September 27, 2006

San Diego and the SEC

San Diego is approaching the bitter end-game on its pension-fund scandal,
with the Securities and Exchange Commission expected to release its own
report on the city council's decade-long bender of overpromising benefits
and underfunding its pension fund. The SEC is likely to require the city's
government to take steps to ensure that the fiasco isn't repeated, allowing
it to re-enter the municipal-bond market.

But the nightmare won't end there for San Diego taxpayers, who are left
holding the bag for the misfeasance of the city council. For them, two big
issues remain: Will the extravagant promises to city employees be honored
without regard to their cost or the improprieties involved in making those
promises? Second, will the city council be held accountable for creating
this mess?

Michael Aguirre, the pugnacious city attorney, has brought suit in federal
court to have some of the benefits granted since 1996 rolled back on grounds
that they violated federal conflict-of-interest laws. A self-described
liberal Democrat, Mr. Aguirre deserves kudos for risking the wrath of the
public-sector unions, but his prospects for success are uncertain.

If he loses, reining in the liabilities will become a matter of negotiation
with the unions. Good luck with that. A victory, on the other hand, would
send a signal that unfunded promises for public-sector employees are not
etched in stone, which would be a valuable signal for other state and local
governments grappling with extravagant retirement packages for public
employees. As Mr. Aguirre points out, current retirees "are drawing 100
cents on the dollar from a pension fund that is only 60% funded." If this
were a private company, creditors would demand a haircut for those lucky
few. But it's a municipal government, so they're getting away with it.

The city council is another matter. Four of its current members were
identified by name as "negligent" in the report on San Diego finances issued
by former SEC Chairman Arthur Levitt last month: Toni Atkins, James
Madaffer, Brian Maienshein and Council President Scott Peters. Mr. Aguirre
argues that Mr. Levitt didn't go far enough, and contends that the council
members may be criminally culpable for ratcheting up pension benefits and
intentionally withholding legally required contributions to the fund to pay
for those benefits.

Both men would like to see those council members called to account, but the
mechanism for doing so is less than clear. The SEC seems to be taking the
position that it has little authority to discipline local politicians, and
it may have a point. But San Diego needs access to the capital markets to
issue bonds, and this gives the SEC a lever. At the moment, according to

those who have reviewed the SEC's draft order, the pension underfunding is
described as something that happened, not something that specific people
caused to happen through deliberate acts. "They don't name names and that's
wrong," Mr. Levitt told us. "These actions didn't occur by themselves."

Fingering the council members would at least offer a small measure of
personal accountability. The SEC is justifiably wary of taking unprecedented
steps against a local government, but the present system offers no
enforcement mechanism at all against local politicians who have put their
taxpayers on the hook for over $1 billion in unfunded liabilities.
Identifying the culprits would at least signal that this sort of dereliction
is as serious when it occurs at a public institution as it would be if it
had happened at a private company.

San Diego's pension fund is now underfunded by some $1.5 billion, or about
30%. And its liabilities will grow by 8% a year for the foreseeable future,
so it will take a great deal of money in addition to some stellar investment
performance if San Diego is ever to climb out of the hole its city council
has dug. Mr. Aguirre estimates that his lawsuit could reduce that liability
by $500 million, but that still leaves a chasm in the budget. At the moment,
30% of San Diego's budget is going toward retirement benefits, a figure that
could rise to 40% over time. Fingering the guilty is the first step back
toward honest local government.