County Board Debates $345M Bond Proposal

Bond would cover pension and retiree healthcare; some Washtenaw County commissioners concerned over fast-track approach

At a May 2 working session lasting more than 3.5 hours, Washtenaw County commissioners were briefed on a bond proposal to fund the county’s pension and retiree healthcare plans, and debated the merits and risks of issuing up to $345 million in bonds – by far the largest issue in the county’s history.

Conan Smith, Meredith Shanle, John Axe, Washtenaw County board of commissioners, The Ann Arbor Chronicle

From left: Washtenaw County commissioner Conan Smith, Meredith Shanle of Municipal Financial Consultants Inc., and bond attorney John Axe, Shanle’s father. (Photos by the writer.)

The bonding is made possible by Michigan’s Public Act 329 of 2012, which the state legislature passed in October of 2012. [.pdf of Public Act 329] The law enables municipalities to issue bonds to cover unfunded accrued pension and retiree healthcare liabilities, but has a sunset of Dec. 31, 2014. The county faces a $30 million contribution toward these obligations in 2014, and is looking for ways to manage that obligation.

The most recent estimates put the county’s maximum retirement obligations at $340.8 million. New actuarial reports are due in June, however, and estimates could change. The board was presented with calculations for borrowing $344 million at an assumed average interest rate of 4%. The county would pay $239 million in interest over the life of the 25-year bond, for a total of $583 million in combined interest and principal.

John Axe of Axe & Ecklund, a Grosse Pointe Farms attorney who has served as the county’s bond counsel for decades, helped craft the state legislation that permits this type of bonding. He was on hand at the working session to describe the proposal and answer questions. “If you don’t issue the bonds,” Axe said, “you’re going to have horrible budget problems.”

County administrator Verna McDaniel has advocated for this move, in part to make long-term budgeting easier by having predictable bond payments. She raised the proposal publicly for the first time at the board’s April 17, 2013 meeting. However, Axe told commissioners that he’d been asked by the county administration to start looking into this possibility in November of 2012. He also met earlier this year with the board in closed session, when labor negotiations were discussed.

During the May 2 working session, several commissioners referred to the fact that the new 10-year labor deals approved earlier this year had been key to moving forward with this bond proposal. Allusions to that connection have been made at previous board meetings, but not directly stated. The crucial point was closing the defined benefit plan to employees hired after Jan. 1, 2014. Unless the defined benefit plans were closed, the county would not have been allowed by law to proceed with this type of bonding.

Also a factor are the new accounting standards of GASB 68, which require that unfunded liabilities be included in an organization’s financial statements for fiscal years beginning after June 15, 2014.

Some commissioners expressed concern that the bonding process, now that it’s public, is being rushed. “If I’m borrowing $350 million, I think we should take our time to ask appropriate questions,” said commissioner Ronnie Peterson. “That’s a lot of money.” He felt it was important to see updated actuarial estimates, but noted that based on the board’s discussion, “it’s like we’ve already made up our minds.”

Dan Smith lobbied to explore more options, rather than just one proposal, and raised the possibility of putting this issue before voters. “What we’re really trying to do is to manage our cash flow,” he noted. Smith also expressed skepticism about projections that the bond proposal would result in more than $100 million in savings for the county over 25 years, compared to the amount that the county would pay for its retiree obligations without bonding.

But Conan Smith argued that the board “set the course” when it approved those labor contracts and voted to close the defined benefit plans earlier this year. He acknowledged concerns about the timing, “but in part it has to move so fast because this board closed the plan, and we’re looking at a $30 million payment in 2014 if we don’t do something. So it was a choice we made willfully and with full knowledge and now we’re designing a fiscal strategy to minimize the severity of the impact on our budget.”

That specific budget impact was not discussed publicly when the board voted on the new labor contracts.

Axe also urged the board to act quickly, saying that the proposal is interest-rate sensitive. The proposal assumes that the county would borrow at an average annual interest rate of 4%, then invest the bond proceeds to earn an average rate of return of 6.5% over the 25-year period.

The proposal calls for the board to take an initial vote at its next meeting, on May 15, followed by final approval to issue a “notice of intent” on June 5. The board would also need to approve a state-mandated comprehensive financial plan in July, setting the amount of the bond issue. The county would then submit an application to the state Dept. of Treasury, which must approve the bond issue.

Some commissioners hope to get more input from experts – faculty at the University of Michigan business school, for example, or the county treasurer – who don’t stand to benefit from this bond issue. Because of these concerns, the county is expected to hire a third-party consultant, Public Financial Management Inc., to review the proposal.

In response to a question from Dan Smith, Axe told the board his firm would earn $485,000 in fees from this bond issue, at his standard rate. The county is also using Municipal Financial Consultants Inc. (MFCI) as the financial consultant on this proposal. Axe & Ecklund provides a 15% discount on its fees if the county hires MFCI as the financial consultant. MFCI president Meredith Shanle attended the May 2 working session. Though it was not mentioned at the meeting, Shanle is Axe’s daughter.

Board chair Yousef Rabhi stressed the importance of community engagement, and outlined plans for getting input – including a public presentation and possibly extra meetings. “Regardless of the decision that we make,” he said, “it’s important that the community is involved in that process.”

Public Commentary

At the start of the May 2 session, three people addressed the board. Wes Prater began by telling commissioners and staff that it was good to see everyone again. [Prater, a Democrat, previously served on the board for 10 years but was defeated by Republican Alicia Ping in November of 2012, following a redistricting that pitted both incumbents against each other in the general election.]

Prater reminded commissioners that when he served on the board, he had raised concerns about the county’s long-term liabilities. He pointed out that at the end of 2011, the county – including the road commission – had long-term liabilities for all types of debt totaling $430 million, up from $379 million in 2007. He urged commissioners to look closely at this increase so that they could determine why it had occurred, and figure out how to take care of it.

Wes Prater, Curtis Hedger, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Former Washtenaw County commissioner Wes Prater, left, talks with corporation counsel Curtis Hedger at the May 2 working session.

He also asked if the county had responded to a letter sent out at the beginning of 2013 from the state treasurer’s office to each local unit of government, asking for a long-term deficit elimination plan. He said the plan must get approval from the governing board, and must be submitted to the state treasurer as part of the annual audit.

Later in the meeting, Kelly Belknap – the county’s finance director – replied that the plan is only required for local governments that have fund deficits. She said none of the county funds have a deficit, so there’s no requirement to submit a deficit elimination plan to the state.

Doug Gross, a certified financial planner from Saline, cautioned commissioners to think carefully about what business they’re in. The business is to provide services to taxpayers, he said. The county isn’t in the investment business, he said, and it takes a risk in borrowing money to fund an obligation that they should have been paying for all along.

It’s a risk to borrow the money and just hope for a higher rate of return, Gross said. There’s certainly a shot at achieving a higher rate of return, he added, given the low-interest rate environment. But the focus should really be on what can be done to lower employee benefits in the future. Are the benefits comparable to what the general public and taxpayers are getting? He thought the county’s benefits were likely way beyond what others are receiving. People are retiring in their 50s with lifetime pensions and that’s not sustainable, he said. And healthcare is no longer a retirement benefit for almost anyone in society, he added.

Gross suggested the county look at its labor contracts, and over time to stop offering the defined benefit plan. He realized there was an obligation to existing employees, but it doesn’t have to keep accruing.

In responding to Gross, commissioner Yousef Rabhi pointed out that the county reached new 10-year labor contracts earlier this year. [The new contracts were approved by the board on March 20, 2013, prior to the state's right-to-work law taking effect.] Those contracts close the current pension and retirement healthcare benefits for people hired after Jan. 1, 2014. Rabhi noted that the county wouldn’t be allowed to pursue the kind of bonds it’s seeking without closing those retirement defined-benefit plans, “so with the 10-year contract, that’s a step that we took – to cap the growing long-term liability.”

It wouldn’t make sense to borrow money if the plans weren’t capped, Rabhi said, because you wouldn’t know what your total liabilities were. “I don’t think that any of us would be at this stage of the road if we hadn’t gone through the 10-year contract process.” He praised the labor unions for making sacrifices. “What we’re trying here is something that isn’t necessarily being tried in a lot of different places. It’s been tried in a few places, and I think it’s worked relatively well,” he said. “But we are, in the tradition of Washtenaw County, leading the way in terms of how we can make some of these changes.” Rolland Sizemore Jr. replied to Rabhi, saying he’d like to know what places have tried this approach successfully.

At the end of the meeting, after commissioners had clarified that the pension and retirement health care plans will be closed, Gross pointed out that any new employees hired through 2013 will still be eligible for those benefits – so the county hasn’t actually closed those plans yet.

Gross also wondered whether the bond would be tax-exempt or taxable. If it’s taxable, interest rates will be higher, he noted, so the spread between what the county pays and what it hopes to earn off investments will be narrower. He didn’t think it would be viable as a taxable bond. [The proposed bond issue would be taxable.]

Thomas Partridge urged the board not to take on such high debt, but rather to put their efforts into funding affordable housing.

Bond Proposal: Public Process

Yousef Rabhi, the board’s chair, reported that he and vice chair Alicia Ping had been working to make sure this process is as open to the public as possible. Between this meeting and the May 15 vote, he wanted to make himself, Ping and Felicia Brabec – who chairs the board’s ways & means committee chair – available to the media. They were thinking of scheduling a press conference or informal discussion, he said. A lot of information has been released already to the public, Rabhi said, but Ping has also suggested that the administration develop a brochure about this bond proposal that would be distributed to libraries and other public places to ensure that the public is well informed about the process.

Yousef Rabhi, Alicia Ping, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Washtenaw County commissioners Yousef Rabhi (D-District 8) and Alicia Ping (R-District 3). They serve as board chair and vice chair, respectively.

He also wants to schedule a public presentation sometime between May 15 and the final vote on June 5, so that the public can come and hear more details about the proposal and get their questions answered. In addition, there will be a formal public hearing at the board’s June 5 meeting. He said it’s an open process, and these outreach measures are a way to ensure that in a more formal way. “There’s an overwhelming sense on this board that we want to engage the public in this process,” he said. “Regardless of the decision that we make, it’s important that the community is involved in that process.”

Rabhi also noted that the county board meetings include opportunity for public commentary, and he encouraged the public to speak during that time.

