Potential Fall-out of State Economic Woes Robert Daddow Deputy County Executive

1. Potential Fall-out of State Economic Woes Robert Daddow Deputy County Executive

2. TAKE AWAYS The ‘take away’ question is - how does it impact my local unit of government? Often referenced as ‘economic environment’ – one of four major criteria used in the evaluation of bond ratings. Much of the matters herein are not controllable by your actions. The revenues used to address the substantial fiscal needs at the State, other local units of government and / or other projects will compete with the ability of local units to provide core services (police, fire, EMS, education, etc.). Revenue resources are limited given the economy in general at the same time the needs to support individuals affected by the economy has never been greater. Federal government – uncertainty as to whether the federal government can afford to solve states’ fiscal problems as they are structural in nature – with their own looming deficits. State leadership has not addressed the State’s fiscal issues and provided the fiscal stability for subordinate governmental units. They have no long-term fiscal plan – the Governor continues to work on the 2010 educational shortfalls. No fund equity remaining. Cash flow needs substantial. Unfunded retirees’ healthcare obligations well over $40B.

3. TAKE AWAYS – (Cont.) • Substantial operating needs in region – running many tens of billions with substantial difficulties in funding these ‘new’ programs against a public with high unemployment, losing their homes, etc.: • Regional transit – retention of SMART millage; $10B expansion for rail. • Road maintenance, bridges, highways, etc – several billion per year requested. • Water / drain projects – compliance with federal regulations. • Fiscally faltering school system. • Public safety declines with reduction of State revenue sharing and at a time that felons are being released from prison. • Numerous local units of government failing. • Increasing social needs. • One success – Cobo Hall. However, Oakland is contributing roughly $600M over the next 30 years that could have been used to solve several of the above issues.

4. OVERVIEW – CAVEATS / ASSUMPTIONS • Impacts on government revenues (in this power point) generally do NOT include of GM, Chrysler and other supplier bankruptcies for recent lost jobs, economic stagnation, and property value declines. Employment declines will take roughly 2 years before the recent job losses work their way through the real estate market. • Absent a second round of federal stimulus funds, the State General / School Aid Funds have a $1.2B to $1.6B unresolved operating shortfall for the 2011 fiscal year on General Fund revenues of roughly $7.0B. • Local governmental units impacted - 58% of State revenues are redistributed to local governments to provide programs directly to the public. Largest State distributions to school districts / ISDs.

5. State Economy – Employment • It all starts with a job. No job. No mortgage payment. Foreclosures. Glut of homes. Economics 101 – increasing inventory, declining demand – prices fall. • October 2009 – 15.1% (U of M predicted 11.3% on January 9, 2009; 7.0% higher than a year ago). U of M predicted by end of 2010, the unemployment will remain at 15.8%, with modest declines thereafter. Sales, Michigan Business and income tax revenues for State adversely impacted – now and into the future. • National unemployment October 2009 – 10.2% (16M unemployed), increasing. Excludes 1.4M unemployed no longer seeking work and 9M who are under-employed. 2nd Quarter – 9.4% productivity gains – likely jobless recovery (no reason to hire if productivity is improving without employees). • Oakland County unemployment in Oct. 2009 – 15.6%. County is now above the State unemployment for the first time. • Detroit unemployment – 28.9%. New Orleans (post Katrina) – 11%.

6. State Economy – Employment / Other • State’s Unemployment Trust Fund (UTF) has used up its resources. Sept. 30, 2001, UTF had $3.0 billion in equity (assets in excess of liabilities). Sept. 30, 2008, $90.4M deficit (liabilities over assets, or insolvent). UTF outstanding borrowing from the federal government at September 30, 2008 - $362.4 million. • Fall 2009, Gongwers reported State borrowed $2.8B from federal government under FUTA. Since September 30, 2008, State borrowing at a pace $200M monthly. • New payroll tax calculated - $21 / employee. $2.8B / $21 x 4M employees = 33 years to resolve. Obviously, the calculation does not make sense – the tax imposed in the fall of 2009 is too low and future tax increases will be substantial. • Payroll tax is a barrier to employment growth. Payroll taxes will grow as the UTF borrowings increase – borrowing at a pace of $200 million per month. • GAO report – fall 2009. By 2019, 92% of federal revenues will be spent on major entitlement programs and interest costs – before federal healthcare now being considered. Tax increases are inevitable and / or program reductions.

