As in, iceberg dead ahead!

Lemer/Farb/Roberts assessment of City of Houston Finances (22 October 2009)

Bob Lemer has become known as a bit of a “disaster monger”, and has been about as welcome as a global warming skeptic at a Greenpeace convention. Unfortunately, he’s also correct, and he’s not pulling his punches.

The City of Houston is financially broke and it appears that the mayor who takes office in January 2010 may have to captain the City through bankruptcy procedures.

Well if that ain’t telling it like it is.

Ok, here is my non-accountant read on it: Yes, if we honestly ‘fess up to what the (out of date and UNaudited) books say, we are flat broke. As in, we have a negative net value. That’s not the same thing as bankruptcy though, and while he confuses the point deliberately, I think he’s doing it in good faith. Bob and his co-signers, Aubrey M. Farb and Tom Roberts, are trying desperately to turn the Titanic before we hit the iceberg.

I recommend the full read above, but if Accountant Math makes your head hurt, you may want to skim at least the first half. If that’s too hard for you, I have highlights for the really attention-impaired, presented somewhat out of order, below the fold.

15. Giving the other current elected City officials the benefit of possible lack of knowledge of the existence of the audited annual CAFR, or at least a lack of ability to understand the CAFR, one can see where their focus has been upon the annual budget and the monthly financial and operations report (MFOR).

I challenge anyone who hasn’t met a Cthuloid entity up close and personal to understand the CAFR. I dug through several years of them once and discovered an interesting fact. No two controllers do them alike They don’t even include the same data from each department.

16. The financial picture presented by the 2008 CAFR is greatly more severe than the picture painted by the City’s annual budgets and the MFOR. That is because the annual budgets and the MFOR are prepared based upon the modified accrual basis of accounting (essentially cash basis) prescribed by the accounting oversight body for governmental entities, while the CAFR is prepared on the full accrual basis of accounting used in the private sector, wherein all incurred assets and liabilities are accrued and recorded.

“B-b-but gubbermint accounting is different!” Yes that’s true. You can get away with a lot more lies using government accounting. But your string eventually runs out.

1. The City incurred operating losses (“Change In Net Assets”) totaling approximately $1.5 billion for the five fiscal years ended 6/30/08— per the latest (fiscal year 2008) publicly available audited Comprehensive Annual Financial Report (CAFR), page 199.

But we got a lot of bikeways and and art deco for that. And I hear we got a really splendid lobby at a sewer plant.

3. The $1.2 billion deficiency in unrestricted assets as of June 30, 2008 (which was created essentially during fiscal years 2004-2008-see item 1) was basically financed, per page 15 of the 2008 CAFR, by (deleted long list of financial shell games)

What is a “deficiency in unrestricted assets?”

In other words, the City’s unrestricted assets were approximately $1.2 billion less than the already recorded liabilities that they will be required to satisfy.

In other words, if you sold the city off today at face value, you couldn’t raise enough money to pay its debts.

5. The City’s deficiency in unrestricted assets is so severe that in their yet to be completed audit for fiscal year 2009 the City’s independent auditors apparently will have to address the audit reporting issue as to whether the City was a “going concern” as of June 30, 2009.

In other words, not only has the string pretty much run out, the city is out of string. If my checks stop going to the bank, I’m going to be more than concerned. But I bet Mckinsey gets paid.

6. Apparently the City has no idea yet as to what its operating loss (“change in net assets”) was for the fiscal year just ended June 30, 2009 or what its deficiency in unrestricted assets was at June 30, 2009, and has no idea as to what is in store fiscally for fiscal year 2010. …the CAFR cannot be completed until the (nearly always very substantial) annual audit adjustments are booked.

Have I ever mentioned how much I hate SAP? What’s funny (in a decidedly non-humorous meaning of the word) is how much ITD Director Richard Lewis will have contributed to the city’s bankruptcy.

7. In recent years, the City has been taking up to almost a year to issue its annual CAFR. See Exhibit A. In comparison, the SEC requires that large publicly-held companies, who normally have worldwide operations and much more complex operating and financial reporting problems than the City, to file their annual complex SEC reports within 75 days after fiscal year end.

Well, yeah, but they’re not run by politicians. We elect a controller separate from the Mayor to keep a tight rein on the finances. And this one DID NOT DO THE JOB. I guess that makes her the Carol Alvarado of Houston finances.

What scares me is that I still (barely) think she’d make the best mayor out of the three major candidates. That says something about the current field, people.

8. The annual delays in issuing the CAFR are due to material weaknesses in internal control (over the City’s financial accounting and reporting system) that are so severe that the City’s independent auditors have been issuing professionally required special warning letters thereon for the last few years. The auditors finally discontinued even bothering to test the City’s system of internal control relative to the last completed annual audit (fiscal year 2008).

And where was the city’s “Newspaper of Record” while all this was going on, hm?

9. The city controller advised city council in an open meeting in January 2007 that the internal control weaknesses delaying completion of the fiscal year 2006 CAFR “appear to be due to a lack of basic accounting knowledge at the departmental level—.”

You get what you pay for, Bob. You aren’t paying for much…

In a meeting Mr. Lemer had with her, the city controller advised him that City civil service requirements prohibited terminating those inadequate employees and thus they would have to be retrained. It seems obvious that one or more of the following situations exist: (a) the existing job specifications were inadequate; (b) the employees in question did not meet the job specifications when hired; (c) the employees in question did not tell the truth on their applications, in which case they should be fired; (d) incompetent management and supervision exists at the departmental level and perhaps all the way to the mayoral level.

