Bloomberg
March 30, 2011

The July opening of a Target Corp. (TGT) store employing 200 may bring the last new jobs for a while to East Liberty, one of Pittsburgh’s lowest-income neighborhoods.

A $650 million shortfall in the city’s pension system is drying up funds for the sustained investments that remade Pittsburgh after the 1980s collapse of the steel industry. A decade of development brought 600 jobs to East Liberty at units of Google Inc. (GOOG), Home Depot Inc. (HD) and Whole Foods Market Inc. (WFMI)

Keeping up with expanding retirement obligations may consume 40 percent of Pittsburgh’s annual budget for the next three decades, according to Mayor Luke Ravenstahl, 31. This year he is facing a state takeover of the pension system, which might force him to raise taxes and cut services, jeopardizing the momentum of the city’s renaissance.

“Pittsburgh is probably the best model in the country for how to redevelop an urban area,” says Tom Murphy, Pittsburgh’s mayor from 1994 to 2006, who helped change laws to enable conversion of abandoned steel-mill sites. “And they are having the same problem as cities all over America.”

Ravenstahl is in the same bind as mayors from New York to Cincinnati to San Francisco. The gap between pension assets and amounts promised retirees by U.S. cities, counties and states may total a combined $3.6 trillion, based on yields for Treasury securities, according to a study by the finance professors Joshua Rauh at Northwestern University in Evanston, Illinois, and Robert Novy-Marx at the University of Rochester in Rochester, New York.

Decades-Old Hole
Pittsburgh’s shortfall, like those of other cities, has been developing for decades. Until 1984, Pennsylvania didn’t require municipalities to prefund benefits, so Pittsburgh paid them from general revenue. Rebuilding the local economy around nonprofit medical and educational institutions removed property from tax rolls. The 200,000 commuters filling many of the new jobs don’t pay city income levies. Then the 2008 financial crisis shrank pension assets as retirements were mounting.

“We’ve dug ourselves into a huge hole with the pensions, a hole we’ve been digging for 50 or 60 years,” says Morton Coleman, director emeritus of the Institute of Politics at the University of Pittsburgh. “It’s going to take time to fix it.”

The pension crisis is statewide. A $30.4 billion shortfall for municipal retirement plans across Pennsylvania will rise to $71.7 billion by 2021, according to Brian Jensen, head of the Allegheny Conference on Community Development’s pension overhaul campaign. Contributions from taxpayers would have to jump from $1.6 billion in 2010 to $13.7 billion by 2035 without changes, Jensen said. As in other states, the Pennsylvania constitution bars cutting pensions for government retirees.

Pittsburgh Bonds
Pittsburgh’s debt has lost value during the pension debate, though investors aren’t panicking. A bond maturing in September 2014 sold above par at 108.4 cents on the dollar, to yield about 2.5 percent on March 9, down from 113 cents, yielding about 1.7 percent, in August, according to data compiled by Bloomberg.

The debt has fared better than most general-obligation bonds with a similar BBB rating from Standard & Poor’s. The Pittsburgh bond yielded about 0.02 percentage point less than a Bloomberg Fair Value index for BBB munis on March 9, down from 0.58 percentage point more on Feb. 14, the data show.

In the $2.93 trillion municipal bond market, holders of mutual funds of state and local government debt have withdrawn money every week since mid-November.

At the end of 2009, Pittsburgh’s projected pension obligations reached $989.5 million, according to the most recent data available, as compiled by Bloomberg. The fund held just $339.2 million, or 34 percent of that total. Pittsburgh is on the state’s list of 27 municipalities with “severely distressed” pension plans.

Population Loss Slows
That contrasts with the praise heaped on the city for its economic revival. Forbes magazine named it a “Top 10 Up and Coming Tech City.” Site Selection magazine included it three years running on a “Top 10 U.S. Metro” ranking for investment. In each of the past four years, Pittsburgh has been on at least one most-livable list, including those published by Forbes and by the Economist magazine, says Dennis Yablonsky, chief executive officer of the Allegheny Conference.

