The city’s newly released long-term financial forecast is either a long-awaited remedy to San Diego’s dire straits, or a dangerous descent into more fiscal chaos.
For Mayor Dick Murphy, it’s a tool that will put his city back on the right track and prevent a repeat of the circumstances that produced a pension system plagued with a $1.37 billion deficit.
For Mitch Mitchell, the vice president of public policy and communications for the San Diego Regional Chamber of Commerce, the scenario will be “absolutely frightening” if the necessary concessions aren’t made so the numbers add up.
“It’s a chance to identify where our financial challenges are and come up with long-term solutions to those challenges, and looking at them on a long-term basis, not just trying to balance our budget year to year,” said Murphy, who, along with two financial advisers, recently sat down with the
San Diego Business Journal.
“It’s a very complicated document, and we wanted to explain how it will work.”
Filled with pages of charts and a myriad of numbers, the plan, scheduled to be presented to the San Diego City Council on April 18, is not meant to replace the budget process, said Murphy, but is designed as a foundation on which to base the 2006 budget deliberations that begin May 2, he said.
“We wanted to get this out while they’re still doing labor negotiations, so they’d know where we’re going in the next few years,” he said, “and pass this on to the credit rating agencies so they know we have a plan.”
Moody’s Investors Service and Fitch Ratings both downgraded the city in the last several months, while a third, Standard & Poor’s, out and out suspended the city’s rating in September.
Mitchell agreed that the ratings agencies “will be happy they are making an effort.”
“It’s a step in the right direction,” he said. But, he added, the long overdue 2003 and 2004 audits of the city’s finances will be the key to turning around San Diego’s image as a fiscally troubled city.
“The plan does a good job of basically telling people what to expect if they don’t get the concessions from labor, or they don’t find some way to get new revenue,” he said. “This is about 1.2 million people and their expectations about their quality of life.”
The problem, Mitchell said, will come if all the numbers don’t fall into place as expected.
“The plan, when you look at the numbers of what the situation could be if they don’t get concessions in all the areas they need to, the numbers are absolutely frightening and will lead to the degradation of the quality of life in the city of San Diego,” Mitchell said.
How the ratings agencies respond , or don’t respond , to the five-year forecast is anyone’s guess.
“This is a sign of good financial management,” said John Torell, San Diego’s auditor and comptroller. “This is what they’re looking for. It certainly won’t hurt us.”
Richard Vortmann, the president of National Steel and Shipbuilding Co., and former member of the San Diego City Employees’ Retirement System board, also served on the city’s Pension Reform Committee, which issued its report in September.
“One of the recommendations we made was the need for the city to adopt a formal and recurring process, a five- to 10-year plan as a basic management tool to prevent surprises from coming,” he said. “I am adamant in my belief that if they had done this, you would not have seen this mushrooming of the pension problem. It’s a good step forward and a critical component of any business. It’s a basic management tool used every day in the private sector. I think the rating agencies would look favorably on it.”
Paul Dyson, assistant director of S & P;’s San Francisco office, declined to speculate on what impact, if any, the city’s five-year plan would have on future credit ratings.
“We suspended the city’s rating back in September,” he said. “We’re not making any public comments until we reinstate the ratings.”
As for similar scenarios from the past, Dyson said, “It hasn’t come up. Suspensions are very rare.”
But, he said, initiatives such as San Diego’s five-year plan alone would not necessarily lead to an upgrading.
“Each case is treated on a case-by-case basis, and there are a number of factors considered the economy, finance, management and debt burden. It would be one factor. It’s not a negative, but whether or not it would improve the overall rating, it’s hard to say. It’s a committee process here. But anytime you get good projections and live up to them, it’s a good thing.”
Spokesmen for Fitch and Moody’s said that analysts couldn’t comment until they finished reviewing the document.
Good Case, Bad Case
The five-year forecast is broken down into two scenarios: the “base case,” which incorporates various solutions to close the gap between revenues and expenditures; and the “alternative scenario” , representing the status quo , resulting in recurring budget deficits, Murphy said.
The base case assumes a 3.2 percent reduction in salaries for fiscal 2006, followed by no change in salaries for 2007, with any increases in benefit costs being paid for by employees; and $24.6 million in service and employee cuts.
The alterative plan, with salary hikes in all years, produces a significant budget deficit in every year, with the mismatch in revenues and expenditures producing a cumulative deficit of $323 million.
“If we keep the status quo, we are running deficits every year,” Murphy said.
The more desirable scenario, he said, would result in “a surplus every year that we can then put into the pension system, in addition to what we’re already planning to put in.”
“If we follow this plan, the city is in sound financial condition,” he added.
Deputy City Manager Lisa Irvine explained that the initial model involves only the general fund, which “has the most fiscal challenges in it, specifically given the percentage of the general fund related to salaries, wages and the pension system.”
Added Murphy: “The water fund, the sewer fund, there’d be no financial problem, because we can increase your water bill. But the general fund relies on tax revenues, which is where we need to focus our attention.”
The model, said Irvine, will help the mayor and City Council make budgeting decisions.
“This will help us identify the long-term trends and opportunities in the city,” she said. “The numbers, I guarantee you, will be changing, depending on the assumptions you put in.”
The city worked with two financial consultants, Public Resources Advisory Group in Los Angeles and the Oakland-based Kelling, Northcross & Nobriga, to develop the plan.
“They looked at the best practices out there in the nation,” said Irvine, “and took the best of those and modeled a financial planning tool around those that were the most effective.”
Jack McGrory, who served as San Diego’s city manager from 1991 to 1997, and now is chief executive officer of Price Legacy Corp., recalls that he worked with five-year plans during his tenure and didn’t know why they stopped.