7. Auto Industry - Barriers • Operations / Restructuring – cash declines caused by operating losses weakened Detroit 3 and suppliers, even as vehicles were selling at over 16+M pace; now at 10+M pace. GM / Chrysler lowered fixed, capacity and legacy costs. “Old-companies” remain unresolved. As legacy costs are shed, however, more unemployed and impacts on employees, and retirees. • Legacy Costs (Pension / Retirees’ Healthcare) – unfunded retirees’ healthcare of Detroit 3 at December 31, 2005 - $113B. Current unfunded pensions, as estimated by PBGC, is $77B. Some retirees’ paid dearly in bankruptcy; some impacts still coming. Retirees’ healthcare liabilities are now in equity for new GM / Chrysler. How does equity pay medical bills? New company value needs to grow and then stock needs to be sold for cash to pay benefits – not assured. • Mileage (Emission) Standards – tens of billions in research and development over the next decade. Operating losses do not provide sufficient cash for R & D – which investments won’t be recovered then for years thereafter. Funding source – likely will have to be from the federal government in form of grants – little national appetite for more investments in auto industry.

8. Michigan Fiscal and Budget Issues • Summary of Michigan’s critical fiscal issues: • Weak balance sheet for General and School Aid Funds (half of State operations). • Deficits (liabilities over assets) in several funds. • Unemployment borrowing from federal government. • Weak / inaccurate budget projections. • Accounting system fails to quickly identify adverse operating trends. • Above ‘hidden’ with infusion of federal stimulus funds. State has Delayed reforms. State structural operating shortfalls for 2011 when stimulus funds depleted. AFTER “resolving” FY-10 budget, State has another $1.2B to $1.6B to go for fiscal 2011. Political capital already expended with the public – this next round will be very difficult – in an election year. • SB 276 reported out of State Senate committee mid October – with bi-partisan support. Critical legislation impacting whole State.

9. Michigan Fiscal and Budget Issues (Cont.) • Some accounting – beginning equity, plus revenues, less expenditures equals ending equity. Equity key to Wall Street in the balance sheets. • Equity (or net worth) is the difference between assets (what the State owns) and liabilities (what the State owes to vendors, employees, etc.). More assets than liabilities = surplus; more liabilities than assets = deficit. • Balance sheets as of September 30, 2008 for the General, Budget Stabilization and School Aid Funds – half the State’s operations. Area where the principal focus of attention for local units of governments occurs. • Balance sheet’s importance can be summed up by the statement – “Miami, Florida is just 20 miles away.” Absolutely true. Who disagrees – show of hands?

12. Michigan Fiscal and Budget Issues (Cont.) • Notable balance sheet problems - prior schedule: • General Fund cash at September 30, 2008 - $7.1 MILLION; vendor payables $1.8 BILLION due to be paid from the $7.1 million in cash – how do you pay $1.8 BILLION in vendor payables with $7.1 MILLION in cash? • School Aid Fund (SAF) ‘borrowing’ of other State funds’ cash based on a study by the Citizens Research Council – roughly $1.3 billion ‘borrowed’ from other State funds for 2006. State Treasury report indicates SAF used $1.6 billion of other funds’ cash at Sept. 30, 2007 principally General and Transportation Funds. • General Fund receivable from SAF of $980.2 million - with the SAF in a $1.3 billion cash deficit and the General Fund providing operating subsidies to the SAF – how does the SAF ever repay General Fund? Is the $980.2 million receivable even collectible from the SAF? General Fund receivable from the SAF of $980.2 million is 76% of General Fund equity! • Receivable increased from $503 million at Sept. 30, 2006 (47% of General Fund equity) to $980.2 million at Sept. 30, 2008 (76% of General Fund equity) – in two years!

13. Michigan Fiscal and Budget Issues (Cont.) • October 2009, S & P reaffirmed the State’s bond rating at an AA- (same rating as 4 other states). In mid-July, Fitch dropped its Michigan rating to A+. Only states with lower rating than Michigan - California at BBB and Louisiana (A). • Gross State pooled cash balances as of September 30 – trend should be obvious (2008 amounts not known): • 2000 - $4.9 billion. - 2004 - $1.2 billion. • 2001 - $3.9 billion. - 2005 - $1.0 billion. • 2002 – $2.8 billion. - 2006 - $860 million. • 2003 - $1.4 billion. - 2007 – Unknown. • Despite the State having a ‘balanced budget’ on paper, the State’s actual performance failed to balance the budget in 6 of the past 8 fiscal years (e.g., they used equity to balance operations). Equity is now depleted – forcing the State into the massive cuts for 2010 or would have been significant fee / tax increases. Reforms not an option – takes too long to realize benefits.

