PERSPECTIVE - President Obama has accused Governor Romney of outsourcing jobs overseas while with Bain Capital.
Romney countered by stating that the President outsourced stimulus spending.
The truth is that neither can stop outsourcing -- it is the natural course of the global economy. We vote with our wallets. That means cheap overseas products and services win most of the time.
But there is a form of outsourcing we can stop. It is occurring in a majority of cities and states, including Los Angeles and California.
I’ll focus on Los Angeles.
Objectivity and judgment are essential components for assuring the existence of transparency. Knowing the true value of the city’s services and financial condition is essential for voters to assess the effectiveness of our local government.
City Controller Wendy Greuel has outsourced both of these components with the blessings of the mayor and City Council. She has used the city’s audit firm Simpson and Simpson as a means to that end. Councilman Dennis Zine will likely follow Greuel’s example if he is elected to succeed her.
It is common practice for organizations and auditors to rely on financial statements audited by other CPA firms for related entities, or assessments by outside experts to determine the consolidated assets, liabilities, income/loss and equity of a company, government, school district or any other reporting unit.
Relying on the work of other professionals does not necessarily relieve a CPA from responsibility for material errors and omissions made by others … and the city’s public pension plans are subject to a high degree of risk when it comes to estimating the unfunded pension liabilities.
Simpson and Simpson routinely relies upon the audit reports and actuarial assumptions of other professionals to help form an opinion on the overall financial statements of the city. One of these reports is the actuary’s analysis of the public employee pension plans. The Segal Group is the actuary for the city.
The reports reflect an earnings rate assumption of 7.75% on the plans’ assets. The civilian plan’s rate was only recently reduced from an 8% assumption.
There has been much debate over what rate assumptions should be. Generally, academia and financial sectors, along with notable leaders, among them Mayor Bloomberg of New York and billionaire Warren Buffett, believe that public plan earnings assumptions are unrealistic. About the only ones supporting the use of high rates are the public unions and the politicians they routinely support – no surprise.
Consider this: the yields of the 10-year bonds of Spain and Italy are hovering around 6.5%. We can all agree that these two nations are at some risk of defaulting without a bailout. Those yields should shed some light on the aggressive strategy implicit in the city’s public pension funds to return 7.75%.
The mainstream media outlets have been significantly increasing their coverage of this issue, too.
They have clearly highlighted the risks associated with defined benefit plans, risks that are the result of union employees failing to contribute a fair share from their paychecks to cover future benefits.
Given the increased publicity and frequency of studies over the last few years about the solvency of public pension funds, you have to be a caveman not to take notice. Ignoring the ramifications a volatile world economy has on earnings potential is the equivalent of burying your head in the sand.
Simply trusting published estimates of unfunded liabilities from a single non-independent source, especially estimates using only a single assumption, is gambling with the future of Los Angeles.
But that is what Greuel is doing, and she has the perfect partner in Simpson and Simpson to support her.
The Government Accounting Standards Board (GASB), which sets generally accepted accounting principles (GAAP) for state and local governments, has been soft in its policy regarding the recognition of pension liabilities. Another name for GASB could be the Generous Accounting Standards Board.
GASB forms a convenient shield for firms, such as Simpson and Simpson, and Controller Greuel to hide behind.
Greuel has an obligation to disclose potential financial risks to the city, its residents and stakeholders, both long- and short-term. Instead, she focuses on the headline grabbers – generally those stemming from waste, fraud and abuse (the values are estimates) that she claims are the reasons for the city’s dire financial situation.
In reality, her findings are small potatoes that have nothing to do with the structural deficit dragging the city down.
And the structural deficit is driven by ever-increasing pension and health benefit contributions by the city to employee retirement plans.
Simpson and Simpson, too, has an obligation to inform the public of the risks facing the city. Lest they forget, the “P” in CPA stands for “public.” That’s us.
The attestation of third-parties does not relieve a CPA firm from questioning the results when contrary evidence from reputable sources is available and widespread. Just because the unions do not agree with alternative views does not mean they are wrong or any less reliable than the in-house assumptions used by the LACERS and LAFPP boards.
Alternatives must be seriously considered in evaluating the unfunded liability in order to serve the needs of those who rely on the audited financial statements of the city. If anything, the unfunded liabilities could be construed as contingent liabilities which require full disclosure in the footnotes to the statements, if not actually recorded.
As more cities across the state and the nation declare bankruptcy, the more likely CPA firms will be sued for negligence due to their failure to adequately disclose pension fund risks.
Unfortunately, self-serving politicians such as Greuel will be virtually immune to such lawsuits.
So what should be disclosed if the city and its auditors want to fulfill the public’s need for transparency concerning pension funds?
A comparative analysis of the unfunded liability using different earnings rate assumptions would be a good start. I do not expect anyone, including the pension boards, Simpson and Simpson and Greuel, to have a crystal ball that predicts future returns - quite frankly, I expect very little from Greuel about anything.
All the more reason why alternative projections must be disclosed for stakeholders to draw their own conclusions.
I would go one step further – a presentation of the unfunded liabilities without the effect of smoothing.
Smoothing is used to spread the impact of investment gains and losses to future periods in order to reduce what are considered short-term distortions to pension portfolios. While the technique serves the needs of actuaries, they tend to obfuscate the true results.
Smoothing assumptions are very subjective and have been used as excuses to reduce the city’s annual pension contribution in order to close a budget gap. In effect, smoothing has become a source of back door financing of the annual budget deficits – undisclosed loans against the future.
We can stop this legerdemain by insisting on enhanced disclosure as I have outlined above.
We should also insist on rotation of CPA firms, a practice followed in Europe to foster independence and objectivity in audits.
It would also help if we end Wendy Greuel’s and wannabe controller Dennis Zine’s political career in the 2013 elections.
(Paul Hatfield is a CPA and serves as Treasurer for the Neighborhood Council Valley Village. He blogs at Village to Village, contributes to CityWatch and can be reached at: [email protected]) –cw
CityWatch
Vol 10 Issue 65
Pub: Aug 14, 2012