Ping, the board’s vice chair, noted that the board has had a lot of conversations “touching around what we’re going to do.” Starting with this working session, she said, and in the next few meetings, “we’ll really be able to dive in” and get all questions answered.

Rolland Sizemore Jr. expressed concern about the process. Some commissioners have told him this process has to be completed by July, he said, and that the proposal might have to get initial approval and final approval on the same night. “That is going to be a major problem with me,” he said. [Typically, an initial vote is taken at the ways & means committee – on which all board members serve – followed by a final vote at the regular board meeting two weeks later. For most of the year, the ways & means committee and regular board meetings are held every two weeks, in back-to-back sessions on the same night. During the summer, those meetings are held only once a month.]

Noting that not everyone has a computer, Sizemore encouraged the public to call the county administration office at 734-222-6852 and ask questions.

Ronnie Peterson criticized the speed of the process, noting that one of the public forums was planned to happen after the board’s initial vote on May 15. “If I’m borrowing $350 million, I think we should take our time to ask appropriate questions. That’s a lot of money.”

Bond Proposal: Financial Analysis

Meredith Shanle of MFCI reviewed the documents she had provided to commissioners, showing how the bond proposal would cover the existing obligations for the Washtenaw County Employees’ Retirement System (WCERS) and Voluntary Employees Beneficiary Association (VEBA) – the defined benefit pension and retiree healthcare plans. The information included charts that compared existing debt obligations with the proposed bond payment schedule, as well as an analysis on the bonding’s impact on future borrowing. [.pdf of MFCI overview memo to commissioners] [.pdf of comparative charts on covering VEBA and WCERS obligations] [.pdf of MFCI memo regarding impact on future borrowing] [.pdf of MFCI debt load analysis]

Actuarial reports are being completed – likely available in June – to show the county’s updated obligations for VEBA and WCERS as of Dec. 31, 2012. The most recent actuarial report showed valuations at the end of 2011, when the county had $101.27 million in unfunded liabilities for its defined benefit pension (WCERS), and $148.46 million in unfunded liabilities for its retiree healthcare (VEBA).

However, those figures were based on assumptions that haven’t been updated since 1999. According to draft minutes of a April 16, 2013 special joint meeting of the WCERS and VEBA boards, county finance director Kelly Belknap asked for an expedited “experience review” to be completed by the actuarial Buck Consultants by June 25, 2013. Her request was approved by the boards at that special meeting. The review will focus on investment returns, mortality, wage inflation and core demographics since 2009, with a more in-depth study scheduled for a later time. According to minutes from a Feb. 7, 2013 VEBA meeting, this kind of study is typically conducted every three to five years, in order to inform actuarial valuations.

Until new actuarial reports are completed, MFCI has estimated that the maximum obligation is $340.8 million – $210.5 million for VEBA, and $130.3 million for WCERS. Calling this a “worst case assumption,” MFCI is recommending that the county board authorize a notice of intent to issue up to $345 million in bonds to fully fund both VEBA and WCERS.

Borrowing that amount at an assumed average interest rate of 4%, the county would pay $239 million in interest over the life of the 25-year bond, for a total of $583 million in combined interest and principal.

The annual payments would vary, beginning at $18.558 million in 2014 for interest only. Subsequent years would include both interest and principal payments: $14.110 million in 2015, $15.170 million in 2016, and $16.278 million in 2017. Payments increase incrementally in subsequent years, and starting in 2024 the county would be paying about $26.2 million annually. [.pdf of comparative charts on covering VEBA and WCERS obligations]

MFCI’s analysis assumes that the county would earn an average rate of return from the bond proceeds of 6.5% over the 25-year period of the bond. Proceeds from the bond, held in an intermediate trust, could be used to call the bonds after nine years, if some future event eliminates the WCERS and VEBA liabilities.

The MFCI analysis also states that the county would pay up to $112 million more to cover its VEBA and WCERS obligations if it doesn’t bond, based on the county’s current 27-year estimated debt payment schedule for those two funds. John Axe, the bond attorney used by the county, noted that the annual estimated contributions that the county will be required to make in the next few years – if it doesn’t bond – are considerably higher than the bond payments it would be making if it does bond. [.pdf of charts showing retiree fund payments without bonding]

The reason that most entities don’t want to close their defined benefit plans is that they don’t want to have to start making those annual contributions, Axe said. But Washtenaw County has done the “responsible thing,” he added, and closed its defined benefit plans. The bond proposal would cover the obligations “in an orderly way,” Axe said, by spreading out the debt over 25 years with a fixed-rate obligation, which is estimated to be about 4% on average. If the estimates are different when it comes time to issue the bonds, Axe said, then the proposal would need to be re-evaluated.

“If you don’t issue the bonds,” Axe added, “you’re going to have horrible budget problems.”

Another aspect of the MFCI analysis looked at how the proposed bond would impact the county’s debt limit and ability to bond for other purposes. Assuming that the county bonds for the entire $345 million, its overall debt would total $445.88 million – or 32% of what it is legally allowed to issue. The MFCI memo states:

We do not believe that the issuance of debt at that level will have any negative effect on the County’s ability to maintain its current credit rating or to issue future debt since the County would have in excess of $975,000,000 in additional room to issue debt in the future. Moreover, because the County is issuing this debt for the purpose of funding a debt which it currently owes, we believe the action will be welcomed by both Moody’s and Standard & Poor’s.

Bond Proposal: How It Would Work

John Axe of Axe & Ecklund, the bond counsel hired by the county, began his presentation by referring to a memorandum he had sent earlier to commissioners that outlined the process. [.pdf of Axe's process memo]

Axe said the process now being pursued by the county actually began in 2008. At that time, the bond proposal would have covered about half of the amount that’s now proposed, he said, and would have covered only VEBA, the retiree healthcare plan. The idea would have been to issue certificates of participation (COPs), a different type of financing than the bond issue that’s now being proposed.

But the county ultimately didn’t move ahead at that time, because of the economic meltdown that occurred about a month before the COPs would have been issued, Axe said. At that time, Washtenaw County was following the lead of Oakland County, he said, which had issued COPs a year earlier. It wasn’t the best type of borrowing situation, he noted, and bonds would have been preferred.

Axe reported that his firm had prepared legislation in 2006 to allow bonding for these retiree obligations. The legislation was supported by many units of local government statewide – including Washtenaw County – and was passed by the state legislature, but had been vetoed by then-Gov. Jennifer Granholm. Because of that, there was no other alternative except for COPs, he said.

In 2008, the proposal considered by Washtenaw County was to close the retiree healthcare plan at that time, and issue COPs to fully fund the liabilities of that plan for the employees that were covered by it. “What we’re doing today involves exactly the same thing,” Axe said, “except we’re now proposing a bond issue because the Michigan legislature finally approved essentially the same legislation that was proposed back in 2006.”

The legislation passed in 2012 permits this kind of bonding, Axe explained, to fully fund the pension and retiree healthcare plans – but only if those plans have been closed to new employees. “You have done that,” he said.

Andy LaBarre, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Andy LaBarre (D-District 7), chair of the Washtenaw County board’s working sessions.

Axe said his firm had been asked by the Washtenaw County administration to start working on this proposal in November of 2012. His firm prepared a memorandum on it that was given to commissioners at a working session in February. [There was no working session on this issue in February. It's likely that Axe was instead referring to a closed session that was held during the board's Feb. 20, 2013 meeting to discuss labor negotiations. Axe attended that meeting and participated in the closed session, which was not open to the public.]

Since February, Axe said, his firm and the financial consultant hired by the county have been working hard on this proposal. [This was not mentioned at the meeting, but the financial consultant – Municipal Financial Consultants Inc. (MFCI) – is closely tied with Axe. MFCI's president, Meredith Shanle, who also attended the May 2 working session, is Axe's daughter. And Axe & Ecklund provides a 15% discount on its fees if the county also hires MFCI as the financial consultant on a bond proposal.]

Axe then reviewed the legal steps that are required in this bonding process. He noted that this is a new process, and no one has ever issued these kinds of bonds – because they haven’t previously been permitted until the new law was signed in October of 2012. As of now, no unit of government has received approval from the state department of treasury – that approval is one of the requirements needed to issue these bonds, he noted.

Local units of government can only issue bonds if they’re “qualified,” Axe explained. To get qualified, a certified financial report must be submitted to the state annually, showing a balanced budget. This has been the case since 1982, he said. Before that, the only way to issue bonds was to get prior approval from the state. Axe said he helped draft the legislation passed in 1982 to allow for the qualifying process, noting that Washtenaw County has been qualified every year since then.

But for this new type of bond issue in Michigan, the qualifying process doesn’t apply, Axe said. Instead, each bond issue must be approved by the state department of treasury, after completing a series of steps. [.pdf of Axe memo outlining bonding process] [.pdf of bonding timeline]

Axe then outlined the required steps in this process:

