Not too long ago, I did a presentation in Minneapolis for a group of people who work for ratings agencies evaluating municipal bonds and the cities that issue them. To say this group had never considered the information about structural insolvency that I presented them with would be an understatement; they seemed shocked by it and acknowledged that it was far outside of what they examine. I thought I was breaking through. But as we continued interacting during the session, I noticed that the audience slowly began bolstering each other’s confidence, using a common refrain that's become predictable among those who are paid to process debt.
I’ll summarize their internal narrative: Since the Great Depression, cities have rarely defaulted on their debts. Things that have rarely happened in the past will rarely happen in the future. Thus, until we start experiencing widespread municipal defaults, the assumption should be that cities will continue to make their debt payments. Granting them a high rating reflects that reality.
Of course, this is silly in so many ways. Things that rarely happen—for example, a nationwide simultaneous decline in housing prices—sometimes do happen anyway. But I don’t want to focus on the myopia. Ratings agencies are pretty clear about the limits of their methods, and no big-time bond trader is relying on them anyway.
What is more interesting is how governments like Cobb County use the ratings agencies as a stamp of approval for their policies—or, more to the point, a signal to constituents that all is well. In the 2017-2018 Biennial Budget Book for Cobb County, county officials refer to this credit rating at least twenty six times, such as this reference on page 58:
Cobb’s emphasis on long-range planning helps the county handle the challenges of decades-long growth, and now those related to recession and recovery. Cobb’s success in both the growth and recession periods was highlighted when the nation’s top three rating agencies again reconfirmed the county’s Triple AAA credit rating in August 2016. The Triple AAA credit rating is the highest grade possible.
That statement came under the heading, “Fiscal Conservatism and Transparency,” and the subheading, “Focus the county operating budget on funding high quality services, while maintaining the lowest possible taxes in the Metro Atlanta area.” Throughout the document, county officials continually referenced how their tax rate is comparatively very low, their services are high and, if you have doubts about their genius in pulling off that fundamental math problem, no need to look behind the curtain because the ratings agencies have given them the highest possible mark.
From page 20 of the Biennial Budget Book:
In August 2016, Cobb County's Triple AAA credit rating for the General Obligation Bonds was reconfirmed by all three rating agencies. Thus, the county has maintained its Triple AAA credit rating for the 20th consecutive year. The three rating agencies cited several factors that attributed to the county's renewed ratings. Those factors included the county's low property tax rates, low debt levels, financial management, fund balance reserve policy, diverse economy, a significant use of current resources for capital needs, and the practice of biennial budgeting.
Strong Towns readers already understand the hole in this proposition, but let’s state it clearly for people just discovering our conversation: There is no financial genius here and no magic trick of management that other municipalities haven't yet figured out. Cobb County has experienced decades of robust growth using a development pattern that provides local governments with immediate cash (read: usually debt) from new growth, in exchange for the long-term liability of agreeing to provide service and maintenance for all the stuff they build. Cobb County has been in what we call the Illusion of Wealth phase of the Growth Ponzi Scheme for a long time. But the bills are starting to come due and the county is going to increasingly struggle to keep up. It’s a story repeated all across the continent, especially the hubris involved.
One of the ways low-tax and high-service local governments pretend the laws of mathematics don't apply to them is the use of debt. Cobb County insists its debt rates are very low, that it limits its borrowing and prudently matches any debt to a revenue stream. But that's far from the truth.
General Obligation Debt
Cobb County has a limit on the amount of debt it can legally take on. The county considers the total size of the tax base and then suggests a total debt load of 10% of that amount. If a Cobb resident's home is worth half a million dollars, the suggestion is that the county could comfortably borrow $50,000 on their behalf without the rating agencies having much concern. (Note: The city you live in could be making the very same calculation. So could your school district. But who’s counting?)
By this standard, Cobb County reports extremely low debt levels: just $18.4 million on $31.2 billion in tax base. That’s less than 0.1%.