15. Michigan Fiscal and Budget Issues (Cont.) • Other issues with 2008 balance sheet / 2009 operations: • Schools - pupil counts have declined from 1,714,705 in 2003 to 1,591,100 in 2010 – 123,605 decline. Base foundation allowance is currently $7,316 per student (123K students x $7,316 = $900M. Had the pupil counts not been declining, the rate per student would have had to decline as the State simply did not have this level of funds. • MBT revenues (new in 2008) - $341 million included in School Aid Fund (SBT was not included). MBT reimburses lost personal property tax revenues of the School Aid Fund. In 2009, $729M in MBT support is budgeted for School Aid Fund. Makes elimination of the MBT surcharge very difficult – will pit new constituency group (schools and MEA) against businesses. Replacement revenue needed. • Deficits in other State funds: IT Fund ($89M and increasing); Unemployment Trust Fund ($90M); and Michigan Education Trust ($97.5M) - serves to increase the General Fund cash stress.

16. Michigan Pensions / OPEB • Pensions: • From FY-2002 through FY-2008, full pension contributions were not made for State and school pension plans in accordance with the actuaries’ recommendations in all but one year. Cumulative contributions shorted (to be funded by future generations) for State and school pension plans were $536 million and $797 million, respectively – total of $1.3 billion (if paid, the General Fund would have been in a deficit at September 30, 2008). • The September 30, 2007 school and state pension reports an unfunded actuarial accrued liability of $7.8 billion as reported in 2008 CAFR. Should not adversely impact retirement benefits currently paid. • Recent substantial market declines in 2008 and 2009, however, will significantly increase pension contributions for 2011 and beyond – particularly if the market does not recover to the prior levels.

17. Oakland County’s Timeline of Retiree Healthcare Changes and Annual Cost of ARC Planned full funding of UAL with COPS Plan closed to new hires Cost differentiation by age Prescription co-pay increased VEBA Trust Created Vesting schedule lengthened Actuarial ARC payment begins Vesting schedule lengthened Increase to 100% of premium Benefit Begins, 50% of Premium

18. State Budget Problems – Pensions / OPEB (Cont.) • Retirees’ healthcare (OPEB): • $39.9 billion in unfunded liabilities at September 30, 2007 and growing at a pace of roughly $2 billion annually as State is only funding medical bills when presented (e.g. “pay-as-you-go”). • State does not pre-fund retirees’ healthcare – if they did, they would have to find another $1.7 billion to $2.0 billion in new revenues (or reduced expenditures) annually for each of the next 30 years from existing revenues (General Fund revenues may be $7B / School Aid - $12B) – OVER the shortfall presently being debated in Lansing.

19. Regional Fiscal Issues Impacting State • The fiscal issues of some of the local units cited in this section will have to be resolved against a limited revenue source – not all of which may be able to be addressed within the confines of the local units (meaning the State may have to fiscally assist – providing less resources to other entities). • Detroit and Detroit Public Schools (DPS) fiscal problems so large could jeopardize State’s fiscal status and all units that rely on State distributions (including hospitals). State’s General and School Aid Funds have no resources. • Debt issues - declining taxable value could jeopardize the fiscal solvency of TIFAs / DDAs. Schools use unlimited G.O. debt. Declines in taxable value mean millage rates for school debt issues may increase to cover fixed debt service costs. These millage increases could pressure other unrelated millage requests for cities, villages, townships and counties. • Pressures will build in calendar 2010 to solve the operating shortfalls via millage increases – tax fatigue could easily set in with rejections by voters.

20. Regional Issues - State Finances (Cont.) • Detroit Public Schools: • June 30, 2008 CAFR reflects a General Fund deficit of $142.3 million and an entity-wide deficit of $496 million (liabilities in excess of assets). • In June 2008, the DPS reported a $400 million deficit for 2008 – e.g. expenditures exceeding revenues. • Jan. 2009, Governor appoints an emergency financial manager.Jan. 2009, DPS announces it has insufficient cash flows to cover payrolls for school year (short $76M). Owes State $42M for unpaid pension contributions. State advanced funds for DPS payrolls for FY-2009. • Operating shortfall of up to $250M remains unresolved – how will they get through FY-10? • Financial manager considering Chapter 9 bankruptcy – would be viewed negatively by bond industry and impact all governments ability to borrow in region.