  • A notice of intent to issue bonds. This standard notice must be published in a “newspaper of general circulation within the county.” It lets residents know that they have 45 days during which they can circulate petitions to require a vote of the people before any bonds are issued. The notice must include a maximum amount of the bond issue, a maximum interest rate, and a maximum term for the bonds. To do this, the board needs updated actuarial information – but those reports won’t be ready until June, Axe said. So the maximum amounts at this point are estimated by the county’s financial consultant (MCFI) and assume a worst-case scenario. Axe said it’s likely that the bond issuance will be lower than estimated. Expected dates of board votes: initial approval on May 15, 2013, with final approval on June 5, 2013. Assuming board approval, a notice of intent would be published soon after the June 5 vote. Axe’s memo indicates the notice would be published in the Sunday, June 9 printed edition of
  • Approval of the bond resolution and “continuing disclosure” resolution. Even though the final amount of the bond won’t be determined, the board will be asked to set a maximum amount for the bond. The continuing disclosure resolution is standard for all bond issues over $1 million, and indicates that the county will provide updated financial information annually during the term of the bond. Expected dates of board votes: initial approval on May 15, 2013, with final approval on June 5, 2013.
  • Meeting with credit rating agencies, request for bond ratings. The county currently holds an AA+ rating from Standard & Poor’s and an AA1 rating from Moody’s. The timeline distributed by Axe indicates that these meetings would be held in Chicago, but he did not address this item during his remarks. Expected meeting dates: June 12-13, 2013, with a request for bond ratings made on June 15.
  • Actuarial reports approved by VEBA and WCERS boards. There are separate boards for the Washtenaw County Employees’ Retirement System (WCERS) and Voluntary Employees Beneficiary Association (VEBA). Members of these boards are appointed by the county board of commissioners. Both VEBA and WCERS boards will receive updated actuarial reports, as of Dec. 31, 2012, which they will then approve. The information in these reports will indicate the size of the county’s unfunded pension and retiree health care liabilities, and thus determine the amount of the bond issuance. Expected date of approval: June 25, 2013.
  • Setting of the final amount of the bond issue and approval of the comprehensive financial plan. After the actuarial reports are received, the amount of the bond issue will be set to cover the unfunded liabilities. This amount will be part of a “comprehensive financial plan” that’s required by state law (Public Act 34). It will include a financial analysis of current and future liabilities, an estimated debt service schedule, and a description of the new retiree health care plan. It will also include a comparison of the county’s obligations with and without a bond issue. [.pdf of comprehensive financial plan components] Expected date of board approval: July 10, 2013.
  • Receipt of credit rating. One of the requirements for these bonds is that at least one credit-rating agency give the bonds a minimum double-A rating. The best rating possible is triple-A. Expected date of rating: July 24, 2013.
  • Expiration of 45-day notice of intent. This bond proposal assumes that petitions won’t be filed for a voter referendum. It also assumes that the notice of intent will be published on June 9. End date of 45-day notice: July 25, 2013.
  • Application to state for approval to issue bonds. The application to the Michigan Dept. of Treasury must include several components, including documentation of the requirements listed above. [.pdf of bond application requirements] Expected application date: July 26, 2013.
  • Approval from the Michigan Dept. of Treasury. Axe expects it will take about two months to receive approval from the state, which might require additional information. Expected date of approval: Sept. 26, 2013.
  • Actions related to bond sale. Assuming that approval is received by the end of September, a notice of sale for the bonds would be published on Oct. 2, 2013, with the bond sale occurring on Oct. 16. Expected date of bond delivery to the county: Oct. 31, 2013.

Axe stressed that until the actuarial reports are completed, the amount of the liabilities – and therefore the amount of the bond issue – can’t be determined. The current estimate of a $345 million maximum amount is a big number, he acknowledged. “It’s on purpose a big number,” he said, “because we don’t want to have to go back and put a new notice [of intent] in the paper later.”

He also noted that this plan couldn’t have been brought forward until the county board approved closing of the current pension and retiree healthcare plans, which was done as part of the new 10-year labor contracts that the board approved in March.

There has been only one other government entity so far to apply to the state for this type of bond issue, Axe said. Saginaw County applied in February. [.pdf of Saginaw County comprehensive financial plan related to its pension bond issue]

The state has not yet approved that application. Axe said he knows there are other governmental units that are in the process of applying, but no one else has submitted an application yet. He also noted that the more entities that apply, the slower the process will likely be. State government has downsized, he said, so there are fewer people to handle these requests.

Board Deliberations

The board’s discussion covered a wide range of issues related to the bond proposal, including many clarificational questions. This report presents a summary of the discussion, organized thematically – with the recognition that there is considerable overlap among these issues. Topics included the timing of the proposal, risks, investment-related issues, bond types, fees, credit ratings, a possible voter referendum, alternative options, and the need to seek additional advice and input.

Board Deliberations: Timing

Ronnie Peterson asked why the board was being asked to take an initial vote on the bond resolution prior to receiving the updated actuarial reports. John Axe replied that it’s simply to publish the notice of intent as early as possible, to start the 45-day clock for the possible voter referendum. If the board waits until its July 10 meeting to vote on the notice of intent, Axe said, then other applications to the state will likely be submitted ahead of Washtenaw County, thus delaying the process.

Ronnie Peterson, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Commissioner Ronnie Peterson (D-District 6).

Peterson said he was disturbed that so much of the board action took place prior to public input. He wondered why the board couldn’t wait until the actuarial reports are seen. Axe explained that even though the board will be asked to approve the bond resolution – initially on May 15, with a final vote on June 5 – it won’t take effect until the rest of the process is completed. If the board doesn’t approve the comprehensive financial plan on July 10, for example, then “we stop,” Axe said.

Peterson again wondered why the board is rushing, noting that the state legislation doesn’t sunset until Dec. 31, 2014.

“Remember this – this is interest-rate sensitive,” Axe said. “The interest rates today are at good levels. No one can tell you for certain what the interest rates are going to be. We don’t think they’re going to go up, but we don’t know.” All of the assumptions are based on interest rates today, he added. If interest rates go way up, he’d likely advise the county to wait before issuing the bond. “We don’t want to sit around and wait the extra 45 days if we don’t have to,” Axe said.

Peterson didn’t appear to be persuaded. “In our conversation, it’s like we’ve already made up our minds,” he said. It seems like the board should have more information. There are three crucial documents – the actuarial reports for VEBA and WCERS, and the comprehensive financial plan showing how the bonds will be retired – that the board and the public won’t have before commissioners vote on the initial authorization for this bond proposal, Peterson said.

The board has another year and a half to work with this bond program, Peterson noted, so he hoped they would take more time to consider the impact of this proposed indebtedness.

Kent Martinez-Kratz asked what would happen if the county waited until after 2014 to make the bond issue. Axe replied that for the current type of bond, the law sunsets on Dec. 31, 2014, so the county wouldn’t have that option. It would be possible to issue certificates of participation (COPs), like Oakland County did in 2007. Martinez-Kratz alluded to a discussion that the board had with a representative of Oakland County on this issue. [This apparently occurred during a closed session – as there has not been a public presentation by any Oakland County official.]

Yousef Rabhi asked a series of clarificational questions about the proposed timeline. He noted that when the actuarial reports are provided in June and the information is not what the board expected, “we can pull the ‘off switch’ then.” Axe replied that the board isn’t committed to do anything until the comprehensive financial plan is approved, which can’t possibly occur until July at the earliest. And the county can’t issue the bonds until receiving state approval. The June 5 board vote simply authorizes the notice of intent and sets a maximum possible bond amount, Axe said.

Rabhi indicated that he’d be open to having an additional meeting in July, given the feedback he’s heard from other commissioners about having only one meeting, on July 10, to give both initial and final approval of the comprehensive financial plan.

Alicia Ping pointed out that the only reason the initial and final approval would be scheduled on July 10 is because the board traditionally only has one meeting in July. “I don’t think the intent here is to push anything through,” she said.

Board Deliberations: Interest Rates, Investments

Dan Smith asked Axe to elaborate on why this bond issue is time sensitive, regarding interest rates. Axe replied that no one can know the future. All of the financial analysis is based on current interest rates. The only reason to vote early is to “get the 45-day notice of intent out of the way,” Axe said. His advice is that unless there’s some good reason for waiting, the board should proceed.

D. Smith wondered why the county should be concerned about the interest rate, given the nature of this bond issue. It’s a bond issue unlike any other, he noted. It’s not for a capital project. Rather, in this case the proceeds will be directly invested back into the market.

It matters, Axe replied, because all of the financial analysis is done based on prevailing interest rates. The analysis is very conservative, and a 45-day wait probably won’t matter, he said. But unless there’s some reason, he wouldn’t advise waiting. All of the steps are interrelated, he added.

The analysis is based on paying an estimated average 4% interest rate for the bond over 25 years, Axe said, with the expectation of investing the proceeds of the bond sale and getting a 6.5% average rate of return on that investment over that period. The proceeds won’t be invested exclusively in other municipal bonds, Axe said. Proceeds will be held in an intermediate trust and managed by investment advisors hired by the county, with an estimated worst-case return of 6.5%.

Interest rates on the bond aren’t likely to go down much lower, Axe said – right now, they’re in the range of rates last seen in the 1930s. Axe added that this approach – borrowing at 4% and investing to get a 6.5% return – is an element of the plan, but it’s not the only element.

Dan Smith, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Commissioner Dan Smith (R-District 2).

D. Smith drew an analogy to taking out a mortgage on a house at 4%. So 100% of his house would be leveraged, and he owes the entire amount of his house. “I should take that money and go invest it in the stock market, because the stock market is going like gangbusters right now, and I could make 6-7% difference on that.” Axe replied that he wasn’t suggesting this is the same thing as Smith had described. The interest differential is only one aspect, Axe said. “I think you ought to hear the complete plan.”

Felicia Brabec asked about the investment strategy – hiring another company to invest the bond proceeds, and assuming that there would be rate of return higher than the interest on the bond payments. If there was a surplus from the investments, can that surplus be used to pay down the debt at a higher rate without a penalty?

Yes, Axe replied. The 25-year bonds would be callable in nine years – meaning that the bonds could be paid off fully or partially at that time, if the county decided to do that. The county could also choose to re-fund those bonds, if interest rates are lower in nine years.

Axe responded to a written question asking if the county is essentially gambling on market performance. The answer, he said, is that all investments – including those made currently by VEBA and WCERS financial advisors – are made by professional advisors. The estimated rate of return is calculated over a long period and is based on past experience, he said. The county is using an estimated rate of return that’s substantially below the current actuarial estimate, as well as below what the county has actually been getting from its VEBA and WCERS investments, he noted.

The most important thing is that you hire good people to make the investments, Axe said. Oakland County, for example, is in much better shape now than before they issued their bond, he said.

Andy LaBarre asked about a hypothetical situation in which the investments made “are bad from the start. Even the best investment management can lead us astray,” he said. “Are we really being as prudent as possible, and are we incurring any risks that we normally wouldn’t through any sort of investment?”

Axe replied that “you already owe the money” and are already relying on the market to provide returns for VEBA and WCERS funds. The board’s main responsibility is to hire the best possible investment managers. The county would want to do that anyway, he said, regardless of the bond proposal – because there is already a huge amount of money that’s currently being invested. “I wouldn’t be here if I didn’t think this process would work,” he said.

Board Deliberations: “Saving” Money

In response to a written question, Axe explained how the county will be saving money with this proposal. First, he said, the county has closed its VEBA and WCERS plans. That means the county now will know what its obligations are for employees who are currently in the plan. [Employees hired through Dec. 31, 2013 will still be eligible for these plans. And the obligations are based on actuarial estimates – for example, estimating how long retirees would be expected to live, on average.]

