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  1. 1. 10/7/13 No More Detroits: The Philadelphia Public Bank Solution Saturday, October 12 / 8:30 AM The Arch Street United Methodist Church 50 North Broad St. Philadelphia, PA Using Existing Government Funding to create a Public Bank in Philadelphia What is a Comprehensive Annual Financial Report (CAFR)? 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: and How is money raised for Philadelphia currently, besides taxes and investments? The city issues Bonds.   Types of City Issued Debt (   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 Debt The 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 Debt In addition to general obligation debt, the City issues tax-supported obligations through the use of its related authorities….   Revenue Bonds The City oversees the issuance of revenue bonds for the Water and Sewer Department, the Aviation Department, and Philadelphia Gas Works (PGW). * As of 2007: * Related authorities include 8 separate entities we will discuss later 1
  2. 2. 10/7/13 Philadelphia Bonds, rated by Moody’s, Standard & Poor’s, and Fitch (page 23): 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 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? 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 Partial Breakdown of Pension Fund Investments. What kinds of risks are there? 2 Examples: (not including 8 separately reporting agencies) Breakdown by investment type on CAFR – page 47: (amounts in thousands)                                                            Classifications                                                                                                           Corporate Equities       Fair Value % of Total 1,745,706 27.29% Corporate Bonds 900,314 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% •  14.07% Certificate of Deposit Total    5,000 0.08% $6,397,670 100.00% Equity Securities subject to Foreign Currency Risk (in thousands of USD) – page 50 Currency Fair Value Euro 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 thirdparty 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! This is as of the end of FY 2012, but we had a pretty good year in the markets since then, so the total is probably higher. 2
  3. 3. Hedge funds underperform. According to Matt Taibbi of Rolling Stone: “And 10/7/13 underperforming is likely. Even though hedge funds can and sometimes do post incredible numbers in the short-term – Loeb's Third Point notched a 41 percent gain for Rhode Island in 2010; the following year, it earned -0.54 percent. On Wall Street, people are beginning to clue in to the fact – spikes notwithstanding – that over time, hedge funds basically suck. In 2008, Warren Buffett famously placed a million-dollar bet with the heads of a New York hedge fund called Protégé Partners that the S&P 500 index fund – a neutral bet on the entire stock market, in other words – would outperform a portfolio of five hedge funds hand-picked by the geniuses at Protégé. What about hedge funds? Is investing in hedge funds safe and prudent? From the Philadelphia Inquirer: Philly Deals: Hedge fund loses money for Pa.* 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! “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. 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% * Swell.  I feel safer already, don't you? Do managed investments outperform benchmarks like the S&P? Well, maybe on a risk-adjusted basis, or maybe not. But not on an absolute basis, with strict comparisons. City of Philadelphia Board of Pensions and Retirement: 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: $1,705,906 Total: $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+” 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: Five years later, Buffett's zero-effort, pin-the-tail-on-the-stock-market portfolio is up 8.69 percent total. Protégé's numbers are comical in comparison; all those superminds came up with a 0.13 percent increase over five long years, meaning Buffett is beating the hedgies by nearly nine points without lifting a finger.” 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 Philadelphia Authority for Industrial Development Total $11,913 $125,644 $2,001,997 What does the repeated shutdown of the federal government (closed as of October 1, 2013….again) do to the ratings of Government Securities (Treasuries)? What about the impending debt ceiling October 17? Are Treasuries still really AAA or Aaa? Is anything? 3
