Pittsburgh and Harrisburg: A Tale of Two Deep-in-Debt Cities

Four hours apart on the Pennsylvania Turnpike, Pittsburgh and Harrisburg are linked not just by geography but also parallel financial woes that bring into view what happens when local governments fail to handle big bills and states get dragged into their mess.

The troubles in both Pennsylvania’s second largest city and its capital stem from mismanagement of debt by local leaders. Pittsburgh is having trouble covering its future public pension bills but escaped a state takeover last month after the city bolstered its retirement fund.

Harrisburg, however, may not be able to avoid state intervention. The city of 50,000 people cannot pay down million it borrowed to renovate a failed trash incinerator. This week, state lawmakers and Republican Governor Tom Corbett may complete action allowing the state to appoint a receiver to rescue Harrisburg from its failing finances. Complicating matters, the city filed for bankruptcy protection last week; a federal judge is expected to hear the case on November 23.

Pennsylvania is not the only state struggling with debt-loaded local governments. Alabama, Michigan and Rhode Island all face similar questions about how far the state should go to intervene in the finances of distressed localities ( see sidebar ). Although the states have taken different approaches, all face the same reality that their financial fate is intertwined with the cities. So, too, is the image of the state, at least in the eyes of Wall Street.

Yet these states, facing their own financial pressure from the recession and coming federal budget cuts, are in no position to give cash to distressed cities. Pennsylvania’s budget for the current fiscal year spends nearly billion less than last year’s — a drop of more than 3 percent . So the story of Pittsburgh and Harrisburg is more than a tale of two struggling cities; it’s a story of what tools a stressed state does and doesn’t have to help.

Trash trouble in Harrisburg

Harrisburg’s debt crisis centers on a doomed public works project. The city opened an incinerator in 1972 to burn trash, produce steam and eventually generate electricity. The idea was to serve not only city residents but also surrounding counties and private companies who paid fees for their use of energy.

The first blow came in 1990, when Dauphin County, which includes Harrisburg, started sending its trash to cheaper landfills instead of the incinerator. The burner “went from a profit generator to a deficit generator,” former mayor Stephen Reed told a local newspaper, The Patriot-News . Dauphin County resumed hauling trash to the incinerator in 1995. But by then, Harrisburg already had begun borrowing money to repair the aging plant.

The federal government shut down the dioxin-polluting incinerator in 2003; by that time, the obsolete furnace had piled up about million in debt, without revenue coming in to pay off the bonds. City leaders decided to borrow another million to upgrade the incinerator to meet federal clean air standards and repay the old and new debt from fees Harrisburg would charge Dauphin County and other governments to burn their trash. The retrofit project was a disaster: The city borrowed additional money when the upgrade fell behind schedule, costs increased and the contractor was accused of mismanaging the project.

Harrisburg residents have paid a steep price for the botched project in higher property taxes and trash fees, as well as reduced city services because of staff cuts. Now city officials, struggling to meet the payroll — let alone the million that has accumulated from the incinerator borrowings – have filed for bankruptcy protection.

The bankruptcy action follows two failed attempts by the city council to accept a state rescue plan developed by the state legislature and Governor Corbett. Lawmakers responded to the rejection by approving legislation allowing the governor to appoint a receiver and financial control panel to run the city. The spectacle in Harrisburg grows almost daily. The city council and Mayor Linda Thompson are not only split about the decision to file for bankruptcy but are even divided over whether it was legal to hire the attorney who is handling it.

Underfunding pensions in Pittsburgh

Pittsburgh escaped a state takeover last month but still is in a precarious position because of years of neglecting its public pension fund covering police officers, firefighters and other city employees. The city’s troubles began as far back as 1984. That’s when state lawmakers approved legislation requiring Pennsylvania cities, including Pittsburgh, to replace their pay-as-you-go pension financing with a system in which they would make higher annual payments determined by actuaries. The change was intended to fully fund city pension liabilities over 40 years.