At Strong Towns, our recommendation is that debt service—not total debt amount, but the annual cost of servicing that debt—be based on the same percentage (10%) but of locally-produced revenue. For us, the danger for a community is not in having a high tax or a low tax approach; it’s the propensity to substitute debt for taxes when things get difficult. Grants, permit fees, fines and other one-time revenues are not cash streams a prudent government should back debt with. By focusing on the revenue produced locally by citizens agreeing to be taxed, we get a good picture of the actual level of local buy-in the city residents have (versus kicking the can down the road by continuing to borrow.)
Below is a summary of the Cobb County budget (page 128). I’ve put red arrows indicating the locally-produced revenue I would count towards a debt analysis, although I’ll note that some of the “Charges for Services” revenue might also be applicable if those are not discretionary services (revenue that will go away in tough times). I’ve also labeled their annual debt service with a red arrow.
Immediately, we can see that the annual debt service ($21 million) is greater than the total debt reported on page 145 ($18 million). It took me a while to discern that the cheerleading on page 145 (one could also use the word “propaganda”) referred to debt levels from way back in 2015. It’s pretty easy to understand why Cobb County would prefer to reference debt levels from three years ago; that was before the Atlanta Braves stadium deal added huge amounts of annual debt service to their budget.
By our calculations, Cobb County's debt service in 2018 is at 7.8% of locally-sourced revenue. That’s less than 10% and so within acceptable limits for a Strong Towns analysis, but all that is for just one big project that taxpayers will be servicing for decades. Cobb County has used nearly 80% of its debt capacity on a single stadium. Yikes!
Oh, but that’s actually quite misleading, because so far we’re only talking General Obligation debt. That’s only the proverbial tip of the debt iceberg.
One of the deep, dark secrets of public finance is the revenue bond. When Cobb County says it has no debt—or, obliquely, that it had little debt if you ignore the financing of the Braves stadium—it doesn’t mean that it has NO debt. It just means it has no general obligation debt. It has lots of other debt, of course.
Here’s how Cobb County defines the different types of debt in their Biennial Budget document (page 578 and 586):
General Obligation Bond (G.O. Bond): A certificate of debt issued by a government in which the payment of the original investment (plus interest) is guaranteed and secured by the full faith and credit of the government. Issuance of these bonds usually requires voter approval.
Revenue Bond: A certificate of debt issued by a government in which the payment of the original investment (plus interest) is guaranteed by specific revenues generated by the project financed.
Let me give an analogy: Say you are a college student and you get a loan for a new car and your parents have to co-sign for you to qualify. That’s like a general obligation bond. Now, say you get a student loan for living expenses and you pledge your future earnings as a doctor (or, if things don't work out, as a barista) against that loan. That’s more like a revenue bond.
And while general obligation bonds have a limit for Cobb County of 10% of the total tax base, the only limit on revenue bonds is the amount of future revenue one is willing to project and then pledge until the bond is repaid.
Local governments use revenue bonds all the time, with very little oversight, for all kinds of seemingly routine projects. They are perniciously intertwined with abuses of the assessment process and with gambling on new development.
For example, local governments will often finance the infrastructure for a new development—or for a road or interchange or traffic signal made necessary by that development—and then pledge a portion of the revenues from that new development for paying back that debt. Sometimes that revenue is a payment from the developer when the land is sold, but sometimes it is future sewer or water payments. There are all kinds of creative ways to do revenue bonds.
Governments like Cobb County's don’t count this as debt because, you know, the money to pay it back is dedicated from some other fund and it’s not a general fund obligation. There are two enormous things wrong with that.
First, and most obviously, if the revenue from some project is dedicated to covering debt, then what about all the other costs associated with that project—you know, the basic stuff that keeps your community running? Who pays for the police and fire protection? Who pays for the added demand on parks and roads and county staff? The result is an unaccounted subsidy from existing taxpayers to taxpayers in special projects, while staff gets squeezed and everybody gets mystified about why they are continually short of revenue.
Second, and most acutely, revenue bonds create all the wrong incentives for ongoing, negative public investments. For people outside of the system looking at a budget or an audit, these are nearly impossible to identify because of how they are reported. But some still crop up here and there.