Ok, one of my favorite issues. “Stupid city employees!” Pardon the detour.

The answer is (e)Both (a) and (d), with the occasional case of (c), and a whole lot of (f) SAP. I cannot stress this enough. Any CTO that recommends his company use SAP should be terminated on the spot. Yes, it’s a wonderfully powerful program, able to do so much. But it gains that power at the cost of hideous complexity. Listen to me folks, you CANNOT turn people who got mediocre grades in high school loose on an interface designed by and for German engineers. The Germans don’t spend SQUAT on making their program interfaces clean and usable. They love complexity for its own sake.

I hate bashing my fellow employees, but given that an entry level accounting clerk makes less than… well see for yourself. Straight from the City’s HR website:

Job code 341.1 Account Clerk Pay Grade 10 Salary $20,800

And this is who’s going to be punching buttons on that SAP interface. (Fellow employees: I’m sorry guys, I know you’re probably cursing SAP almost as hard as you’re cursing me right now but this has to be said.) When an employer pays jack and offers little advancement for the employees, but has good benefits, it will get a particular kind of applicant. People who are on average, described as “slow but steady.” Not really imaginative, not innovative, but well suited to exciting days of chasing numbers down through reports and entering them into little electronic boxes attached to viewscreens. And it works; it keeps the city running, but that’s just not who you hand a complex, powerful program to that doesn’t act like every other program you’ve trained them on.

The controller’s comments pertained to the fiscal year 2006 CAFR. Yet the City still continued to receive annual “material weaknesses in internal control” letters through the latest (fiscal year 2008) completed and publicly reported upon audit.

Reiterate: The CAFR was produced just fine before 2006. SAP was introduced in 2006. Coincidence? Hell no. Did I mention that Richard Lewis should be fired for recommending SAP? I think I did by inference. Oh, he’ll point to his date of tenure as ITD director and try to escape it. Don’t be fooled. By the way, have you tried to pay your water bill online lately? I heard they might have fixed the problem today…

… as of June 30, 2008, the City’s elected officials essentially had transferred financial ownership of the City from the taxpayers to the City’s employees, about 43.7% of who do not live in the City, according to documentation we have received from the City’s human resources department. Very troubling, 63.3% of first responders (police officers and firefighters) do not live in the City, versus just 30.0% of civilian employees, according to the City’s human resources department

I have so many possible responses to that, just pick the one that you like best:

• So? Does that mean anything?
• Heh. So what do we know that you don’t?
• Wait, so if I get a job with the City, I have to move there? Who’s paying my moving expenses?
• Wait, I already work there. Is that not hell enough, you want me to live in Houston too?
• Police and firefighters who make squat can get in on city programs to buy houses inside the city. The civilian employees are left in the cold. You think that accounts for the difference?
• Shut up Bob, it’s just a cheap shot and you know it. I’m not moving from my subdivision with the part-time contract deputy that takes up the majority of our association’s budget, just to make you happy.

I know which one I like.

I think this has gone on long enough, and I’m letting myself get derailed. I do strongly recommend that everyone read item #21, which discusses what I’ve said before: Mayor White did not fix the pension mess, he only delayed the reckoning.

Will the city go bankrupt in a few months? I give it a 5-10% chance of happening. No more than that. Bob Lemer and his compadres are being a bit alarmist. In a good cause — they’re absolutely right that we’re facing a disaster, but the reason they’re doing this is that there’s still a little time to avoid it. We need to put our house in order NOW, or all hell is going to break loose.

My call? I don’t think it will happen. More likely, disaster will be held off for a couple of years, maybe as much as five or ten. I’m thinking 2014 most probable, or 2021 at the outside. (That’s just two mayors away folks, so choose wisely!) The bondholders don’t want a bankruptcy, so they’ll try to pretend everything’s ok, and keep propping up an increasingly unstable house of cards, while mayor after mayor piles on the debt and stupidity until the whole thing falls apart. As long as they can maintain the cash to pay current bills, the city will remain “a going concern.” Businesses on the way to failure can operate at a negative net worth for months or years. Hell, GM did it. It’s when the payments on the debt become so great that the city has to make a choice between paying salaries or paying the debt that it will end. The term, ladies and gentlemen, is default.

And when it happens, the repercussions are going to be nightmarish. You’ll think every bank and company failure until then was nothing.

Why? From a few months ago, when I wrote, quoting Ms. Parker herself:

The controller noted that financing through other governmental entities is one alternative that has been employed successfully. For example, she said the city has purchased the debt of (loaned money to) city governmental partners at Metro and Harris County. Likewise, Harris County and Metro have purchased city debt.

City invests in own debt

Parker said the city’s own investment portfolio holds about $229 million in city debt, made possible because the city maintains segregated funds. Interest rates in the municipal bond market have varied widely. By investing in its own debt, the controller said the city earns 1.5-2%. An earlier purchase of $30 million of Metro debt yielded about 4%, and investment in Harris County Flood Control debt returned 6.25-8%. In comparison, more traditional financing options are yielding less than 1%.

Elsewhere, she mentions casting as far and wide as Florida for investment (and borrowing) opportunities. This has become the norm in the last year or two; governments borrowing from each other.

Meaning when any one of them defaults, it’s going to have a ripple effect. The size of Houston and its debt means taxpayers across the nation could be affected by a city of Houston default. Especially if it triggers other debt calls (like happened to Metro), and therefore yet more defaults, which puts more pressure on the remaining creditors…