The financing change could not have come at a worse time for Pittsburgh. During the 1980s, Pittsburgh was reeling from the loss of jobs, people and tax revenue associated with the collapse of the steel industry. Initially, city officials set up a schedule of gradually increasing pension payments to keep the city’s contribution low until Pittsburgh recovered from its industrial decline. But by 1996, the unfunded pension liability swelled to million, with only million in assets. By contrast, the entire city budget was million.

City leaders thought they would solve the problem by selling pension bonds — essentially, borrowing from investors to reduce debts to retirees. The temporary injection of cash into the retirement fund allowed Pittsburgh to cover 67 percent of its pension bill by 2000, up from 18 percent in 1996. But the bonds were “noncallable,” which meant that when interest rates subsequently dropped, the city could not refinance them to save money.

Pittsburgh — and Pennsylvania — made another big mistake. The city got permission from the state to calculate its annual pension payment assuming a 10 percent rate of return on investments, compared to a 6.5 percent rate assumed by other Pennsylvania municipalities. That had the effect of setting Pittsburgh’s pension payments lower than they should have been: Between 1998 and 2002, the actual rate of return averaged about 2 percent. The city has since lowered the assumed discount rate to 8 percent.

Despite Pittsburgh’s successful efforts to diversify its economy by attracting institutional employers in health care, education and financial services, the city could not boost revenue enough to keep up with its growing expenses, including public pensions. Nearing insolvency in 2003, the city laid off hundreds of employees and curtailed services. The credit rating agencies downgraded Pittsburgh’s debt to junk bond status, the lowest rating among big cities. In 2004, the state said the city qualified for “financial distress,” a legal distinction that paved the way for the city to appoint an outside manager to develop a fiscal recovery plan.

Under the plan, Pittsburgh had to fund at least half of its pension system by 2011, or else the state retirement system would take over the city plan and require larger pension payments. The city avoided the takeover in part by pledging to pump parking tax revenue into the pension fund, which helped bring its funding ratio up to 62 percent, according to Mayor Luke Ravenstahl. But that does not mean Pittsburgh’s pension crisis is over. Pittsburgh’s 62 percent is well below the 80 percent funding ratio that most analysts recommend to sustain a healthy public pension plan. Ravenstahl’s 2012 budget proposes to pay the pension fund 6 percent less than it paid this year, prompting critics to question his commitment to shoring up the fund.

‘Inconsistent leadership’

Analysts who have followed the debt crises in Pittsburgh and Harrisburg say there are lessons that can be learned from each. In Pittsburgh’s case, there are two morals for cities, and they are pretty straightforward.

The first is to make your full pension payment each year and tie it to a reasonable rate of return. James L. McAneny, executive director of the Pennsylvania Public Employee Retirement Commission — the system that decided against taking over Pittsburgh’s pension fund last month — says the city should not have used the 10 percent rate of return. “Unless they change the way they do things,” McAneny says, “Pittsburgh will be right back to where they were: under 50 percent funding.”

The second moral from Pittsburgh is to carefully consider the pros and cons of pension bonds. Issuing pension bonds made sense at the time, says Chris Briem, a University of Pittsburgh economist. “Without the pension bond, the city would have been broke,” he says. But the terms and size of the borrowing doomed the city. Moreover, stresses Duquesne University professor James Burnham, Pittsburgh started from a weaker financial position than many issuers of pension bonds have.

“Pensions are a long-term problem,” Briem concludes. If Pittsburgh “had just put in a little more money over the last 20 years, it would be a far better situation.”

Harrisburg’s debt woes are more layered. Through no fault of the city’s, the incinerator was snake bit from breakdowns and federal Clean Air legislation that forced its shutdown. But the decision to borrow money to ask a dubious contractor to retrofit the plant and count on fees from neighboring counties to finance it proved to be the incinerator’s unraveling. “They just got far too ambitious for the size of the city,” says G. Terry Madonna, a professor at Franklin and Marshall College.

The dysfunction among elected officials has only made the situation worse. Seven in 10 Harrisburg residents view Mayor Thompson unfavorably and the same number view the council’s performance as fair or poor, according to a public opinion survey of 400 residents that Madonna conducted. “The city just suffers from erratic, inconsistent leadership,” he says.