This bond will be paid off over 25 years, Axe said. In contrast, the county’s estimated actuarial liability has been calculated over a period of 27 years – so the county is actually shortening the period of its pension and retiree healthcare obligations.

When the bond proceeds are invested by the trustees – the managers of the intermediate trusts for VEBA and WCERS – the estimated average return is 6.5% He noted that the county’s current actuarial estimates call for 7.75% and 7.5% returns for VEBA and WCERS, respectively. So the estimated percentage return for the investments of the bond proceeds is more conservative than current actuarial estimates.

Conan Smith pointed out that the 7.75% is a policy target. The actual 10-year trailing return is 6.75%, he said.

Axe noted that the county already owes the money for its unfunded pension and retiree healthcare liabilities. “You’re not borrowing more than you already owe.” Instead of owing it to everyone who’s entitled to receive the benefits in the future, he said, “you’re going to owe it to the bond holders. That’s the only difference.”

C. Smith pointed to the MFCI estimate that the county would save $112 million because of the bond issue. When the bond is paid off in 2039 and if the estimate is accurate, he said, “we’re sitting on $100 million. What could we do with that money?” He wanted to know if the excess funds were restricted in any way.

Axe replied that the money would be coming to the county over a long period of time, and most of it would be seen in the early years of the bond schedule. If there was money left in the intermediate trust after VEBA and WCERS obligations were fully met, then that money could be returned to the county for other purposes, Axe said.

C. Smith observed that if the earnings from the bond are saved and invested, after the retiree obligations are met, that money would become general operating funds that a future board of commissioners can allocate in any way.

In light of the estimated $100 million-plus in savings, Ronnie Peterson wondered if the county is borrowing too much money. He felt the county would be better served by breaking close to even on this bond issue. He said he wasn’t troubled that there would be savings, but he was troubled by the large amount.

Dan Smith asked if the $112 million “savings” was largely due to “playing the spread” between the average 4% interest rate paid on the bond and the anticipated 6.5% earned from investing the bond proceeds. Yes, Axe said, that’s a large part of it. The restructuring also allows the county to avoid paying a “huge” amount upfront, he added. The county has closed its defined benefit plans, so it must make contributions to VEBA and WCERS, Axe said. “This is simply one of the ways that you can do it.”

After identifying a typo in MFCI’s report that resulted in a $10 million under-reporting of the total VEBA/WCERS estimated obligations, D. Smith addressed the issue of estimated contributions. He pointed out that MFCI had used a conservative estimate of the county’s total contributions – without bonding – which made the option of bonding appear more favorable. He said his understanding is that without bonding, contributions to VEBA and WCERS will spike in the next few years. [Estimates provided by MFCI call for roughly $30 million annual contributions for the next five years, without bonding.] But after that there could be a tapering off, he said. That’s why he’s interested in seeing the new actuarial projection, which might provide a different scenario.

Board Deliberations: Bond Types

Responding to a written question from the board, Axe explained the difference between a bond issue that’s authorized by the county board, and bonds based on approval by voters.

Bonds issued based on approval of the county board are called general obligation limited tax bonds. The word “limited” is critical, he said. It means that the only money that can be used to pay those bonds is money that comes into the county already – through taxes, state funding or other means. “You cannot levy any extra tax above the amount of tax that you can levy for operating purposes.” He noted that the county currently levies the maximum rate that it can. [That millage rate for 2013 will be set by the board by June. The 2012 county general operating millage rate was 4.5493 mills.]

Rolland Sizemore Jr., Washtenaw County board of commissioners, The Ann Arbor Chronicle

Commissioner Rolland Sizemore Jr. (D-District 5).

In contrast, if the county gets voter approval for a bond issue, that gives the county the power to levy an extra tax in any amount – and there’s no limit to the rate or amount, Axe said. [At this point Conan Smith raised his arms in a gesture of enthusiasm, which elicited laughs from other commissioners.]

Axe then fielded another written question: What’s the chance of defaulting on a limited tax bond issue, compared to an unlimited tax bond issue? Washtenaw County has always been very careful about its bond issues and has paid everything on time, Axe said. The county has substantial reserves and is very conservative in its approach. “You don’t go out and issue a lot of bonds for wild purposes,” he said. The county always has a plan for allocating specific funds to make bond payments over many years. Axe said he’s been doing bond issues for Washtenaw County for decades, and in that time the county has never had any difficulty making bond payments.

Dan Smith followed up on the question about the default risk. He noted that Axe’s written response to this question had indicated that there’s no difference in default risk between limited and unlimited tax bonds. Axe replied that this is the judgment of the credit rating agencies. Washtenaw County bonds sell almost at the triple-A level, he said, because people are satisfied with the county’s history. The county is much more stable than other counties because of its demographics, Axe added. Specifically, the University of Michigan and other colleges and universities are located here, and the county has been on a growth path, although that growth has slowed in recent years.

D. Smith replied that there are still considerable differences in the way that limited and unlimited tax bonds are funded. It’s highly improbable, he said, but the county could go bankrupt in 15 years – how would that affect the situation? Axe replied that the county could go bankrupt regardless of whether these bonds are issued. If the county failed to make its obligations, it would go under emergency management.

Meredith Shanle of MFCI clarified that in general, there is a large difference between limited and unlimited tax bonds. But in the specific case of Washtenaw County, those types of bonds are basically the same, she said. With unlimited tax bonds, the county could keep raising the millage rate to cover those bond payments, she noted.

D. Smith observed that in the case of General Motors, no one thought that GM would ever default on its bonds, but it did. So it’s not reasonable to say that a default could never, ever happen – even in Washtenaw County, he said.

Responding to a question about whether the county would have a harder time issuing a limited tax bond if voters turned down an unlimited tax bond, Axe said no. That’s because the county has excellent credit rating, he said, and any action by voters wouldn’t have any bearing on that credit rating.

Regarding a voter-approved bond, Axe noted that the ballot question can’t be put forward until there’s an election, and the next time the county could do that would be at the November general election. He also pointed out that the county doesn’t plan to levy any additional tax as part of this bond proposal.

Axe was also asked about the experience of other government entities. He noted that Detroit had issued pension obligation certificates of participation (COPs), but failed to close its defined benefit plan. That meant that the liabilities were open-ended. In addition, when the city made an estimate of its unfunded pension liability, the estimate undershot the actual amount by $300 million, he said. “Even if everything had worked out brilliantly, they were still not going to be fully funded,” Axe said. “That was a catastrophe.”

Axe also responded to a written question about the Water Street project in Ypsilanti. The city of Ypsilanti had been working with a developer who was interested in redeveloping an area near downtown. The developer had told the city that the city needed to buy the property, remediate it, and put in public services, then the developer would put in housing there. The city agreed and issued a roughly $13 million bond to cover its costs. But remediation cost more than expected, Axe said, and worse than that, the developer backed out. Now, those bonds have been re-funded with a $15.74 million issue, he said. Axe indicated that it was a different situation than what the county is facing.

Board Deliberations: Risks

Felicia Brabec asked about possible pitfalls. She noted that Axe had mentioned the fact that Detroit hadn’t closed its defined benefit plan. That was one possible problem, but Washtenaw County had addressed it already, she noted. What other things should the board be concerned about?

So far, Axe replied, he hadn’t seen anything in the county’s approach that was inappropriate. He stressed that he’s had a lot of experience with this issue, dating back to his work on the state legislation in 2006. “You’ve done what you need to do,” he said, adding that he had confidence in the board that they would pick a strong investment manager and monitor the performance closely.

Brabec also wondered what the board could learn from Detroit’s experience, including the fact that Detroit’s defined benefit plan had been underfunded by $300 million. Underestimating the liabilities is one of her biggest concerns, she said. Axe replied that the board should pay very close attention to the actuaries. He noted that the actuaries are also making a projection. “They’re telling you how many people [they] think are going to live, and how long.” In the case of Detroit, he said, the actuarial reports were “terrible.” That’s how the city ended up with a $300 million underfunding.

Conan Smith, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Commissioner Conan Smith (D-District 9).

Conan Smith told his board colleagues that the bond itself “is not the thing that should scare anyone.” The bond is the most stable, predictable part of the entire formula, he said. The county will borrow a certain amount of money at a set interest rate, and with set payments over a certain period.

Rather, the “calculus of risk” for the county, C. Smith said, is on the return on investment from the bond proceeds, and whether that return will be sufficient to make the county’s actuarially-required contributions. Also unknown is what those contributions will actually be. If cancer is cured and people suddenly live 15-20 years longer, he noted, that will affect the actuarial projections dramatically, “and we will not have prepared for that with this bond.” But those extra costs would be incurred even if the county didn’t bond, he added. The bond is “a good, smart, stabilizing plan,” C. Smith said, and it ensures as much predictability in the budget as possible.

There are a lot of things out of the board’s control, he noted, including the market and how long people will live. “We’ll have to deal with those variables one way or the other.”

The other risk-tolerance question can be seen using Dan Smith’s house analogy, C. Smith said. If he could mortgage his house and get $200,000 in cash at 3%, then invest it in the market and earn 6%, “why wouldn’t I do that?” The question is how much risk are you willing to tolerate? he said. The board can look at the entire earnings history of the VEBA and WCERS funds, and use that as a fairly reliable measure of return on investment. “It’s just a question of how much confidence we as a board have in those figures.”

The board needs to assess if the bonding lessens the risk somewhat, C. Smith added. “My own personal assessment is that it lessens our risk.” The actuarial projections might change and the market might shift up or down, he said. But at the very least the bonding provides a foundation that the county can work from, to deal with the volatility between the bond payments and the market return, rather than the volatility for the VEBA and WCERS funds as a whole.

Dan Smith referred to communications from Axe that characterized the bond as “fully funding” the county’s VEBA and WCERS systems. He noted that it would really only be fully funded at the moment that the bonds are issued, “because everything in the future is dependent on the actuarial reports.” It’s possible that the bonds will overshoot or undershoot the actual amount needed. “Five years into this, we could be back in the same position,” D. Smith said.

