused just by a downturn in the economy, although it has that feature. Not one caused just by a bad deal with a pro football team, although it has that, too.

Not even one caused mainly by a severe cutback in state support, although that's part of it as well.

No, San Diego's financial problem is largely of its own making. By underfunding its public employee pension program, the city is now so deeply in the red, critics assert, that without drastic action, pension payments will virtually suck the treasury dry.

Wall Street has lowered the city's bond rating. Moody's now rates the city's general obligation bonds at Aa3, the same as San Francisco and — embarrassingly for San Diego leaders — one level below Los Angeles. The lower rating potentially will pile on hundreds of millions of dollars in additional interest costs for building projects.

The city's pension program has an unfunded liability — a shortfall — of $1.157 billion and growing. Add the bill for medical care for retirees and the tab goes up another billion or so.

"San Diego is in a real mess," said Scott Barnett, former executive director of the San Diego County Taxpayers Assn. "All the bad financial news is coming together at the same time, and the city is facing a load of hurt."

When the booming stock market made the city's pension accounts flush, San Diego officials sweetened benefits for city workers. Then the market crashed and they were left with much less money in the bank and bigger bills coming due.

Lots of other California cities and counties have similar problems, but this is San Diego, where fiscal conservatism was thought to be the civic religion.

"We found that the emperor has no clothes," said Carl DeMaio, executive director of the San Diego-based Performance Institute, a Libertarian think tank, studying the city's budget and budgeting process.

The crisis arose quickly — one study points to 2000 as the key year — but could take decades to resolve even if the City Council is forced to make painful choices.

Among those possible steps — things that have long been considered anathema — are cutting pension benefits, borrowing a lot of money, trimming the payroll, privatizing some services, and telling residents that services are going to be reduced even though the city already has fewer police officers and firefighters than almost any comparably sized municipality in the nation.

Like the fellow who borrows money from the neighborhood loan shark, the city finds itself barely able to pay the weekly interest while the principle gets larger and larger and the threat of dire consequences grows.

The City Council this year opted to trim library hours, close swimming pools and essentially abandon the filling of potholes in the streets.

The scandal has blocked the city from refinancing bonds for Petco Park, the new downtown ballpark for the San Diego Padres — costing it millions in higher interest payments.

Securities and Exchange Commission regulators and the U.S. attorney's office are sniffing to see if someone should face charges for filing incomplete statements with Wall Street prior to the selling of bonds.

The pension board, which advises the City Council, has sued its counsel for allegedly providing inadequate advice. Two lawsuits were filed by retirees who fear the city will end up defaulting on pensions.

Officials who initially downplayed the crisis now admit that this year's problems could be only a faint taste of what may come.

Mayor Dick Murphy, a mild-mannered Republican now running for a second term, believes his critics are sensationalizing the issue.

"We have a pension situation that is a serious problem, but it is a problem that can be solved with some discipline," he said. "It's not a crisis; it's a problem, and we have a plan to deal with it."

In many ways, Murphy is reprising the role he played during last year's disastrous wildfires: offering reassurance to a panicky public that the city, though bloodied, will survive.

Still, the city's own pension reform committee has warned that only a "miracle" in the stock market will bail out the city unless drastic and politically combustible action is taken, including capping benefits for current retirees and reducing them for future pensioners.

Amid controversy, the two city officials closest to the budgeting and bond process — City Manager Michael Uberaga and City Auditor Ed Ryan — have quietly retired.

"It's an ugly, ugly situation," said Jack McGrory, former San Diego city manager and now executive director of a land development company.

In hopes of restoring the city's reputation with Wall Street, the council is paying $1 million to the KPMG accounting firm for an audit of the city's books and has hired a former SEC official to review the city's history of providing financial information to bond rating firms.

A pension reform committee has concluded that the city is caught in a "perfect storm" — but one of its own making.

In a draft of the committee's final report, a group of lawyers, pension experts and taxpayer advocates assembled by Murphy has concluded that three factors collided:

One was the City Council's decision to greatly increase benefits for retirees, making it possible for employees to retire earlier and with a higher percentage of their salary.

Second was a decision to reduce the amount the city contributes to the pension fund, which survives on interest on investments and on city contributions. For years the pension plan was 100% funded.

At 90%, Wall Street begins to get edgy. At 80%, analysts start to question the fiscal prudence of decision-makers. The city of San Diego's pension plan is now funded at less than 70%.

When the third factor — the stock market decline due to the bursting of the dot-com bubble — kicked in, the City Council initially failed to take action.

Far more than pensions in the private sector, public employee pensions are protected by state and federal law. Also, San Diego retirees have proven to be successful litigants when the pension board or City Council have done things that they see as a threat to their benefits.

Any attempt to roll back benefits would have angered the increasingly powerful public employee unions. Reducing city services to pump money into the pension fund would have brought the wrath of neighborhood groups. City Council members are elected by district; in habitually low-turnout elections, a few thousand votes can make or break a political career.

A number of business leaders see employee labor unions as the villains. Every current member of the City Council has enjoyed union support.

Union leaders dismiss the idea that avarice on the part of employees is driving the city to ruin.

They note that city employees do not qualify for Social Security and thus their pensions are their only reward for decades of service. City salaries, they insist, are low compared to other cities and to similar jobs in the private sector.

Indeed, a common budget tool for decades has been to freeze employee salaries. Also, promotions are slow in a city where the workforce is small compared with other cities and turnover is minimal.

Making matters worse, with a glut of baby-boomer workers nearing retirement, the City Council decided it needed to retain their expertise. So it devised the Deferred Retirement Option Plan, or DROP.

By delaying retirement by five years, an employee can receive both his salary and an early pension benefit. A portion of that pension benefit is put into an interest-earning account.

At the time of retirement, the employee can either take the money in a lump sum or let it ride to continue gathering interest. For most job categories, a worker with 30 years of service can retire with a pension of up to 90% of the final year's salary, along with annual cost-of-living increases and nearly fully covered health plans.

Pension board members estimate that the average city employee is eligible for a check of $306,104 upon retirement and a lifetime pension of $50,000 a year. The average pension has doubled in 10 years.

The pension committee has recommended dropping DROP and raising the average age of retirement from 55 to 62. Other critics want retirees to pay more for medical care.

"This is solvable, but it's going to be very painful," said April Boling, a certified public accountant who served as chairwoman of the pension reform committee.

So far, the City Council has put on the ballot only two of the less-controversial reform ideas: changing the membership of the pension board to dilute the impact of retirees, and banning future underfunding of the system but giving the city 15 years to clean up the current shortfall.

"These are not even a half-a-loaf — they're crumbs," snorts DeMaio of Propositions H and G on the Nov. 2 ballot.

County Supervisor Ron Roberts has made the city's financial problem a major issue in his run for mayor against Murphy, who defeated him handily four years ago. Murphy, Roberts notes, has been endorsed by the municipal employees union.

But the pension fund issue is incredibly complex and not easily made into a bumper sticker, unlike, for example, the city's controversial deal with the San Diego Chargers that required the city to pay for unsold tickets.

Roberts blasts Murphy for poor leadership and reneging on the fiscal legacy of their mentor, Pete Wilson, a fellow Republican who served as San Diego mayor from 1972 to 1983.

"San Diego is a very different city than it's been," Roberts said. "You'd have never seen this under Pete Wilson in the old days."
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