21. Regional Issues Impacting State Finances (Cont.) • Pontiac – in Act 72 with emergency financial manager. Police department reduced from 170 FTEs to 65 FTEs. School district struggling as well. • Wayne County - $105M operating shortfall for FY-2010 (500 non-union layoffs with potentially 440 union lay-offs). • Macomb County – recently ‘solved’ their 2009 operating shortfall with a tax increase to its authorized limit. • SMART (bus services) has an unresolved 2012 operating shortfall of $9.6M and increasing thereafter – assuming that the extension of a millage to be voted upon in August 2010 is passed. SMART operations would have to be substantially curtailed to very basic services if it fails.

22. Regional Fiscal Issues Impacting State (Cont.) • City of Detroit: • Detroit to sell $250M in deficit elimination bonds with junk bond as a credit rating. • June 30, 2007 CAFR (last one issued) reflects a General Fund deficit (liabilities over assets) of $155.6 million and an entity-wide deficit of $602.5 million – about the same as 2006. • Unresolved $9 billion plus in retirees’ healthcare obligations in 2004 CAFR – likely has grown since then to maybe $12 billion. • $300M ‘deficit’ (e.g. operating shortfall) on roughly $1.3B in General Fund revenues for 2009. Deficit ‘resolved’ by sale of lighting and parking facilities and securitization of tunnel receipts (however, securitization used to balance budgets is no longer permitted under GASB rules). • The City could be at a deficit of over $400 million by the end of the June 30, 2009 fiscal year. By 2012, it rise to $750M – cash would be depleted before then. • Mayor indicated that the City could run out of cash in October and would have to consider going into receivership (Chapter 9).

23. Regional Fiscal Issues – Schools • Schools are ‘fiscal canaries in coal mine.’ Fiscally, many schools will fail (payless paydays; debt issues potentially; vendor delays; and / or similar issues leading up to Act 72 – emergency financial manager). • Total cuts for 2010 of $515M – four months into the fiscal year – with schools having largely fixed costs (people / facilities / equipment): • 2010 budget cut $165 / pupil in continuation budget. Total $262.3M. • Executive order cut of $127 / pupil. State Treasurer announced sale tax revenues have declined. Total $201.6M • 20j veto – Total $51.5M to certain school districts. • Taxable value declines impact ISD special education millage revenues – dollar impact is not known, but will require declining base foundation allowance to supplant losses in special education programs. • Above BEFORE $1.2B to $1.6B in unresolved 2011 operating shortfalls – meaning further reductions are likely.

24. Regional Issues - Healthcare • Hospital costs (just like schools) are comprised of real property, equipment and personnel – fixed and very difficult to reduce in the short-term. • As auto-related employees lose their jobs, their ‘premium’ healthcare is also lost. Few unemployed can afford elective procedures where hospital profit margins are strong. Number of patients presenting to the hospitals and lower insurance coverage creating substantial fiscal pressures. • Unemployed individuals use Medicaid (requiring an increasing State grant match) or no medical coverage at all. State stressed to secure matching funds for Medicaid. • Hospital and other healthcare providers will be fiscally stressed in the next several years with fewer admissions. • These costs will be passed back through BC/BS and other insurance providers to employers – look for increases in healthcare rates and / or financially struggling hospitals / clinics. BC/BS financial health evaluated by regulator – now on ‘negative financial outlook’ (meaning likely downgrade shortly). • The above may be ‘solved’ through a federal healthcare actions being considered this summer and fall.

25. Summary • The solutions to resolve the budget beast facing State and local governmental units are many. There is no shortage of solutions – new taxes, service reductions and / or structural reforms – it seems a shortage of political will to undertake tough decisions before the crisis occurs. • Unfortunately, there will be numerous governmental units who will be unable to plan longer-term for the fiscal crisis ahead and likely will find themselves facing Act 72 – an emergency financial manager or worse. • Proper management principles, long-term planning, leadership and political will can solve the tough business issues facing Michigan governments.

26. Robert Daddow Deputy County Executive Oakland County, Michigan daddowr@oakgov.com