Three-punch combo takes out Sedona Mayor's advisory committees

From: J Rick Normand
Subject: Council: Relative to Staff Burden, You're Asking the Wrong Question!

Date: Monday, February 9, 2009, 8:12 PM

Dear Mayor and Council,

To begin with, I want to say that I write this e-mail to you of my own volition, that is, I am NOT speaking for the Mayor's Economic Steering Committee, nor did I counsel with them over the contents herein. They have had no part in what is written below. Meanwhile, I am formally requesting that this e-mail be archived for purposes of making it a part of the public record and posterity.

Some of you continue to question whether there is a cost/benefit ratio favoring or disfavoring the time required by Staff to service the above-mentioned committee. Unequivocally, you're asking the wrong question, which if ignored, irrespective of the answer to the question upon which your are focused, will lead this City to dire consequences. The question you should be asking is, "What is the cost to the City of having staff perform budget busywork that leads, not only to work product of no practical consequence but, to work product that leads the City to adopt financial policy that will place the City in a risk position of not being able to refinance its debts in the municipal bond market three through six years from now?"

Below is a chart that each of you should study. What this chart will tell you is that Arizona is the second worst State in the Union at mismanagement of its budget process. This tells us that the State does not incorporate modern financial modeling techniques which has resulted in the huge budget deficit we are now facing as a State. Please note the catastrophic variance between budget forecast and actual budget numbers for the State's most current budget.

Yet, when Alison Zelms and those who assist her (by the way, this is NOT a criticism of Alison's capabilities as I can assure you she is quite capable, hard working, and easy to work with as is all of Staff), spends an inordinate amount of time in budget preparation (probably 80 to 100 hours), she follows a forecasting methodology which was taught to her that is deeply flawed and cannot, therefore, produce any reliable information for Council to rely upon. Why? Because she acquires her budget revenue forecast assumption input numbers and variables from 1.] off-base and unreliable information given to her from the state personnel who botched the State's budget, 2.] the League of Arizona Cities & Towns who get their information from state provided sources and Chambers of Commerce who are upside-biased and over-zealous, 3.] comparisons to budget assumptions from other selected cities who are running deficits and, worse yet, 4.] from assumptions in prior City of Sedona budget forecasts and flawed forecast models which were derived from a misunderstanding of classical economic models, lack of access to modern forecasting methodology and technology (which would allow Alison to do her budget preparation in less than an hour), and an inability to foresee and understand the consequences of the current near-depression in which we find ourselves.

So, the correct question discussed by Council should have concerned what the direct and intangible costs to the City is/are of not being able to avail itself of sufficient talent to teach to Staff proper budgeting methodology and afford them knowledge of support budget preparation technology? You have that talent available to you right now in Sedona, yet you seemingly ascribe no value to it. At the moment, you're worrying about time constraints on available Staff time instead of how much time they spend performing work that hasn't any reliable output of discernable value.

The difference between asking the right question and the wrong question is in the consequences that will impact your legacies which will be bitterly remembered by your supporters three or four years from now. If you focus on the question of how much Staff time is spent with the much-debated Economic Steering Commitee, the best result is that you relieve some workspace stress from Staff. However, if you don't address the question I have posed, then the consequence will likely be that you will find that this City may not be able to return to the municipal bond market on viable terms to finance its next presently unrecognized debt issue requirement, beginning around 2012. And, what is this unrecognized financing issue? It will be a new financing issue which will come about when the community of bond underwriters recognizes that the City is financing the entirety of its current $75-76 million bond indebtness through the Waste Water Enterprise Fund Reserve Account, which equates to approximatey $6-1/2 million dollars annually for interest and principal. The issue is, then, will there be sufficient reserves in the Waste Water Enterprise Fund Reserve Account to insure that this debt service can be made from 2012 through 2016? If not, the City will find itself insolvent at that point. This would be catastrophic, especially in light of the fact that there are some very serious deferred maintenance and misunderstood processing-capacity specifications issues existing relative to the City's Waste Water Treatment Plant right now as I write this. I know because I've been there and seen the problems .

This City's participation in the municipal bond market is no longer assured. The U.S. and global credit markets are being re-structured in their entirety for the first time since 1933 and debtors, including this City will have to now start competing for money. Nothing is any longer guaranteed. In fact, the rating agency and the insurer of your Chapel Sewer Bond Issue have both been discredited. When I mentioned this before Council on January 27, it was obvious some of you just weren't paying attention.

