The moral of the story

The members and beneficiaries are not precluded in bringing lawsuit on behalf of the Retirement Fund even prior to the enactment of Public Law 17-51. They can do so even without this law. What makes it so burdensome to the Fund’s service providers is the fact that most of their offices are located outside the CNMI. Any lawsuit, with merits or not, filed in the state court, will result in the service providers bearing the extra cost for their lawyers, airfare, hotel accommodation and other related costs to defend their cause. These incidental costs were not projected and included in their fee schedule when they entered into a contract with the Fund.

If there is an obvious reason such as a breach of contract, of course the first party to know that is the Fund management. It is the principle of trust and confidence of doing business that is at stake and PL 17-51 opens the gates for frivolous lawsuits. This may mean too much inconvenience on the part of the service providers and the Fund as well. Instead of dedicating time and efforts to benefit the Fund, the focus will be diverted to defend themselves from frivolous lawsuits.

The Fund started dealing with Merrill Lynch from day one when the Fund embarked in the investment arena. If the initial Fund management did not have trust and confidence in Merrill Lynch, that company should not be hired in the first place. The contract was open-ended and could be terminated anytime by either parties. How long was that? Over 20 years! Did Merrill Lynch perform its role in the contract for the Fund’s benefit? Please verify the actual numbers at the Fund. From my recollection of one of the reports, the over $100 million invested capital produced over $300 million in total portfolio market value.

Beginning in the last quarter of 2007 up to the last part of March 2009, there was a total market breakdown worldwide due to the toxic subprime mortgage (real estate) collapse. All investors, both institutional and individuals, were not able to escape due to the subprime bubble. The only investors that profited from this catastrophe were the so-called short seller hedge funds (the gamblers) because they were aware, one way or the other, that in due time the subprime mortgages will meet its end. And it did! The investment philosophy of the Fund precludes short-selling and, following that discipline, of course if the market turns south the effect will result in what is called unrealized loss or paper loss.

Investing is management of risks and of course to earn a reasonable rate of return based on the level of risks taken. Higher risks mean higher expected returns, moderate risks will mean moderate returns and conservative risks will give you conservative returns, equal to a time certificate of deposit. I do hope this section provided you a simple explanation of the negative effects of PL 17-51.

As for the pension obligation bond, we all know the defined benefit plan’s sponsor is the CNMI government. There are many factors to consider in floating a POB. First and foremost, the CNMI Constitution prohibits issuing bonds to finance government operations. Simply, a POB aims to finance government operations because the Fund was underfunded and the POB proceeds will be used in its entirety to be invested in the Fund. That’s the very reason the POB was placed on the ballot—to exempt POB from the category of government operations—but voters rejected this in the previous election.

Another important aspect to consider is the current credit ratings of the CNMI. If the credit rating is low or bad, the interest that would be attached to the POB will be higher because the risk of default is high. Investors who will buy the POBs will not take higher risks if the stipulated interest rate was low. Higher risks will mean higher interest rate and vice-versa.

On top of these, the underwriting cost will be higher as well because the underwriter needs to spend so much in marketing the POBs. The economic climate for issuing bonds nowadays is not very appealing. You may have heard the news about Europe and its member sovereign countries. The massive risks of default are all over the continent, no one wants to invest in bonds. Therefore, the timing for the POB is not encouraging.

This is the most practical consideration: POB is a debt and not an asset. You are paying a debt using another debt. The commonly known term is refinancing a debt. If you refinance your mortgage, for example, you extend the terms and you’ll end up incurring more debt than you originally had. In fiscal year 2009 Single Audit Report of the CNMI government (http://www.opacnmi.com/content/cnmi-general-fund-deficit-increases-174-3008m), the accumulated deficit was $300.8 million. The actual revenue collection was short by $18.4 million or 11.8 cents for every $1 of estimated revenue. On the other hand, the actual expenditures exceeded estimates by $18.6 million or 11 cents for every $1 of budgeted expenses. It is a “double-edged negative” if both the actual revenue falls short of the estimates and the actual expenditures is higher than what was budgeted. From the 2006 deficit level of $188.1 million to $300.8 million in 2009, that is a 17 percent annual growth in the CNMI deficit. Using the “rule of 72,” in four years’ time the deficit will double! The bond rating agencies that monitors the CNMI will be reluctant to give a good credit grade. Simply, find out the CNMI government’s revenue trend in the last three years. Isn’t it on a downtrend?

Here are excerpts from the Bureau of Economic Analysis, U.S. Department of Commerce news release on July 12, 2011, (http://www.bea.gov/newsreleases/general/terr/2011/pdf/cnmi_071211.pdf) “The estimates for the CNMI show that real GDP—GDP adjusted to remove price changes—decreased 19.8 percent in 2009 after decreasing 12.1 percent in 2008 (see Table 3)”. These were two consecutive years of double-digit declines. And here: “The decreases in real consumer spending in 2008 and 2009 negatively impacted economic growth, most notably in 2009. In 2009, real consumer spending fell by approximately 13 percent after decreasing by less than 1 percent in 2008 (see Table 3)”. Consumers are not spending, causing the negative economic growth for the CNMI.

To add the POB, is it practical to incur additional debt with the current economic environment? How could the government pay the debt holders on top of the current deficit? Who will be the ultimate payer of both the POB and the deficit? Isn’t it the CNMI residents? How? In the form of higher taxes, higher utilities, higher business license, higher vehicle registration, higher fuel tax and many more. If you would like to pay higher taxes, go ahead and vote for the POB.

The moral of this story is that “we must live within our means” until the economy grows again.