  4. 4. 10/7/13 Additional Investment Sources in CAFR 2012 Additional Investment Pools in CAFR 2012 (continued) In thousands. Capital Assets not listed Governmental Funds - Page 26 Assets In thousands - Capital Assets not listed Governmental Activities & Business Type Activities Cash on Deposit and on Hand 8 Agency Component Units 82,679 310,248 0 40,022 927,436 Equity in Pooled Cash and Investments 0 Equity in Treasurer's Account 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 Interest and Dividends Receivable 34,324 490,998 Accounts Receivable - Net 335,973 1,440 Inventories 20,438 459,647 Due from Other Governments - Net 113,670 47,316 215,406 144,229 0 Current Assets (includes $195,634 in Equity in Treasurer’s Account) Deferred Outflow – Derivative Instruments, Non-Current Assets (Restricted) (includes $862,766 in Treasurer’s Account) Non-major governmental fund (Combined) – page 123 Debt Service, Capital Improvement, Permanent Funds Total Combining Statement of Fiduciary Assets - Page 126 Gas Works Retirement Reserve Fund Total Municipal Pension Fund Total Totals $381,811 $1,104,535 Totals $418,694 Totals $445,868 $4,590,877 118,398 4,295 Other Assets Enterprise Funds: Water & Sewer, Aviation, Industrial & Commercial Development – page 31 Deferred Outflow - Derivative Instruments Restricted Assets: Cash and Cash Equivalents 241,769 211,148 Restricted Assets: Other Assets 862,766 310,368 $3,498,164 $2,001,997 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): $5,500,161 Grand Total of Governmental/Bus Activities, Enterprise Funds, and Fiduciary Assets: $12,441,946 Totals Total of Governmental Activities & Business Type Activities + Component Units = $5,500,161 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? Capital Assets are not listed since they cannot be used to fund a public bank. I don’t mean to imply that money could simply be swapped from certain investments into a public bank. However, two of the biggest categories – Treasurer’s Accounts and Restricted Assets – are often highly liquid pools of cash and short-term investments, which could be reinvested elsewhere at will, or through a simple change in the law. 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 Why A Public Bank? “showing up” and 20% of any profits? Fund expenses? Fees states pay for withdrawing from certain hedge funds? 4
  5. 5. Banks with low levels of loans to assets, like JPMorgan Chase & Co. (JPM - Free 10/7/13 JPMorgan Stock Report), where loans are 31% of assets, have more diversified sources of revenue, including from investment banking and asset management. “It seems likely that larger, mostly out of state, banks were the big loan generators for the oil and gas exploration companies as they ramped up operations in the state; thus the effect on smaller, in-state banks (the BND’s target audience) was minimal.” Getting_To_Know_A_Bank_With_Financial_Ratios.aspx (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! Dividends Community banks Substitute “City” for “State” and add community banks in between City Bank and City Projects. Don’t forget community banks! In North Dakota, there hasn’t been a bank failure in over 20 years. Nationwide, there have been over 500 bank failures just since 2000 (FDIC). Public Banks support community banks! Which system is more risky? “CSI analysis shows that banks in North Dakota reduced lending 33%-45% less than comparable states, and we believe that this is in no small part due to the stabilizing effects of its state bank.” Center for State Innovation - State Bank Legislative Guide, pg. 59 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+” 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 cashstrapped FDIC which has to pick up the pieces: 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? Other Municipalities are Investigating alternate CAFR Investment strategies   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:   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. Existing Public Banks in Green: North Dakota: Bank of North Dakota Oklahoma: Chickasaw-owned Bank2 of Oklahoma City. Is it a better fiscal solution for Philadelphia to reallocate some CAFR Funds into a Public Bank? * - citing National Conference of State Legislatures 5
  6. 6. 10/7/13 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. Does anyone still believe the money center banks are a safe place to store the public’s money? From the Office of the Comptroller of the Currency: Just in case you have forgotten what kinds of things the TBTF banks were speculating upon…Note the multitrillion dollar notional value of derivatives of the top 8 banks trading in that space. Don’t forget to add 6 zeros. Source: Office of the Comptroller of the Currency, 2 qtr, 2012 report: derivatives-quarterly-report.html The TOTAL size of the Derivatives market? $1.2 Quadrillion: risk-quadrillion-derivatives-market-gdp/ Think about this the next time a large commercial bank says there’s no need for a Public Bank because they have “everything under control.” Where do you think the state’s money is safer? 6