Providence’s Pension Bond Plan Is Risky and Reckless - Ken Block

Providence’s Pension Bond Plan Is Risky and Reckless - Ken Block

Providence's (PVD) proposal to float a half a billion-dollar "pension obligation bond" is fraught with risk, reckless, and another massive example of elected officials "kicking the can down the road."

PVD elected leaders, for decades, have failed to save enough money to properly pay for what in many instances, have been outrageous pensions. PVD leaders have failed to truly reform the city's pension abuses.

The idea behind a pension obligation bond is that a government borrows money, invests the money, earns more per year on those investments than must be paid out in interest on the loan, and then uses the profit to pay down pension liabilities.

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For starters, interest rates across the board have risen dramatically, which will impact PVD's cost to borrow. The rise in the loan's cost lowers the net profit PVD can expect from investing the loan monies. It is a terrible time to borrow money for this purpose.

Worse, the stock market is extremely volatile right now, with a lot of negative pressures in the form of inflation, rising interest rates, global geopolitical issues and in general, corporate valuations that are still quite high. Terrible time to invest.

Since pension obligation bonds are taxable, governments must pay higher interest rates than their normal borrowing, which is, for the most part, done with tax-free bonds.

What will Providence do if the markets have one or more years where market returns are negative? The city will be on the hook for at least $25 million in interest payments on the loan with no investment gains from which to pay it.

In a bad scenario, let's say the markets tank 20% after PVD has fully invested the $500,000,000. That would be a $100,000,000 paper loss, plus selling underwater investments to the tune of between $25 million and $40 million to pay the interest. #Nightmare

What would be the annual cost to carry this massive loan? Let's crunch some numbers.

Annual loan payments for a $500,000,000 loan at 4% interest compounded annually:

20-year loan: $36+ million

30-year loan: $28+ million

40-year loan: $25+ million

Annual loan payments for a $500,000,000 loan at 4.5% interest compounded annually:

20-year loan: $38+ million

30-year loan: $30+ million

40-year loan: $27+ million

Annual loan payments for a $500,000,000 loan at 6% interest compounded annually:

20-year loan: $43+ million

30-year loan: $36+ million

40-year loan: $33+ million

At a bare minimum, if PVD is hell-bent on this risky pension obligation bond maneuver, the city should insist that retirees and unions agree to major pension give-backs and reforms - especially regarding disability pensions.

In the worst-case outcome, today's city leaders could be saddling future generations of PVD taxpayers with digging out from losses incurred by taking half a billion dollars in pension obligation bonds to the casino.

Ken Block is a businessman and a former candidate for governor of Rhode Island.