“It’s a significant step in the right direction,” he said. “The city has been ricocheting from year to year reacting to budget crises. It’s a long time coming for a long-term plan.”
McGrory said a major focus should be revenue generation.
“There are many areas where San Diego has lagged behind other cities in terms of revenues,” he said.
For revenue generation, on a per capita basis, San Diego is in the bottom of the 10 largest cities in California, he said, with the lowest tax load, and in the bottom 20 in terms of business taxes nationally.
He also pointed out that while other cities have utility taxes on water, sewer, telephone and cable TV, “San Diego has none. We are the last city in the state with free residential trash collection.”
McGrory says the five-year forecast will help with the ratings agencies, but the main issue remains completion of the 2003 and 2004 audits.
“The city’s financial integrity has been called into question because of the audits,” he said. “They can’t issue bonds or plan for the future. Everybody has to stop throwing mud on each other and get in a room and say we have to get these audits done.”
Stath Karras, the president and chief executive officer of Burnham Real Estate Services, said the challenge for the city will be to find financial solutions that are fair to employees without busting the budget, and at the same time send a positive message to the business world.
“My concern is that if the perspective from the outside looking in gets any worse, it will impact the interests of capital coming into the marketplace,” he said. “If that starts to happen, it becomes a more critical issue. We have to make sure we’re not sending a message out to business that San Diego is not a place they want to be.”
So far, Karras said, his business hasn’t been hurt by the city’s reputation as “Enron-by-the-Sea,” as San Diego was dubbed by the New York Times last year.
“Our business is largely dependent on economic activity and growth and, to the extent this is curtailed for any reason, it adversely impacts our business,” he said. “We’ve had good employment growth in the last several years and employment growth is what impacts our business the most, with the additional need for office, industrial, retail space.
“The last few years have been good for the industry, and San Diego was viewed as a good center for a variety of industries , biotech, communications and the military. We’ve seen a pretty vibrant leasing market. To the extent that issues with the city detract from employees choosing to come here, and capital getting concerned, you could start to reverse that trend. Nobody wants that. We don’t necessarily control our destiny in that regard. We have to respond to the market.”
April Boling, a certified public accountant in solo practice, is the former president of the San Diego County Taxpayers Association, former chairwoman of the city’s Pension Reform Committee, and currently chairs the San Diego Convention Center Corp.
“I think it’s going to depend in part on whether or not it is the city’s five-year plan or the mayor’s five-year plan,” said Boling, who made it clear that she is not speaking in any official capacity. “I believe that if the mayor and City Council are behind the plan, it will be seen in a positive way.”
She pointed out that her pension reform committee, as well as others in past years, has recommended a multiyear budgeting plan.
“That it took this many years to get there, hurray for them for getting there now,” she said. “It’s never too late.”
But, she cautioned, what the city needs is a plan to show how it is going to recover, not “just a model you poke numbers in.”
An example: The living wage ordinance, which would raise wages and offer benefits for employees who work for firms with city contracts, was approved by the City Council on April 12, with a two-year phase-in period beginning in 2006.
“If that is not in the plan, then we know the plan is deficient,” Boling said. “If the mayor and City Council jointly agree that this is our road map , how we are going to conduct ourselves over the next five years , then one week later, vote something that is not in the plan, this is an indication of how sincere they are about having a five-year road map.”
It also raises the issue of the plan’s impact on what she said is the City Council’s tendency to approve something today and let a future City Council deal with the political and financial fallout.
“It’s a phased-in plan and, in and of itself, it shows that they know there isn’t money to pay for it,” she said. “It’s what got the city into trouble before. You would think they would have learned. Some future City Council is not going to get the political pluses for enacting it, but will get the fiscal responsibility for attempting to implement it. It’s almost like child abuse. It keeps getting passed from generation to generation.
“There would be more fiscal integrity in the process if they had implemented this immediately and forced them to sit down and decide where the cuts would have to happen. Now a future council will have to make that decision.”
Said Mitchell: “She’s right. Future councils will be left to deal with how to pay for increased costs. It’s a dangerous situation, writing checks when you have no idea you can cover those checks. This is exactly what we are dealing with in the city of San Diego. The ‘hope for the best’ mentality isn’t enough these days. It’s about being certain. Wall Street or a president and CEO or a small-business owner, when they see a $50 million budget deficit, they hope to see an effort to reduce that deficit, not increase the deficit with the hope things will get better.”
According to Irvine, the ordinance will cost $3 million to $4 million in fiscal 2007, and about $5 million to $7 million in 2008. While these numbers haven’t yet been added to the five-year forecast, she said, “This might be another scenario we run to show what the impact might be. It’s less than 1 percent of the general fund.”
Carl DeMaio, the president of the Performance Institute, a San Diego-based government reform group, said that a five-year plan is a good sign.
“I’m glad they are doing this,” he said. “This is a good business practice and the start of something good. But I don’t put a lot of credibility in this. This is a city that has not been right on a financial forecast. How credible is the data presented here? Given that the past information on projections, the condition of funds, the expenditures expected, have been so out of whack with reality. I haven’t seen a change in the culture or the approach to see if they’ve fully moved away from the practices of the past. You have to show me and Wall Street and the public, demonstrate with evidence.”
DeMaio doubts the ratings agencies will be impressed.
“No, not at all,” he said. “Remember, this is the same city that, if you called them every year in the last five years, they would swear that you should take this lock, stock and barrel as completely accurate. There is no reason to request that kind of faith in the numbers coming out of City Hall. We are accepting numbers without asking for backup.”