Hidden Debt – Hidden Risk


This is the debt story of zip code 80301-80305.

As many won’t follow this post, I’ll give you a rule of thumb.

If you are under 50 years old then reduce your social security and defined-benefit pension assumptions by 35%.

…and plan on working an extra five years.

What follows is why.

Back in 2005, I came across covenant free loans => banks lending money without rules or restrictions. That observation, combined with reading Fooled By Randomness, started a process of de-risking my life.

Despite taking a whack to my family’s net worth in the last recession, life has worked out well.

It worked out because I had reserves to get me through the tough years.

Collectively, our reserves are being spent on our behalf.

This fall Colorado is asking voters to approve a modification to TABOR, our state’s “bill of rights” for taxpayers. The supporters have a strong pitch, if you vote in favor then the money goes to schools and roads => I love schools and roads!

At the last recession, I was burned because I increased spending to the top of the cycle. So I’m inclined to keep the state’s powder dry for other uses.

What other uses?

PERA => our public employees retirement fund => we’ve been told the fund was fixed last year. The fix assumed net returns of 7.25% per annum going forward. However…

if PERA’s actual returns are 6.75 percent, the debt grows by $5 billion.

Round numbers, every 1% shortfall in PERA net returns creates a need for an additional $10 billion. As I publish this article the 30-year treasury is trading at 2.24%. A net return of 5% over treasuries strikes me as unlikely.

How does that potential shortfall compare to State Tax & Excise Receipts?

Fiscal year 2019/20 Colorado revenue receipts are forecast to be $12.6 billion.

Now, you don’t need to fund a pension deficit immediately. It can be dealt with gradually with a mix of benefit cuts, increased employee contributions and increased government funding. That’s what all parties did with the 2018 fix.

It’s a safe bet that state taxes are going up and benefits are going down.

In the last recession, my unemployment resulted from the credit markets slamming shut and creating a liquidity crisis…

  • The bank went bust
  • The developer went bust
  • The general contractor (and many of its subs) went bust
  • The management company went bust
  • The equity went to zero (within 90 days)

All of the above, culminated with the CEO going bust.

Chains of debt are lethal in recessions.

Noticing the debt bomb sitting in Colorado PERA, I asked myself, “Where else have people borrowed on my behalf?”

  • School district borrowing => ~$800 million in my district => money very well spent to strengthen our future tax base
  • CU Boulder is my neighbor => ~$1.5 billion on their books => the university has a big impact on my local economy and real estate market
  • City of Boulder => ~$225 million => big ballot initiative coming as they want to borrow big, take technology risk and purchase utility assets on our behalf
  • County of Boulder => ~$200 million at the end of 2018
  • State Level => ~$10 billion at the middle of 2018 => over $50 billion if PERA used a rate of return similar to my own

Sitting above it all => $1 trillion Federal Deficit and $22.8 trillion of National Debt.

There could be some double counting and I might have missed another public entity that can issue bonds on my behalf. The precise numbers don’t matter.

This is what matters…

#1 – there is leverage through the entire taxpayer chain with no consolidated visibility or oversight. No consolidated financial statements for you, the taxpayer. The ratings agencies have the entire debt chain rated as very safe. Does this sound familiar?

#2 – every single government entity that touches me has a debt-financed cash flow deficit and off-balance sheet commitments. This sounds familiar as well.

Debt financed, cash flow negative entities blow up.

I remind myself:

  • As a society, we can’t increase taxes at every level simultaneously. This counters my thought, “it will work out, I’m lightly taxed right now.”
  • 600,000 members of PERA are at risk and probably taking comfort from 2018’s fix.
  • If you are planning on receiving a defined-benefit pension then cut your assumptions and plan on working (at least part time) until you are 70 years old.
  • People are going to be pissed when financial reality hits their benefits.

What to do?

Protect your family by saving, investing conservatively and reducing your “total tax bill” as a percentage of net assets => this limits the government’s ability to hurt you via tax increases. I’ve been doing this since 1990 and it works.

Let’s say that again because your financial advisor will not focus you on this number…

“Total family taxes” as a percentage of “total family net assets” is a number you should manage downwards across your career.

Knowing that the system is highly leveraged:

  • keep personal borrowings low
  • be careful with long term obligations (leases)
  • don’t issue personal guaranties
  • don’t capitalize luxury spending

Being able to take pain => how might these scenarios impact your family?

  • 6 months unemployment
  • retirement benefits being cut by a third
  • social security benefits being cut by a third
  • portfolio value cut by a third

I’ve lost jobs, written down portfolios (65% in 90 days, ouch!), put my employer into insolvency (on my 40th birthday) and muddled through multi-year cash crunches (2009-2012).

Bad things happen and life remains pretty good even when they are happening => my wife’s companionship and leadership got me through.

Be careful out there.