For example, Cobb County has revenue bonds on a series of parking ramps they have constructed. They have pledged the revenue from the parking fees towards paying back this debt. However, what happens when that amount of revenue is insufficient to cover the debt? Because that's exactly what happened.
From page 168 of the Biennial Budget document:
Debt service requirements on the deck are growing slightly and the revenue is not enough to offset this growth; therefore, a subsidy from the General Fund has been required the past two fiscal years and this is budgeted to continue in both FY17 and FY18.
Where does a subsidy from the General Fund show up in the Budget document? It shows up in the expense category “Transfers Out.” I’ve highlighted that in yellow here. That amount in 2018 ($22.4 million) exceeds the total debt service ($21.0 million).
Some of these transfers may be innocuous (it’s impossible to tell due to the opacity of revenue bonds) but it’s clear that the 2015 report's suggestion that the county had almost no debt was far from the truth. Here's how the Budget Book defines interfund transfers/transfers out:
Interfund Transfers: This source represents approximately 8.7% of FY 2016 total budgeted revenues. Interfund Transfers represent revenue resulting from the transfer in of monies from another fund for various projects. (page 137)
So...how much debt is there? It’s impossible to say; the 594-page Cobb County Budget Book never details this important figure. Still, there are more hints here and there to its true extent.
For example, here’s the budget summary for something called the Six Flags Special Services District. Back in 2015 when Cobb County reported hardly any debt, they issued $10 million in revenue bonds to pay for redevelopment and infrastructure improvements around (one assumes) an amusement park. Taxes were raised within that district to cover the cost; thus, there was no need to account for that as real debt.
The same budget document is showing over $40 million in principal alone—not counting interest—to be paid over the next thirteen years on parking ramps (page 170).
The sewer and water portion of the budget suggests that development fees pay for “a portion” of these infrastructure facilities (page 184). Here is a handy chart showing that (despite Cobb County supposedly having very little debt) interest expenses have climbed dramatically on a loan for water infrastructure.
While the chart doesn’t show future cash flows beyond 2019, it does show cash flow staying constant (consistent with a low-taxes, high-service mantra) while interest expenses climb, and less and less principal is paid off each year. That's what we call kicking the can down the road. And when you start bringing on new debt to offset the interest, that's what we call a Ponzi scheme.
Gambling on Growth
Cobb County officials would surely respond to this revelation by advocating that the municipality invest in new growth. Who better to fund new growth, they might say, than the developers and property owners whose taxes will be paying off the revenue bonds?
But it shouldn't be that hard for this county to dig into its collective, recent memory in order to understand the fragile situation they're facing, and allow that knowledge to guide its future decisions with regard to debt.
We’re ten years—a full decade of growth—past the worst of the national housing crisis, but the Biennial Budget document still reflects on that situation with concern and seriousness (page 10):
The most significant challenge that faced this government in recent memory was the severe impact of the global recession and drastic decline of the real estate market since 2008. Between 2008 and 2013 the fair market value (FMV) of property in Cobb County decreased by a little over $12.5 billion. This equates to a decrease of about $5 billion in our gross property tax digest, or a $2.9 billion decrease in the net property tax digest. As a direct result, our property tax revenues declined as did many other revenues sources linked to the economic health of this region.
And more than just a decline in revenues, these impacts were painful for the people assembling this budget document. From the same section of the budget:
As a brief reminder, during these last few years several key measures were undertaken to successfully navigate through the difficult times faced by our community: strategic employee hiring freezes; four-year suspension of employee pay increases; employee early retirements; positions eliminated or under-filled; vacant positions unfunded or funded at lower percentages; employee unpaid-furlough days in 2011; and the reduction of health care costs to the county for employees and retirees with modifications to plans and coverage.
If Cobb County is able to recognize how detrimental the Great Recession was for their municipality, why can't they also recognize the financial decisions that steered them towards such a crisis?
The Budget Book indicates that property in Cobb County is presently worth $31.2 billion (page 145). A decade ago, an adjustment of $12.5 billion would have been catastrophic, particularly for a government that was relying on developers, assessed homeowners and special investment districts to cover revenue-based debt service.