Axe replied that there’s no guarantee about what will happen in the future. It’s not allowed under the law to borrow more than the fully funded amount, he said. That amount might change if people live longer. At least for future hires, the county is protected because the defined benefit plan is closed, Axe noted. But if people who are currently covered by the plan live an extra 10 years beyond the actuarial projections, “it will mess up the actuarial reports something fierce, there’s no doubt,” Axe said.

Axe added that all actuarial reports are based on history, but people are living longer than they used to live. He noted that when the federal Social Security system was set up in 1935, it was based on people beginning to collect benefits when they were 65. But the life expectancy at the time was 63.

D. Smith observed that it appears people have forgotten about recent history, and what dismal years there have been in the economy, especially in Michigan. To make long-term assumptions, using the past as a predictor of the future, is a scary approach, he said. In 2000 or 2001, no one except doomsday extremists would have predicted a housing market bubble. Basing the future on the past “is a little dicey,” D. Smith said.

Board Deliberations: Advice from Others

Rolland Sizemore Jr. wanted to get input from experts at the University of Michigan and Eastern Michigan University business schools. It bothered him that the county would be paying a third-party advisor to look into this proposal. “We’ll be paying out a ton of money to get the bonding, and we’re going to pay out a ton of money to figure out if it’s right.” He also asked for the opinion of the county treasurer, Catherine McClary, as well as the county’s current actuaries for the VEBA and WCERS funds, and the local state senator and representatives. [The state senator representing the Ann Arbor area is Rebekah Warren, who is married to county commissioner Conan Smith. The state representative for the district covering Ann Arbor is Jeff Irwin, a former Washtenaw County commissioner.]

Catherine McClary, Dan Smith, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Washtenaw County treasurer Catherine McClary talks with county commissioner Dan Smith after the May 2 working session.

Sizemore was concerned that the board seems to be pushing this through, without time to get outside advice.

Yousef Rabhi responded, saying he felt those concerns are valid. As a reaction to some concerns he’d heard from other commissioners, Rabhi said a third-party firm that’s not affiliated with Axe & Ecklund could be hired to review the process. That firm would be paid by the county. “We certainly don’t have to do that,” Rabhi said. But he’d recommended it, because he’s heard from others that another set of eyes is needed.

[That third-party firm is Public Financial Management Inc., with offices in Ann Arbor. Both PFM and Axe & Ecklund are part of the county's bond and financial consultants pool. For this project, PFM has not yet provided an estimate of their fees, which will be based on the number of hours needed to review the bond proposal. (.pdf of PFM's general consultant proposal, including the firm's fee structure)]

Rabhi agreed with Sizemore that the county is lucky to have others in the community who are qualified to look at this, and it would be great to have their input. He offered to work with Sizemore and the administration to find out the best way to engage these people.

Sizemore said that in his experience, when a consultant is hired, that consultant can be swayed to present the kind of response that the client wants. That wouldn’t be the case with a university expert, he said.

Dan Smith wanted to see a study that “paints the absolute worst-case scenario.” Looking at the markets today, predictions are “all over the place.” At this point, the board is getting only one opinion, he noted.

Board Deliberations: Axe & Ecklund, MFCI

Ronnie Peterson asked about the financial obligations that the county would have toward Axe & Ecklund. Axe replied that there are no financial obligations if the bond proposal doesn’t go through.

Axe also responded to written questions related to his firm. He was asked how the board can be assured that his advice is sound, when he stands to benefit from this proposal. Axe said that this question could be asked any time his firm gives advice on a bond issue. He noted that “we’re the lawyers, we’re not the financial advisors.” [The financial advisor used in this and many other county bond deals, MFCI, is led by Axe's daughter, Meredith Shanle.]

Axe said that if there’s any indication of a problem with a bond issue, “we would naturally bring it to your attention.” The firm has represented Washtenaw County on 131 bond issues since 1973. Since 1981, that amount has totaled $668 million. There’s never been a problem or legal challenge, he said. As bond counsel, his firm has the legal responsibility to defend the bonds for the life of the bonds. Over the years, he said, his firm has issued a lot of legal opinions on behalf of Washtenaw County.

Andy LaBarre asked if it was correct to say that as bond counsel, “you’re on the hook for 25 years?” Yes, Axe replied. “Absolutely.” He added that he valued the county’s business, and it’s his firm’s responsibility to point out any problems. Axe also noted that his firm is not being paid any extra to work on this particular bond issue. “We’re being paid the regular rate that’s already established in the contract we have.” [.pdf of Axe & Ecklund professional services contract with Washtenaw County]

Axe did not discuss details of his fees during the working session. Responding to a request from The Chronicle, the county administration provided that information. For bonds less than $500,000, the firm is paid $5,000. For amounts higher than that, the firm is paid a combination of flat rate and percentage of the bond issue. For amounts over $2 million, the flat rate is $12,500 plus .0025% (one quarter of 1%) of the amount in excess of $2 million. Additional fees and expenses may also be incurred, according to the fee schedule. [.pdf of Axe & Ecklund fee schedule]

The fees for this bond issue fall under Axe & Ecklund’s fee schedule for capital improvement bonds, because the state legislature amended the capital improvement bond statute to permit governmental entities to bond for their unfunded actuarial accrued liabilities (UAAL). In addition, Axe & Ecklund’s bond counsel fees are reduced by 15% when the county also hires MFCI as a financial consultant.

In response to a direct question from Dan Smith, Axe replied that his firm’s fee for this bond issue would be about $485,000.

Board Deliberations: Voter Referendum

Dan Smith noted that Axe, as bond counsel, didn’t see any reason to take this issue to the voters. However, as an elected official, Smith said, increasing the taxpayers’ debt load by about $700 per person sounds like a really good reason to ask them for their opinion, “whether we have to or not.” Smith said he understands that the county isn’t required to get voter approval.

Responding to a follow-up question from Andy LaBarre, Meredith Shanle of MFCI clarified that from an historical perspective, if the proposed bond issue takes place, the debt load would be 410% (about four times) higher than the debt that the county carried 30 years ago. During the same period, the county’s taxable value increased 445%.

Wes Prater, Andy LaBarre, Washtenaw County board of commissioners, The Ann Arbor Chronicle

Andy LaBarre, right, talks with former county commissioner Wes Prater.

Alicia Ping ventured that the county would not be increasing the debt load but simply recognizing it. When Shanle confirmed this assessment, Ping stated that the county is actually reducing its future liability with this approach.

Ping said she initially agreed with Dan Smith about taking this to the voters. Then she was informed that if the county did that, certain commissioners – like Conan Smith, she noted – could advocate to increase the millage rate and use the extra money for other purposes. So she felt that by not going to the voters, the board would be limiting its power to further tax the county’s residents. Shanle said that was correct.

Ronnie Peterson pointed out that the voters could be asked whether this approach – the one being proposed by Axe – is acceptable, capped at a certain amount to cover the VEBA and WCERS liabilities. That is, a voter referendum would not need to be only for an unlimited tax bond. A referendum could be put before voters for the exact proposal that’s now being considered by the board. “That’s not an open-ended bonding proposal,” Peterson said. “I don’t want the public to be mislead by the answer to that last question.”

Axe said that Peterson was correct, and noted that there is no proposal now to levy an additional tax. The proposal, however, “would certainly free up a huge amount of money to use for other projects,” Axe added.

That’s not the question, Peterson replied. The question, he said, is whether voters could have a choice to make this decision – to retire the debt obligation for VEBA and WCERS. And the answer is that they can.

Dan Smith said he wasn’t currently proposing that the proposal be put to voters, but rather he was exploring the board’s options. If commissioners did decide to put a question on the ballot, they’d likely ask voters to levy considerably less than the current proposal, he said. The amount of a new levy plus the bond proceeds would equal the amount required to retire the debt, he said.

In this approach, voters would be asked to approve levying a millage to cover a smaller bond issue, and the county would continue to contribute a portion of the retiree obligations from its general fund. “That keeps those general fund dollars from being directed toward something else,” D. Smith said.

Axe explained that if there’s a voter referendum for a general bond issue, then voters have given the board the power, over the life of the bond, to levy an unlimited tax in any year to pay the debt service due on that bond issue. The current proposal was made, without a recommendation for voter approval, because it’s well within the county’s ability to pay these bonds without levying a tax, Axe said.

On the other hand, if you put a specific millage on the ballot to pay for the bond, Axe said, that’s a different approach and one that wasn’t considered by his firm.

D. Smith reiterated that in the approach he described, the county wouldn’t issue bonds in an amount to cover the entire VEBA and WCERS liability. The bond issue would only be in an amount to manage the county’s current “cash flow crunch,” and the board would be getting the voters’ approval to do that.

Ping gave an analogy of having a $10 budget, and using $2 of that each year to pay back the bonds. If the board decides to do other projects and can afford to only pay back $1, would it be possible to levy a new millage to pay back the additional dollar? Axe replied that this would be possible if the voters approved the bond issue. Ping then stated that under this scenario, the board could spent $9 – knowing that there was a $2 debt obligation – and levy a tax for that additional $1. Axe replied that if the voters approved a bond issue, the board would have the flexibility to do that for the next 25 years.

Ping clarified that if voters don’t approve the bond issue, the board would always be required to make the $2 bond payment from existing funds, without an extra tax. “You got it,” Axe replied.

Yousef Rabhi continued Ping’s analogy, saying that right now, out of a $10 budget the county has a liability of $1.75 for its retiree obligations. Next year that amount could be $2, and $2.10 the following year. But by borrowing to cover those liabilities with a limited tax bond, the variations in those payments will be minimal. It’s money that the county would have spent out of its general fund anyway, he said. “But instead of paying off those liabilities, we’re paying off the bond,” Rabhi said.

With a voter-approved unlimited tax bond, the amount that’s borrowed could be covered in full or in part by an additional millage, Rabhi said. So if the general fund is only paying $1 and the millage is covering the other $1, then an extra $1 has been freed up from the general fund for other uses, he said. That approach would “actually expand the realm of revenue to pay off the bond.” So the potential would be there for taxpayers to end up paying more, he concluded.

At this point, Conan Smith observed that commissioners were blending two different things. “The only person in this room who is at all interested in an unlimited tax bond is me,” he joked. No one is proposing putting an unlimited tax bond on the ballot, he said. Rather, he said, Dan Smith and Ronnie Peterson are asking whether the board would voluntarily put the general obligation bond up for voter approval.