The local economy’s rebound slowed the loss of population in the decade through last year to 8.6 percent, the smallest drop since the 1950s, the U.S. Census Bureau reported. With 305,704 people in 2010, Pittsburgh was the 59th-largest city in the U.S. and had fewer than half the number in 1950, when it ranked 12th.

As long as the retirement system is less than half-funded, it is subject to being taken over by the Pennsylvania Municipal Retirement System. The agency may order the city to increase minimum annual pension-fund payments to $127 million by 2017, possibly forcing cost cuts or new taxes, Ravenstahl said, citing a state takeover plan.

Budget Buster
In the last year for which data were available, Pittsburgh poured $60 million into the fund, and the city is required to make annual payments of at least $45 million. But the system paid out $82 million in benefits to the city’s 4,538 retirees.

Fully funding the pension program even without a state takeover may eventually require city contributions of as much as $150 million a year, says Ravenstahl, the city’s mayor since 2006. With a total budget of $447 million, that would be out of the question, he says.

“It’s a real challenge,” Ravenstahl says in an interview in his City Hall office. “Pittsburgh is a city that has been reborn and has rebuilt itself. Many of the same challenges that other municipalities and cities are facing across the country, we too face here in Pittsburgh — and arguably our biggest is our pension plan.”

Pledging Parking Revenue
For now, the mayor and the City Council are focusing on getting pension funding up to 50 percent of estimated liabilities. That would fend off a state takeover, which could force them once again to seek the Legislature’s support for taxing commuters, to charge residents more or to try squeezing new revenue out of medical, educational and technical employers, Ravenstahl says.

In December, the City Council approved a plan to pledge about $736 million of parking revenue through 2041 to the pension fund to increase annual contributions and cover at least half the obligation. The city has a Sept. 1 deadline to show the plan meets the 50 percent funding requirement.

If the city fails, the state agency has 60 days to take control, said Jim Allen, secretary of the Pennsylvania Municipal Retirement System, in an interview. The authority plans to ask Pittsburgh in a letter next week to provide the data sooner, he said. Otherwise, the agency may ask the Legislature to extend the time required to assume control to six months, Allen said.

Belt Tightening
There are few viable alternatives, says the mayor, who didn’t support the City Council plan. He proposed selling the next 50 years of parking income to JPMorgan Chase & Co. for $452 million, of which $220 million would have gone into the pension fund. The City Council rejected that proposal.

Since taking office at the age of 26 when his predecessor died, Ravenstahl has also sought to increase fees paid by the suburbanites who work in the city, students and nonprofit organizations, none of which stuck. That leaves only deeper cuts to services and maintenance for balancing the budget, he says. In a round of belt tightening earlier this decade, Pittsburgh cut about 1,000 of its 4,000 employees.

Road, Stairway Repairs
“It’s going to be the story over the next 5 to 10 years,” Ravenstahl says. “You’re going to see local governments going bankrupt. You’re going to see pension plans going bankrupt. You’re going to see bond obligations defaulted on. It’s that serious. It’s that dire.”

While Pittsburgh is nowhere near that condition, the city has slashed road repaving to 30 miles a year from the 80 it should be doing, Ravenstahl said. It also has to maintain 149 bridges over the Allegheny, Monongahela and Ohio rivers.

Because of the hilly topography, residents rely on 580 sets of so-called city steps to get between neighborhoods. About 20 are closed because of disrepair, city records show, and many more show signs of decay.

“The problem with the pension in Pittsburgh is that regardless of how much money you throw at the current situation, the pension is not sustainable as it exists,” says Michael Lamb, 48, the city’s elected controller. He stands on a crumbling stairway in the Southside Slopes neighborhood overlooking downtown. The pressure to find more cash for pensions will only increase in the future, Lamb says.

