City Hall

5 Things You Should Know About Dallas' Pension Crisis

The biggest problem facing the city of Dallas isn't Tony Romo's left clavicle. It's not the Trinity toll road. It might not even be, despite a compelling case that can be made for it, the city's crumbling infrastructure. The biggest problem facing the city is a massive, looming shortfall in its pension fund for police and firefighters. No matter how one looks at the numbers, the city is going to owe retirees a lot of money it doesn't have. According to the Dallas Police and Fire Pension System board, the city is about $1 billion behind in the fight to fulfill its pension obligations. Under new accounting rules established by the Governmental Accounting Standards Board set to go into effect this year, the liability would be calculated at about $5 billion. Either way, Dallas faces a crisis. Cities with large, unfunded pension obligations, such as Chicago or Detroit, have faced having their bonds downgraded to junk status. Dallas is in far better shape than either of those cities, but it nevertheless saw its bond rating downgraded by both Standard and Poor's and Moody's.

Wednesday, the Dallas City Council will be briefed on the pension fund by Kelly Gottschalk, the fund's recently installed executive director. Gottschalk replaced Richard Tettamant. Tettamant, who ran the fund for more than 20 years, favored creative real estate investments, like the Museum Tower, for the fund. Over the last couple of years, many of those investments were found to be worth far less than the values once assigned to them by the fund.

Ahead of Gottschalk's meeting with the council, here are five things worth knowing about Dallas' pension problem.

1. Whether it's $1 billion or $5 billion, everyone agrees: The shortfall has gotten bigger over the last year.
The depth of the hole depends on who's measuring it. By any traditional accounting standard, it's a lot — at least $1 billion. Over the past year, the funds' investments have decreased in value about 5 percent, by the DPFP's own accounting. Earlier this year, it was seen as a big deal by the ratings agencies when the pension fund cut its assumed rate of return on investments from 8.5 percent to 7.25 percent. Moody's said in July that if the assumed rate of return dipped to 7 percent, the fund could be bankrupt by 2038. It doesn't help that, under Tettamant, the fund valued its investments based on what it had paid for them, rather than what they were actually appraised to be worth.

2. DROP is a big part of the problem.
Under the  Deferred Retirement Option Plan, Dallas' uniformed personnel could work the full 20 years required for them to earn their pensions and keep working while their pension checks were put into special DROP accounts, which are guaranteed to grow at a rate of 8 to 10 percent — more than the pension fund itself expected to get on its investments. The city stopped enrollment in the program in January, but it accounts for almost $1.3 billion of the system's $3.4 billion total size. Each year, pension board member and City Council member Philip Kingston told us in January, DROP accumulates $300 million more in liability.

In 2014, Kingston and the rest of the board — which is made up of council members and representatives elected by police and firefighters — developed a plan to get DROP under control by reducing interest rates on a sliding scale. Members of the pension system sued the board and state District Judge Tonya Parker declared the planned reduction in rates to be against the Texas Constitution. The board appealed, but the final result in the case could take years to arrive. In the meantime, DROP continues to roll up liability at a tremendous rate.

3. Despite the problems, Dallas' bond rating is still pretty good. 
Moody's recently downgraded Dallas' bond rating from its second highest level, Aa1, to its third highest, Aa2. S&P did the same thing, using slightly different terminology. Neither ratings firm evaluates the city poorly, they just don't view Dallas quite as positively as they did in the past. Dallas now has the same rating as places like Phoenix.

4. The bigger risk, at least at the moment, comes from the bad appearance the problem gives the city.
When we talked to municipal finance analyst Matt Fabian about the credit downgrades in early November, he said the bigger risk to Dallas right now is the negative publicity even the appearance of a pension crisis can cause. 

"Investors are becoming a lot more sensitive to headline risks related to pensions, because pensions can create political instability. The debate about pensions can have a meaningful impact on how the city does business. Investors have been far more cautious on this topic than almost any other," he said. "If the city lets things fester and get worse, a penalty that it pays could easily become much larger and the rating downgrades could accelerate. [The ratings cut] is a clarion call to the city to take action."

Dallas Mayor Mike Rawlings told the Dallas Morning News' editorial board last week that he didn't intend to ask taxpayers to shoulder the burden of an unfunded pension system. Still, he maintains that the men and women of Dallas' police and fire departments need to be paid. Something has got to give. Any changes to to the pension plan have to be approved by 65 percent of members of the plan, making that easier said than done.

5. Dallas' pension system is important for recruiting.
One of the reasons Dallas police and firefighters stick around is the pension system. Dallas' police salaries are some of the lowest in the region, but officers hang around because of a pension plan that could make them millionaires. Fabian says that Dallas is deferring current costs it needs to pay (salaries) at the expense of a future that becomes less distant by the day.
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Stephen Young has written about Dallas news for the Observer since 2014. He's a Dallas native and a graduate of the University of North Texas.
Contact: Stephen Young