D. Smith and Peterson indicated that this was a correct assessment of their views.

Board Deliberations: Credit Rating

Andy LaBarre asked if the proposed savings anticipated with this bond issue – savings estimated by MFCI to be more than $100 million – would positively affect the county’s general credit rating, possibly getting it to a triple-A status.

Meredith Shanle of MFCI said rating agencies have indicated generally that they’d lower credit ratings if government entities don’t address their pension and retiree healthcare obligations. As far as increasing the county’s credit rating, she said the bond proposal might have a positive impact but that’s difficult to say. It certainly wouldn’t hurt the county, she said. “It will help you.”

Brian Mackie, Ronnie Peterson, Washtenaw County board of commissioners, The Ann Arbor Chronicle

From left: Washtenaw County prosecuting attorney Brian Mackie talks with county commissioner Ronnie Peterson.

Conan Smith noted that the county doesn’t have control over the process of moving its credit from a double-A to a triple-A rating. Over the last six months, there have been a number of bonds issued in Michigan – by Oakland County, for example – that have received a triple-A rating. What have those entities done that Washtenaw County could do to get a triple-A rating for this bond issue? he asked. C. Smith also noted that when Axe spoke to the board several months ago, he had indicated that the maximum difference between a double-A and triple-A rating, in terms of the interest rate that could be secured, was one-sixteenth of a percent.

Shanle replied that she could look into specific examples, but in general rating agencies want an entity to be conservative. In the case of Oakland County, she said, they operate on a three-year budget planning cycle. They’ve made cuts in their budgets – rating agencies like that, she said. Agencies also look at the fund balance as a percentage of expenditures, she noted.

C. Smith said his line of questioning was aimed at budgetary policy. The county administrator, Verna McDaniel, came to the board with a scan of the county’s financial situation, he said. She had proposed increasing the county’s fund balance up to 20% of total expenditures. He said he was skeptical of that move, because it takes away hard dollars from the county’s ability to spend that money on programs and services.

If the county is able to win triple-A rating, C. Smith said, and the interest rate that the county pays on its bond issue drops by one-sixteenth of a percent because of that, then it would take an “awfully big” bond offering to make it a worthwhile investment – one that could result in adding $4 million a year to the fund balance. “Well now, we have an awfully big bond offering,” he said, which might allow for moves like that to make fiscal sense. It would stabilize the long-term prospects of the organization, he said, and allow for more cash-on-hand to spend on programs and services. “This is why I’m keenly interested in that calculation,” he said, and keenly interested in what the county can do quickly to improve its credit rating.

He noted that on May 1, the board authorized McDaniel to develop a four-year budget process, and he hoped that would help the credit rating. He asked Shanle to run an analysis on the interest-rate differential if the county secures a higher credit rating. He also asked for other recommendations for things the county can do over the next several months to increase their chances of a better rating.

Board Deliberations: Unfunded Liabilities

Ronnie Peterson criticized the fact that the board hadn’t been paying sufficient attention to the unfunded pension and retiree healthcare liabilities over the years.

Conan Smith responded to that complaint, saying that the county didn’t deliberately underfund the system. The county has always made its actuarial contributions to the retirement system. There were two contributing factors to the current situation, he said. The most impactful, he said, was that the county re-opened WCERS after it had been closed in the 1990s. “It was a closed plan. We opened it back up. We brought a lot of employees in, and now they’re ready to retire,” he said. “There’s been no time to develop a fund sizable enough to cover those liabilities.” [The decision to re-open WCERS was a board decision.]

The second factor was that in 2008 and 2009, the county lost a lot of money because of the market crash, he said. “It’s only 2013 – we haven’t had enough time to recoup those funds in the market.” It’s not the irresponsibility of government that has led to this point, C. Smith continued. “I want to make that absolutely clear – we have always been fiscally responsible.”

Board Deliberations: Other Options?

Ronnie Peterson asked if Axe and Shanle had looked at other options, such as transferring WCERS to the Municipal Employees’ Retirement System (MERS). Only a small subset of county employees are currently enrolled in MERS. Peterson wondered if it would be possible to do the transfer, and if it would change the county’s contribution for retiree obligations.

Conan Smith said he found Peterson’s suggestion really creative, but added that his gut feeling is there won’t be any savings from it. “We’re not going to be allowed to balance our costs on other people’s incoming employees.” He guessed the costs would remain about the same.

Diane Heidt, the county’s human resources and labor relations director, told the board that the new 10-year collective bargaining agreements specifically call for existing employees to use WCERS as the defined benefit plan. The only thing that the county could explore would be to use MERS for new hires starting in 2014, she said.

She also noted that any changes would require the county to re-open those labor agreements, which would “trigger all of the other issues that we’ve talked about.” [The new contracts, approved by the board on March 20, aimed to protect unions before Michigan’s right-to-work law took effect on March 28, and to cut legacy costs for the county. All but one of the new agreements run for more than 10 years, through Dec. 31, 2023. If the contracts are re-opened before that time, then the right-to-work law would take effect for county employees.]

Dan Smith noted that the board hasn’t been presented with other options, “and we’ve been put under incredible pressure to do this now.” He didn’t put a lot of stock in the argument about interest-rate sensitivity – saying he thought the county would end up borrowing at about the same interest rate that they would get from investing the bond proceeds. He’d like to investigate other options, rather than proceeding “headstrong” down this path. Given the law’s sunset date of Dec. 31, 2014, the board has about another year to look at this, he said.

“This truly is a restructuring of our debt,” D. Smith said. “What we’re really trying to do is to manage our cash flow.” The main concern is how to deal with the roughly $30 million annual contribution that the county would need to make to VEBA and WCERS, if the county didn’t bond. He equated it to refinancing into a 10-year interest-only mortgage. For the first 10 years, the payments are substantially less, but those payments increase when you start paying principal as well as interest.

Conan Smith said it’s important to remember that the board “set the course” when it approved those contracts and closed the define benefit plans earlier this year. He acknowledged concerns about the timing, “but in part it has to move so fast because this board closed the plan, and we’re looking at a $30 million payment in 2014, if we don’t do something.” He continued:

So it was a choice we made willfully and with full knowledge and now we’re designing a fiscal strategy to minimize the severity of the impact on our budget. That’s why we need to move fast, and I think we should move fast. I don’t want to see us taking that full amount out of the 2014 general fund. So let’s find some other way to do it. That’s critically important.”

Public Commentary, Part II

At the end of the meeting, Wes Prater spoke again and cautioned commissioners about the “visions of sugar plums” they were seeing from projected savings. He noted they were operating in a global economy, pointing to the ongoing financial crisis in Greece. All of the assumptions could change “with the line of a pencil,” Prater said. He indicated that the board was moving too fast, with not enough scrutiny and too many unanswered questions. Structural changes need to be made, he said, and the county needs to tighten its belt. He said he planned to be part of the process to help do that.

Doug Gross also spoke a second time, noting that to satisfy current employees, the county is discriminating against younger people, who won’t have access to the defined benefit plan. At a certain point, those new employees will want a better plan and the board might reverse itself and decide to re-open the defined benefit plan again. That’s what happened in 2008, when the board re-opened WCERS and pulled a lot of employees into the plan – when it had previously been closed in the 1990s. “You’re basically laying the groundwork to do the exact same thing all over again,” Gross said. The county needs a sustainable plan it can actually afford.

Thomas Partridge criticized the working session for being an unbalanced, single-issue meeting, even though the residents face multiple other issues, like homelessness, affordable housing, public transportation and health care.

Responding to the public commentary, Andy LaBarre – who chairs the board’s working sessions – said that the purpose of this meeting had been to discuss a single issue, and to have a policy discussion about the bond proposal. At this point, he said, this proposal is a possibility, not a certainty. “The die has not been cast.”

Present: Alicia Ping, Felicia Brabec, Andy LaBarre, Kent Martinez-Kratz, Ronnie Peterson, Yousef Rabhi, Rolland Sizemore Jr., Conan Smith, Dan Smith.

Next regular board meeting: Wednesday, May 15, 2013 at 6:30 p.m. at the county administration building, 220 N. Main St. in Ann Arbor. The ways & means committee meets first, followed immediately by the regular board meeting. [Check Chronicle event listings to confirm date.] (Though the agenda states that the regular board meeting begins at 6:45 p.m., it usually starts much later – times vary depending on what’s on the agenda.) Public commentary is held at the beginning of each meeting, and no advance sign-up is required.

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  1. By Steve Bean
    May 7, 2013 at 12:27 pm | permalink

    “…the new 10-year labor deals approved earlier this year had been key to moving forward with this bond proposal. […] Unless the defined benefit plans were closed, the county would not have been allowed by law to proceed with this type of bonding.”

    If “labor deals” refer to wage contracts, then they will more than “mov[e] forward” the bond proposal, they might very well necessitate it, if not this year then eventually, current sunset date notwithstanding.

    Wages and other costs will deflate in coming years, which would otherwise have been manageable circumstances for what John Axe predicts to be “horrible budget problems”. Does it make sense to take advantage of currently low interest rates (they are already heading up and will continue) to address this at the risk of not being able to repay the debt? The board seems to have made its decision more difficult by locking in costs (if that’s the case) at a time when revenues are poised to drop with deflating property values.

  2. By Joe Zurawski
    May 7, 2013 at 1:24 pm | permalink

    The Washtenaw County Board of Commissioners has a long history of making (I’ll be charitable) “Questionable” financial decisions. This proposed sale of bonds is right up there with the best of them. The sale of bonds should be done ONLY to finance infrastructure. Think of it like as a capital investment like buying a home or car. Instead our esteemed commissars are proposing to use the sale of bonds to pay for expense items they SHOULD have been setting money aside for all along. Think of it like buying beer and cigarettes and paying for them with your credit card.


  3. By Steve Bean
    May 7, 2013 at 1:53 pm | permalink

    I appreciate Doug Gross’s cautionary comments. An assumption of 6.5% return is unrealistic, certainly for the life of the bonds if not just the rest of this year. We’re heading into a decades-long depression (or back-to-back, shorter ones), perhaps global in scope in a matter of several years.