He is among those urging that Pittsburgh join other cities in steering new municipal workers toward adding 401(k)-style investment options alongside fixed-benefit pension plans, reducing the city’s future obligations. Other ideas include changing age-of-retirement and length-of-service rules. Most of the proposals would require legislation or union approval.

Firefighter Pensions
The Pittsburgh firefighters union would support “creative” solutions for future pension funding, says Joseph King, the group’s 61-year-old president. While new firefighters may work longer, he argues against relying more on 401(k) plans because the benefits probably would be smaller. Like other public-safety workers, firefighters face high risks and tend to die young, he says.

The average Pittsburgh firefighter’s pension is about $2,597 a month, reflecting a formula based on 50 percent of average wages over three years, according to a 2010 report from the union. Workers are eligible to retire at 50.

Medicine, Education, Technology
Today, Pittsburgh’s economy is based on education, medicine and technology. There are more than 1,600 technology companies and 500 in medical devices and biotechnology that didn’t exist three decades ago, said Yablonsky, the Allegheny Conference chief. The University of Pittsburgh Medical Center is the largest employer, with 42,000 workers. In 1979, U.S. Steel Corp. led the local economy with about the same number.

From 1997 to 2007, the Pittsburgh area had the biggest gain in venture capital spending and the second largest in number of completed deals, according to a 2008 report from the National Venture Capital Association. There were 52 such investments last year totaling $159.5 million, compared with five totaling $2.7 million in 1995, the group said.

The combination of startup funding, low cost of living and a thriving arts community were among reasons the closely held Alzheimer’s disease research company Cognition Therapeutics Inc. is in Pittsburgh, said Chief Scientific Officer Susan Catalano. She left San Francisco for Pittsburgh to form the company because of local university biotechnology research, she said.

Tax-Exempt Property
The University of Pittsburgh, Carnegie Mellon University and other educational institutions in the city have provided technology and personnel for many of the startups.

Some of the things that make Pittsburgh attractive to entrepreneurs like Catalano are hurting municipal finances, says Lamb, the controller. About 40 percent of Pittsburgh property is tax-exempt. Nonprofit and untaxed organizations also don’t pay a city payroll processing fee.

Five decades ago, Pittsburgh had more than 600,000 residents paying taxes, compared with today’s population of around 300,000. While the city still provides services for about 600,000 people, almost half of them are commuters or other nonresidents who pay taxes elsewhere, Ravenstahl said in a 2011 budget presentation. The city can levy only a $52 annual fee from them for public safety. The Legislature, controlled by suburban lawmakers, has resisted increasing taxes on commuters.

Pittsburgh can’t resolve its fiscal problems until the state rewrites laws from the 1950s that don’t recognize most employees now live and work in different communities, says former Mayor Murphy, who is now a senior resident fellow at the Urban Land Institute in Washington. After about six years in office, he says, he realized that economic growth wasn’t easing Pittsburgh’s finances because the city wasn’t capturing taxes from nonresident workers and exempt employers.

‘Further Behind We Got’
“The more we grew, the further behind we got,” Murphy says. “The state legislatures are the only place with the power to fix this.”

Lawmakers could take several steps, said Coleman at the University of Pittsburgh’s politics institute. They may include consolidating administration of the state’s 3,207 local- government pension plans, strengthening oversight and restricting benefit increases from underfunded programs, he said. The proposals, outlined in a 2009 report to the Legislature that he helped write, may also help other states, Coleman said.

In Pittsburgh’s East Liberty neighborhood where the Target store is about to open, future projects may be stalled for lack of $20 million for additional road work as the pension costs and solutions are sorted out, said Ernie Hogan, executive director of the Pittsburgh Community Reinvestment Group. Developments at risk include an 80-unit housing project and additional commercial development around the Home Depot store, he said.

“This is going to be something that is going to hang over us for the next 20 years,” Hogan said. “We’re paying off legacy costs from 30 years ago.”