The municipal bond market typically is backward looking, usually to the extent of three years. In other words, this City's current budget work-product will be the start-point for analyzing the accuracy and efficacy of your budget in 2012. If your forecast assumptions are far off target this year, that will exponentially compound the variances next year and even more so the year after and make bond underwriters question the reliability of your assertions of debt repayment capacity in the next refinancing round. Not understanding this dilema now will be a fatal mistake of unrecoverable consequences on your parts since this City lives off debt!

It's clear to me that your priorities are singularly confused and need to be reassessed. In fact, setting new precedences are critical to our near-future quality of life here in Sedona.

J. Rick Normand
(see below the chart and following article)

TABLE 1: SIZE OF FY2009 BUDGET GAPS
	Amount	Percent of FY2008 General Fund
Alabama	$784 million	9.2%
Arizona	$1.9 billion	17.8%
Arkansas	$107 million	2.5%
California^{1 2}	$22.2 billion	21.3%
Connecticut	$150 million	0.9%
Delaware	$217 million	6.4%
District of Columbia	$96 million	1.5%
Florida	$3.4 billion	11.0%
Georgia	$245 million	1.2%
Illinois	$1.8 billion	6.6%
Iowa	$350 million	6.0%
Kentucky	$266 million	2.9%
Maine	$124 million	4.0%
Maryland	$808 million	5.5%
Massachusetts	$1.2 billion	4.2%
Michigan¹	$472 million	4.9%
Minnesota	$935 million	5.5%
Mississippi	$90 million	1.8%
Nevada	$898 million	13.5%
New Hampshire	$200 million	6.4%
New Jersey	$2.5 - $3.5 billion	7.6 - 10.6%
New York	$4.9 billion	9.1%
Ohio	$733 million - $1.3 billion	2.7 - 4.7%
Oklahoma	$114 million	1.6%
Rhode Island	$430 million	12.6%
South Carolina	$250 million	3.7%
Tennessee	$468 million - $585 million	4.2 - 5.2%
Vermont	$59 million	5.1%
Virginia	$1.2 billion	6.9%
Wisconsin	$652 million	4.8%
TOTAL	$47.6 - $49.2 billion	9.3 - 9.7%
¹These states have not yet adopted budgets for FY2009. ²In a special session earlier this year, California adopted measures to close $7.0 billion of this shortfall. A gap of $15.2 billion remains to be closed. Assumes that FY08 gap would have carried over to FY09.

Muni Sales Dry Up as States Face $42 Billion Deficit )
By Jeremy R. Cooke and Michael McDonald

Dec. 31 (Bloomberg) -- The worst year for municipal bond investors since 1999 may further reduce demand for tax-exempt debt just as state governments face the biggest budget deficits in at least a quarter-century.

State and local borrowers sold $385 billion of long-term bonds through yesterday, down 9 percent from 2007, according to data compiled by Thomson Reuters. Next year, sales will drop more than 6 percent to about $364 billion, the least since 2004, based on an average of estimates from London-based Barclays Plc, Merrill Lynch & Co. and Loop Capital Markets LLC.

The combination of the worst financial crisis since World War II and the collapse of the $330 billion auction-rate debt market will leave 41 states and the District of Columbia with shortfalls just as financing sources diminish. Merrill Lynch�s Municipal Master Index, which tracks 14,000 bonds, fell 4.6 percent this year, the first decline since a 6.34 percent drop in 1999. The biggest underwriters are merging or leaving the business.

�It�s been an absolutely horrible year,� said Robert MacIntosh, a money manager at Eaton Vance Management in Boston, who oversees $17 billion in tax-exempt bonds. He said he�s never seen such turmoil in the $2.67 trillion municipal debt market during more than 25 years in the business.

A freeze in global credit markets this year drove municipal borrowing costs to unprecedented levels. Yields on AAA general obligation bonds due in 30 years rose to a record 2.2 times Treasury yields from the historical average of about 0.96 times, according to Concord, Massachusetts-based Municipal Market Advisors. That represents an extra $2.93 million a year in interest on every $100 million of debt sold.

Lowest-Rated Borrowers

The lowest-rated borrowers were hit hardest. Merrill Lynch�s index tracking debt ranked BBB, the bottom tier of investment- grade, fell 22.3 percent, the most since the firm began compiling the data in 1989. Five of the 12 largest municipal-bond underwriters, including New York-based Merrill Lynch and Zurich- based UBS AG, agreed to merge or have exited the business.

