A better alternative to Washtenaw County's $345 Million bond issue plan
Washtenaw County's Commissioners are seriously considering a plan to borrow up to $345 million to fund the shortfall in the county's retirement plans.
The plan is misguided and likely to cause the county and its taxpayers further material losses. The merit of borrowing now is that long-term interest rates are low, however that money will be invested in stocks and bonds, which are at high levels.
For stocks, the 10 Year Cyclically Adjusted PE Ratio is 50% above the Mean & Median of the past 122 years. The Tobin Q ratio is more than 45% above fair value. So any benefit from borrowing at current record low interest rates is likely to be given up though future substandard investment performance. Bonds are at yields even lower than in the depths of the Great Depression.
The short-term benefit generated by the financial engineering the bond deal promises will turn into future losses. Some of the commissioners want to use these paper profits to close a multi-million dollar annual deficit instead of cutting spending in line with revenues.
I suggest that there is a better alternative. Let me share with you a story from my own past.
Back in 1988 when I was 23 years old, Bank One lent me $3.2 million to buy a tiny bank today known as University Bank in a leveraged buyout because I figured out something the sellers didn't know, that the bank's pension fund was overfunded.
After buying the bank, I terminated and defeased its pension plan by buying an annuity from a AAA rated life insurance firm. The extra funds, some $800,000, I used to fund an Employee Stock Ownership Plan for the bank's employees, which purchased common stock in the bank holding company and paid down Bank One's loan. This greatly reduced the loan, raised the equity in my firm, and gave Bank One the confidence to back my loan.
Similarly, the county could take advantage of over optimism among professional investors and defease it's retirement plans by buying an annuity from a top rated insurance firm.
While this would also require a borrowing to close the large gap between the plans' assets and liabilities, by terminating the plans and buying an insurance annuity, the county would eliminate its future investment risk and lock in today's low interest rates. The cost of this plan is likely to be lower than the plan on the table because insurance companies are hungry for these kinds of long-term annuities.
Because the plans are defeased, the risk of investment underperformance will never haunt the county or it's taxpayers.
The one downside of this plan is that the county loses permanent control of the over half billion in pension fund dollars.
However, if there is no intent to use any of these funds for local economic development, that is no great loss and in fact prevents possible future mischief. The sum that is targeted for economic development can be set aside and an annuity for the rest of the plan liabilities can be purchased. In fact, I recommend this same course of action to all the other units of government in the county to reduce their future risk from the likely under performance of their retirement plans over the next decade.
(Stephen Lange Ranzini is president of University Bank and resident of downtown AnnArbor. He's also an occasional columnist on AnnArbor.com.)