    “However, those figures were based on assumptions that haven’t been updated since 1999.”

    I was wondering what the assumptions were. 1999 was 18 years into the longest bear market in history, a year before the orthodox top. We’re in a similar position today with the stock market once again topping.

    “The review will focus on investment returns, mortality, wage inflation and core demographics since 2009, with a more in-depth study scheduled for a later time.”

    Looking at the recent past that encompasses the “b” wave upward in stocks (and corresponding economic improvements) while overlooking the period of 2000-2008 would be foolhardy. The near future will look much more like 2002-2003 or 2008 than 2009-2013. More specifically, as Robert Prechter, Jr. suggests in Appendix C (Figure C-16) of his book, Conquer the Crash (2nd edition), it might look very much like a larger-scale version (months vs. days) of late 1987 [link].

  4. May 7, 2013 at 2:11 pm | permalink

    Re (2) I can only agree, having been on the BOC for many of those disastrous years when we were spending with abandon. I was unpopular and have had accusations made that I am “difficult to work with” because I kept raising questions. Being “right” in retrospect is no balm.

    I’ve told this story before, but here goes again. Our budget director repeatedly presented us with glowing 10-year projections and the mantra, “the best predictor of the future is the past”. This was after several years of the biggest real estate bubble in history. We seriously overbuilt and committed to such schemes as the Sylvan township bonds (county full faith and credit) predicated on a rosy development scenario (it didn’t happen). Among other adventures, we built a Head Start school (not our responsibility) which the county is now trying to dispose of and the Zeeb Road building (now mostly empty).

    Is the past prologue? Probably not, at least in that precise way (the collapse of the real estate bubble). But I hope our current commissioners will show a hearty dose of skepticism toward any long-term projections of interest rates, investment returns, etc. (as a number of them appear to be doing). While I don’t necessarily buy in to Steve Bean’s scenario, the last decade and a good read of the current newspapers should show that we are in uncertain times. It is no time to gamble with public money, which is what this proposal is. (Tell me that there are any investment plans that do not represent either gambles in the stock market or interest market.)

    I’ll quibble with the analogy in (2). It is more like trying to pay for your past due mortgage payment by borrowing on your credit card and investing that money in a plan that your Uncle Joey is selling. He says it is a sure thing and will double your money in no time. Great guy, Uncle Joey. What could possibly go wrong?

  5. By Joe Zurawski
    May 7, 2013 at 3:04 pm | permalink

    Vivienne – I L-O-V-E your analogy in the final paragraph!

  6. By Larry Baird
    May 7, 2013 at 3:47 pm | permalink

    Glad to hear about the 45 day notice of intent and voter referendum (petition drive) possibility.

    If the BOC continues along this proposed, “rushed” timeline and begins making decisions (initial vote) without complete, up-to-date information, then the voters may just have to file those petitions and ask for a say in this matter.

    Does anyone know how many signatures would be required for such a petition drive?

  7. By Steve Bean
    May 7, 2013 at 3:48 pm | permalink

    Conan Smith’s assessment that issuing bonds would lessen the county’s risk is faulty. It’s based on assumptions wherein the risk resides.

    Stability is not a lack or reduction of risk, it’s a lack or reduction of uncertainty. He was apparently conflating the two concepts.

    The risk in issuing the bonds is higher than not doing so by the introduction of an unknown rate of return on held funds.

    If the rate was higher on average than the interest rate paid on the bonds over the full bond period, then Conan could raise his arms in triumph. If the rate of return on the invested funds was lower than the projected 4% (and it almost certainly would be), this approach wouldn’t ‘pay off’.

    In any case, this is not a minimal-risk proposition.

    I do agree with John Axe that the sooner the better in terms of interest rates. They might dip briefly in the near term (weeks to months), but the long-term trend is upward. If this were about refinancing existing debt currently at a higher rate, now would be a good time. That doesn’t seem to be the case.

    Another option would be to bond for a portion of the WCERS and VEBA obligations, rather than for 100% (or more). That might be a workable compromise if the board is split, but I would still oppose it.

  8. By Larry Baird
    May 8, 2013 at 8:46 am | permalink

    Re (6) The answer to my own question, is 10% of the registered voters in the county up to a cap of 15,000

    So 15,000 required signatures in 45 days would be required to put the pension bonding decision to the voters, unless the BOC wishes to do the right thing and ask for voter approval.

  9. By Conan Smith
    May 13, 2013 at 7:35 pm | permalink

    Steve, I think you are actually not understanding that the risks inherent in the bonding strategy (the probability that it will or will not produce the results we desire) are directly related to the stability of the county budget (our expectation that strategy will result in the reduction of uncertainty in the amount we will have to pay annually for retiree benefits). There are two separate but interrelated issues driving this bonding strategy that folks ought to be taking into account. The first of those is the county’s portion of the actuarially required contributions to the pension and OPEB plans set up for current employees, which are estimated at $24-30M annually. The second issue is the county’s annual budget and our capacity to invest in critical community programs.

    The retiree liabilities are existing debt, we have a contractual obligation to provide these benefits. Most of that debt is not capitalized in any way. Some of it is fundable through the assets of the WCERS and VEBA investment funds, but the unfunded liability is about $340M. Not having a source of capital locked in for this liability threatens the long-term stability of the County because it introduces volatility into the annual budget process. While our boards have consistently made the actuarially required contributions, it is conceivable that future boards won’t (as has happened in many communities). That potential and its consequences (emergency management, declining bond ratings, etc) are some of the risks we are trying to mitigate with this bond strategy. Again: this debt already exists for the County; bonding brings it into the open and secures a fund via which it can be retired.

    When the County closed WCERS and VEBA as part of the new labor agreement (incidentally, I did not support closing WCERS), it locked us into a scenario where the contributions to the retiree funds would be unusually high until the plan had no more beneficiaries, in large part because new employees would not be contributing to the sustainability of the plans. That burden on the general fund, unless managed proactively, will further compromise important programs for community priorities (e.g. our general fund contribution to offset road patrol costs in our townships). Bonding for the liability provides a more predictable figure for the County to budget against and the arbitrage opportunity (Steve, where you say I raise my arms in triumph), provides a potential annual offset to the impact of retiree liabilities on the budget ($2-4M each year or $25-$100M over the life of the bond).

    The risk that the fund would underperform is mostly moot: if the investment of the bond revenues underperforms, so would the WCERS and VEBA trusts if we do nothing. We’d be stuck with the same complicated situation of having to fund retiree benefits with more general fund dollars.

    Joe, to suggest that bonds should only be offered to capitalize infrastructure misses the whole point of the instrument. It is a tool for insuring indebtedness to the lender. Having a capital asset in public bonding is mostly meaningless — unlike a housing mortgage, a bond-holder can’t repo your public road if you miss a payment. Rather the security is the full faith and credit of the borrower (typically) and has nothing to do with the underlying asset being capitalized. In the case of this bonding scenario, the instrument is probably more desirable than an infrastructure bond because the County is already budgeting for payment on the asset. In the case of infrastructure, you’re often adding a new expense to the budget.

  10. By Steve Bean
    May 13, 2013 at 9:03 pm | permalink


    Thanks for the reply.

    “the risks inherent in the bonding strategy… are directly related to the stability of the county budget”

    I understand that.

    “the arbitrage opportunity… provides a potential annual offset”

    “The risk that the fund would underperform is mostly moot: if the investment of the bond revenues underperforms, so would the WCERS and VEBA trusts if we do nothing.”

    “potential”=risk. I didn’t doubt that you got that. :-)

    However, you seem to be suggesting that we double down.

    Have you considered that taxpayers like Joe might prefer a little uncertainty to a much larger, though stable, tax bill?

    With regard to potential returns (“that the fund would underperform”), I don’t think you’ve considered (as Dan Smith seems to have, at least conceptually) the potential worst-case scenario like an extended version of 2008′s deflation of stocks and property values.

    From my ongoing study of the stock market and global finance, I’d say that the choice before you is not between (A) an unstable budget with a potentially underperforming fund and (B) a stable budget with a potentially underperforming fund. Instead it’s between (A) a large debt and (B) a larger debt in the midst of plummeting property tax revenues. In other (your) words:

    “We’d be stuck with the same complicated situation of having to fund retiree benefits with more general fund dollars.”

    Better that than to be stuck in the same situation with LESS general fund dollars.

    Choose the large debt and ask us to just pay it and make the necessary, difficult choices. The alternative (the realistic one, that is) would be almost certainly more costly.

    I also don’t think that the board’s responsibility is to minimize future risk taken on by future boards. Even if it were possible for the board to do so (which seems unlikely), current—not future—voters elected you. After all, you don’t hold past boards responsible for the risks this board has taken, right?

  11. By Conan Smith
    May 14, 2013 at 10:25 pm | permalink

    Steve, I’m not understanding how the bonding scenario results in a higher debt load for the County (but believe me I could have missed something, there being a load of details). My read is essentially that we are converting a portion of the unfunded retiree liability to a budgeted bond liability. Help me understand what you’re saying about both the doubling down and the increase in the debt. Yousef and I talked just yesterday about one of the major risks being the occurrence of a market downturn at a maximally in opportune moment, but I am still struggling to understand a scenario where the current situation is more secure or less costly than the bonding option. At any point it seems that a market downturn would impact the sole relance on the WCERS/VEBA trusts more dramatically than if we have the bond intermediary fund since without the bond cushion both the funds and the County general fund are likely to suffer, meaning the continued draw of retiree benefits cracks both the corpus of the retiree trust and the general fund where in the bonding scenario the general fund is more insulated. Does that make sense?

  12. May 15, 2013 at 6:42 am | permalink

    I think the key point in (11) is this: “My read is essentially that we are converting a portion of the unfunded retiree liability to a budgeted bond liability.” What Conan Smith and some other commissioners appear to be hoping to do – with both the 4-year budget and this bonding plan – is to secure a firm, predictable financial outline in which these costs can then be set aside – leaving other county monies available for new projects and initiatives. That is one of the things that concerns me – that this is only the first step in expending even more county funds, once this problem can be said to be “solved”.