But how is Cobb County choosing to make this math "work" today? By taking on more debt. Doubling down. Tripling down. They're following the "go big or go home" mentality, and hoping they can just grow their way out of the mess.
At Strong Towns, we have found that the ratio of private to public investment for any community should be greater than 20:1 in order to achieve stability, and a 40:1 ratio is an optimal target. Stated another way: So long as a community has a minimum of $20 of private property wealth for every $1 of total public capital investment, there is enough wealth to tax for a local government to maintain everything it builds.
With total wealth of $31.2 billion, Cobb County would be financially stable maintaining up to $1.6 billion in total public capital investment. They’re in way deeper than that, though. Way deeper. I’ll wager they are approaching a billion dollars just in current debt, not to mention all the miles of road, street, sidewalk, curb, pipes, buildings and playground equipment they have promised they will maintain (using only the money generated by those low, low taxes).
If Cobb County officials want to refute that contention, let them release—in a succinct and transparent way—the number that is conspicuously absent from their massive budgeting document: total debt. Not merely general obligations and internal transfers, but the total debt of the county in all its forms.
Like most local governments, pension obligations are an easy target for derision, especially in our current dysfunctional political atmosphere. Those right of center criticize the bloated level of benefits current taxpayers are paying to people who had—comparatively—more job security and often better compensation than most private-sector workers throughout their careers. Left-of-center thinkers focus on those dependent on meager public pensions—and there are many—and contrast this with handouts to sports franchises and well-connected developers.
What is rarely examined is the fatal assumption that made pensions insolvent in the first place: that sacrifices in compensation decades ago would allow for higher rates of growth, greater financial strength and the tax base to pay increased future benefits. The sacrifices occurred, but the theory of growth—which current pensioners joined most of the rest of society in championing—turned out to be incorrect.
This is a tragedy on many levels. Not only are current taxpayers on the hook for pension promises, they are simultaneously saddled with unfathomable levels of infrastructure maintenance and ongoing service costs with a tax base not financially productive enough to cover it all. It’s the inevitable downside of Cobb’s development pattern.
Here’s how the Atlanta Journal-Constitution described the pension situation:
Today, the Cobb pension’s funded level is just 52 percent, making it one of the poorest funded in the state. In order to fulfill its promise to more than 6,000 current and retired employees, the county will have to increase its contribution to the pension by about 30 percent over the next 20 years.
The $55 million Cobb County will contribute to the pension fund this year represents 20% of their reliable revenue stream. But, they are not “operating funds” and therefore are “not adopted as part of the annual county budget” (page 15).
The New Braves Stadium
Regardless of reality, when you tell yourself something repeatedly, in time you might start to believe it. And when you tell yourself how exceptionally wise and prudent you are, the narrative starts to write itself. Here's the tale the Budget Book spins:
Cobb County has a history of operating in a fiscally conservative manner, leaving very little ‘fat’ or excess to be squeezed out of the budget. [...]
Cobb has wisely undertaken policies to minimize the use of long-term debt and to borrow primarily for important capital projects that require large expenditures up-front and only when the annual interest and principal payments can be satisfied by annual revenues. The county has occasionally refinanced/refunded debt to get lower interest rates and lower annual payments. Sometimes the debt is paid off early. All of these financially prudent and beneficial measures are taken to lower the cost of the government for the taxpayer.
So, when opportunity knocks, wise and prudent people—those who have not only steadily managed a county through crisis but have sacrificed so much to put their community in a financially strong and healthy position—they get an opportunity to enjoy the bounty of their hard work and perseverance. Again from the book:
Coming in 2017, will be another superior aspect of life in Cobb: Arrival of the Atlanta Braves professional baseball team to an amazing state-of-the-art sports venue, SunTrust Park, within a new high-quality mixed-use development in the Cumberland Special Services District. (page 20)
There is a direct vector between the peak delusion embodied in the Cobb County Biennial Budget Document and the peak delusion manifest in the taxpayer subsidy for the Atlanta Braves stadium.
Tomorrow, we'll look at how Cobb County's development pattern has played a key role in this delusion and how this risky situation is impacting other municipalities like yours.