Budget analysts are increasing their estimates of state deficits as the U.S. economy enters its second year of recession. The Center on Budget and Policy Priorities in Washington, a nonpartisan budget and tax analysis group, said last week that states faced a combined budget shortfall of $42 billion this fiscal year, up from $8.9 billion on Oct. 10.

�It�s going to be very hard to get refundings done, at least in the first part of the year,� said Evan Rourke, part of a team that manages $7 billion in municipal bonds at New York- based M.D. Sass Associates.

Harvard Penalized

This month, top-rated Harvard University in Cambridge, Massachusetts, sold tax-exempt bonds due in 2036 at a yield of 5.8 percent, or 1.31 percentage points more than similar securities it issued in June.

New York City offered investors 6.25 percent on bonds due in 20 years, up 1.65 percentage points from December 2007. Cascade Healthcare Community�s yields shot up more than 3 percentage points in seven months to 8.5 percent, as the Bend, Oregon-based hospital�s ratings were cut, in part because of higher debt costs.

Rising bond expenses are forcing municipalities to postpone projects. Merrill Lynch estimates the backlog of offerings to fund public works has grown to more than $120 billion.

The school district in Fort Bragg, California, a town of 6,600 located 170 miles (273.5 kilometers) north of San Francisco on the Pacific coast, put off construction at its high school and delayed a solar-power project after shelving a $7 million bond sale when interest rates jumped following the collapse of Lehman Brothers Holdings Inc. in September.

�Really Crazy�

�It got really crazy right about the time we wanted to sell,� said Kathryn Charters, the district�s business manager, who hopes to issue the debt next year.

A total of $390 billion of bond sales are anticipated in 2009, said analysts Ivan Gulich and Chris Mier of Loop Capital, a Chicago-based underwriter. �Interest rates are the most important predictor of municipal bond volumes,� they said in a Dec. 18 report.

This year�s turmoil is a reversal from 2007, when sales reached a record $430 billion as hedge funds, banks and other institutions borrowed money to buy municipal securities and boost returns, according to Thomson data.

Analysts at New York-based Citigroup Inc. led by George Friedlander estimated in a Dec. 19 report that the amount being used by investors in that type of strategy fell to about $12 billion from a peak of $120 billion.

Auction-Rate Collapse

Losses started in February, when the auction-rate market collapsed as dealers who supported it for two decades abandoned the weekly and monthly sales where rates were set on the long- term bonds. Interest costs soared to 20 percent for issuers such as the Port Authority of New York & New Jersey when dealers stopped buying securities that went unsold.

At the same time, bond insurers that guaranteed more than 50 percent of all new municipal debt began suffering credit rating downgrades after standing behind the same subprime mortgage-related securities that have triggered $1 trillion in losses and writedowns at the world�s biggest financial institutions.

�Everything you thought was not possible in the muni market basically has come to fruition,� said Peter Hayes, head of the municipal product group at asset manager BlackRock Inc. in Plainsboro, New Jersey.

Refinancing

Instead of selling bonds to finance public works, issuers from California to New York were forced to refinance auction-rate and other adjustable-rate securities with fixed-rate debt.

With demand drying up among institutions, state and local governments are turning to individual investors.

A marketing campaign by California, the biggest municipal borrower, helped draw a record of more than $3.9 billion of orders from retail investors in a $5 billion short-term note deal in October, according to the state treasurer�s office.

�Issuers should not presume that market access will necessarily be available on demand,� underscoring the need to cater to individuals, Phil Fischer, a municipal strategist at Merrill Lynch, said in a Dec. 8 report.

California officials said Dec. 11 the state�s shortfall will reach a record $41.8 billion over the next 19 months, and the state may run out of cash as soon as February.

California Downgraded

A day earlier, Standard & Poor�s said it may lower the rating on California�s $46.6 billion of general obligation debt and $7.8 billion in bonds backed by lease payments. S&P reduced to �SP-2� from �SP-1� its ranking on $5 billion of short-term notes that the state sold to cover its tax shortfalls.

Public officials are pinning their hopes for a turnaround on a stimulus plan of as much as $1 trillion being developed by President-elect Barack Obama. New York Governor David Paterson wrote in a Dec. 29 letter to Obama that he �strongly� supported spending $300 billion for �ready-to-go projects to rehabilitate and construct� infrastructure.

�We have got a huge infrastructure problem that will start to be funded in 2009,� said Kevin Giddis, a managing director of fixed-income trading with Morgan Keegan Inc. in Memphis, Tennessee, in a Dec. 29 interview with Bloomberg Television.

To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net; Michael McDonald in Boston at mmcdonald10@bloomberg.net.