    Smith is arguing that the only uncertainties are vagaries of the stock market, which apply both to this scheme and to the existing trust funds. But the proposal will actually cost more upfront, and does not have a guarantee – except that the county is guaranteed to have to pay the interest! Meanwhile, the VEBA and WCERS future contributions are also only actuarial estimates. They might actually decrease. By continuing to pay the excess needed out of general funds, the county maintains a flexibility of response.

    I’ll look forward to the further exposition of the plan, with information provided by Monday’s press conference. I understand that the Chronicle was present.

  13. By Steve Bean
    May 15, 2013 at 8:46 am | permalink

    Conan, as Vivienne pointed out, the interest on the bonds would be the increase in the debt.

    The way the current situation could be less costly than the bonding scenario (but still very challenging) is if the market downturn is not just a downturn in stocks but also a broad, deep deflationary event, which is what we are ”due’ for.

    In that scenario, property values would drop as well, unemployment would increase, and wages would fall. Foreclosures would multiply again. The tax base would be greatly reduced, stressing the county’s ability to pay off existing debt. (Debt would be the main challenge since costs in real time would also be dropping due to deflation.)

    The kicker would be that most investments would not just “underperform”, they would lose most of their value (principal). Bonding would put the county in a position of needing to make a positive return on the held funds. That would be extremely challenging in a deflationary collapse. Corporations would be going bankrupt, which would devalue not only their stocks but their bonds as well. Municipalities would be defaulting on bonds in large numbers. Only the most secure bonds might retain their full value, and the bond-rating agencies have demonstrated that they are not truly good judges of which are most secure.

    So even the held funds could be at risk of being lost due to this timing. By that I mean that the deflation that history has shown will likely occur over the next several years would coincide with the county receiving a lump sum. Much of that could be lost in the first wave (of five) down, which would occur over the next year or so. Much of what’s left could be lost in the longer third wave (the “crash”) a few years from now. In order to get a decent return you have to maintain your principal, and neither would be easy.

    The best approach for the county (and the city, as well as individuals) would be to protect its financial assets in the form of cash (which goes up in value during deflation—”cash is king”—the dollar has already begun its rise) and pay off existing debt.

    While investing in dollars would be safe, it wouldn’t help with bond interest payments because those are also dollars (i.e., the return on cash is 0%)—the burden on taxpayers would still be greater with the additional bond interest payment debt, and the risk of default would be high.

    If the county has the discipline to hold cash and limit other investments to US Treasury notes (short term, since interest rates will continue to rise, though it could be a while before they top 4%—that’s also assuming that the federal government doesn’t ultimately default, but at that point we might be ready to throw in the towel on this whole money idea anyway), bonding could possibly work out.

    But then there’s that future risk you referred to. Would a board two years or so from now at the top of the second (corrective, upward) wave in the stock market think that a recovery was underway and that they needed to get higher returns? Most likely. Then the crash (wave three) would come and wipe out most of that riskily invested principal. (Maybe I take back what I said earlier about minimizing future risk.)

    Getting to your question of whether the more-insulated general fund scenario makes sense, the reason I think it doesn’t is because of the above and, specifically, because you overlook the potential for negative returns (i.e., loss of principal). That’s where I was referring to an unrealistic alternative—you can’t have a glass that’s half full if you don’t have a glass.

    The current situation is clearly challenging. Pretending that it’s not would most likely make matters worse. You’re not doing that. The challenge for you is to not pretend that matters (beyond our control) couldn’t get drastically worse. The probability that they will is high. That means more risk.

  14. By Steve Bean
    May 16, 2013 at 11:11 am | permalink

    Will 1661.39 in the S&P 500 (15,300.68 in the Dow) at 12:49 yesterday prove to be the market top?

    After several ‘false tops’, humility is in order. It’s a valid count, though. If it’s not the top of the fifth wave, it’s likely the top of the third, with the fifth to come in due time. If it breaks below 1623.40 (the bottom of the previous fourth wave of one lower degree) by the middle of next week, that would indicate that it was the fifth wave and that the uptrend that began in 2009 had ended.

    Today, the third sub-wave downward is beginning in the S&P. It will likely fall rapidly over the next several hours after completing the upward corrective second sub-wave around 1658. It’s going sideway below that line currently.

  15. May 16, 2013 at 12:11 pm | permalink

    Steve, I wonder whether your wave model was constructed to accommodate the extraordinary effort by the Fed to pump up the stock market. They have an overt and unapologetic mission to keep those numbers high and are printing money to make it work. (Also, making interest rates so low that savers are pushed into stocks.) Unless the Elliott wave model has some means of adding in such an activity, I doubt that it can be very predictive under the current circumstances.

  16. By Steve Bean
    May 16, 2013 at 1:34 pm | permalink

    Good question, Vivienne.

    The wave principle (as it’s called—and it’s not mine) wasn’t constructed but rather observed. It describes the historical movements of stock market indexes as well as many individual stock, bond, and commodity prices over time, which play out according to rules and guidelines that make them predictable to a certain degree.

    The Fed can do what it does, but it can’t control social mood and the decisions of millions of people. In the context of QE, the waves no doubt play out differently than they would otherwise, but they’re still a reflection of social mood—the most immediate one, in fact, since people can buy and sell in a matter of a very short time.

    One might say that like every other influencing factor, the Fed’s actions are ‘baked in’. In this case the waves might extend longer but there won’t be a sixth wave, for example—five is still the limit (with special exceptions for extensions and combinations). So one might also say that the Fed has simply postponed the inevitable. Robert Prechter, Jr. addresses this subject more extensively in his book, Conquer the Crash.

    And now that the second sub-wave continued up even higher this morning I’m even more humbled (or is it humiliated?) :-) Trying to predict the next movement at that scale is just fun (unless, of course, your livelihood depends on it). At the Supercycle scale, though, the big movements affect all our lives significantly.

  17. May 16, 2013 at 4:08 pm | permalink

    Steve, I knew that it wasn’t “your” model, just “the one you espouse”. And I surmised that it is observational. I wanted to point out that the Fed’s actions could alter timelines. An article in the NYT today discussed the current stock bubble. It seems likely that it will peak before long, but predicting on a day-to-day basis seems dicey.

  18. By Steve Bean
    May 23, 2013 at 10:54 am | permalink

    The point in watching the market closely is to determine whether the long-term prediction is playing out. And it is. Not paying close attention—and deciding on an escape route—is like ignoring the tsunami warning sirens.

    After all, there’s no point in not ‘predicting’ a cataclysmic event until after it’s happened. Having an idea of what’s ahead can help us see it when it’s happening, so we don’t mistake it for a lesser event while in the midst of it.

    Preferably, we will take the warnings seriously and adequately prepare in advance. Some of us have done that. Those who haven’t still have some time: on the order of months to a year before the (just-beginning?) downward wave 1 finishes and the corrective wave 2 rebounds part way up to yesterday’s high (assuming that holds up) and is then followed by the swift downward wave 3 (all at Cycle level, one degree below Supercycle) over the course of the subsequent year or so. Negative impacts on the broader economy will likely lag by several months to a year or so. And by “negative”, I mean Great Depression scale.

    My purpose in regularly sharing my thoughts on this subject has been to familiarize people—including our local government representatives—with what’s happening. Many of us don’t pay attention to what’s happening with our financial investments (retirement funds in particular) and get complacent when the headlines say it’s all good and/or getting better, which is the peak optimism that accompanies a market top.

    As I said to the mayor when I met with him a few months ago, there’s no good time to talk to people about this. So I just started as soon as I realized that too soon was better than too late. That was back in December. What I thought might be an eleventh-hour alarm turned into a 6-month-long heads up. So be it.

    This is part of the big-picture context within which the county board will be making its decisions about issuing additional debt.

    Update: The high (S&P 500) on last Wednesday appears to be the top of the third sub-wave, followed by the sideways fourth and the upward fifth that peaked yesterday morning. That would complete the double-zigzag Supercycle B wave that began in March 2009.

    If instead yesterday’s top is the end of the third sub-wave (wave counts aren’t always clear until some time passes), a fourth (the drop that started yesterday) and fifth would follow over the next month and a half or so. (Other timing indicators point to May—that is, yesterday—being a more likely period for the top, which also fits with the currently high sentiment indicators of a significant top.)

    Whether it has already begun or doesn’t for several weeks, the downward Supercycle-degree C wave will be of one higher degree than the C wave that included the crash of 2008. (The B wave that’s wrapping up was one degree higher than the B wave that spanned from the bottom in 2002 to the top in 2007. The crash of 1987 was also part of a C wave that was several degrees lower than this one that’s getting underway. See comment #3.)

  19. By John Q.
    May 23, 2013 at 12:31 pm | permalink

    I think this criticism [link] of the Elliot Wave Principle concepts pretty much sums up my take on all this. I’m not discounting the principle that there is an emotional aspect to market behavior. But I find the efforts to predict the “waves” to be about as useful as the take on the markets from the screaming heads on the various financial news outlets.

    The Elliott Wave Principle, as popularly practiced, is not a legitimate theory, but a story, and a compelling one that is eloquently told by Robert Prechter. The account is especially persuasive because EWP has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations. I contend this is made possible by the method’s loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude. This gives the Elliott analyst the same freedom and flexibility that allowed pre-Copernican astronomers to explain all observed planet movements even though their underlying theory of an Earth-centered universe was wrong.

  20. By Steve Bean
    May 23, 2013 at 4:19 pm | permalink

    Interestingly, the EWP and the “screaming heads” ARE about equally useful, as the EWP is an observation of the social mood that the screamers represent. Equally useful, but oppositely indicative—when the screamers finally think it’s a roaring bull market (like now), that’s when the bear market begins. Watch for the optimistic headlines over the next month or so that express that optimism (with “!!”, yet), even as the market doesn’t reach new highs. (Of course, there’s also that underlying reality of the still-weak economy and that there’s something ‘not quite right’ about the ongoing market rally up to this point. That’s typical of a B wave, per Prechter.)

    I certainly wouldn’t want to try to use the EWP to make a living. It’s not that easy, and the rules and guidelines, while not “loosely defined”, imo, (and much more extensive than what Wikipedia lists) don’t turn probabilities into certainties. Yet, at the longer-term scale, I think it makes sense to consider what it has to offer along with other context, especially at a juncture like this where being prepared for the worst (when “the worst” really would apply) can make a big difference for individuals, families, small businesses, and communities.