First, cities do not access pension funds, they have employees who invest into their pension systems. Some cities have their employees’ accounts on their books others have contracted out this service for larger firms to manage. Large portions of government expenditures for a city are funds to pay employees for their retirements (wage bill is one of the largest classes of expenditures for a city). For example, the City of North Miami has a Pension Trust Fund. These specific funds are used for the sole purpose to account for the accumulation of resources that are used for retirement benefits of city employees. The employee retirement plan are located under the Public Employee Retirement Systems (PERS) which include the Clair T. Singerman Employees Retirement System, also known as the CTS, and the North Miami Police Fund. These two pension plans provide employees and their beneficiaries with pension, disability, and death benefits.
Second, pension funds can serve as a source of equity for city governments to finance projects. In this regard, pension funds are used as an asset from within a city’s budget, but they also are one of the most costly expenditures. Cities may use their pension funds as collateral for public debt. In this regard, pension funds can be used for guaranteeing other financial instruments such as municipal bonds (munis for short). In developing countries, because of the status of fiscal federalism, cities use future inter-governmental transfers as a form of a grantee for municipal debt and not typically from their pension systems. Because saving rates, in general, are low in developing countries, the national government through development banks (such as BANOBRAS in Mexico) provides the financial instruments for public debt. There are two common forms of munis in the US:
a. General obligation bonds that finance government projects like parks, streets, schools and public buildings. They usually use a full government guarantee, exempting them from taxes. They must be approved by referendum. Monies to pay interest to bond holds are raised through taxes and some user fees.
b. Revenue bonds are issued for special purpose projects or facilities for specific usage like development or improvement of sewer and water systems, public airports, toll roads, hospitals, housing and public parking facilities. They require repayment from usage fees or charges or sale of a project generated from the financed project. (These are the types that were used for the BABs and PACE).
Additionally, Industrial development bonds are special purpose to promote economic development, but they serve both public and private benefit. They must include job creation and strengthening of the local tax based to create a multiplier effect to help the local economy. In the US, these bonds were to expand to attract, or retain existing financing for example hospitals, utilities and transportation services, which are entities that can use the tax-exempt status. The new type of taxable bond comes from Build America Bonds (BABs) program, which were intended to be temporary, but has continued through special appropriations in Congress through the Treasury department. Green bonds have been proposed to model after the World War II era ‘War Bonds’ program for investments in green technology. Green bonds are just another name for the BABs program, which is described below.
Third, large-scale pension funds (off the books from a municipal governments financial statement) invest in other financial products such as munis because they are one of the safest investments (in the US second only to Treasure bills) and almost always guarantee a positive return for their beneficiaries. For example, the city of North Miami carries the Florida Retirement System (FRS), which it uses as a “cost-sharing multiple employer defined benefit pension plan.” The FRS is administered by the State of Florida. This fund provides for monthly employer contributions at actuarially determined rates that, expressed as percentages of annual covered payroll, which are adequate to accumulate sufficient assets to pay benefits when due. This pool resource, such as the FRS, looks much like an investment fund (such as mutual funds) in which they seek to invest the employees’ savings into larger capital markets in order to have higher returns. One of the most secured investments for large pension funds are municipal bonds, but they may also invest in other financial instruments depending on the risk tolerance of the board of directors/fund managers.
Therefore, urban projects may have matching investments such as a pension fund, but first must undergo scrutiny depending on the project and loan type. A city government first contracts a feasibility study prior to accessing a municipal bond. For example, if the city seeks out a revenue bond (i.e. to improve a toll road or sewage system repairs) it is expected to generate repayment from usage fees by local residents. Forecasting is used to determine the viability of the project. With the study, a city finds a bond issuance. In addition, each individual muni must be rated from a rating agency. Its rating is determined on the specific revenues dedicated to the debt service compared to the costs of the services themselves. Ratings rang from AAA to BBB- and each rating firm has a different methodology to determine the availability of repayment for a project.
As part of the stimulus legislation passed by the Obama Administration in 2009, BABs were proposed for infrastructure improvements some of which include “green” projects. The Treasury department offered issuers to choose either a direct subsidy of 35% of the coupon interest or buyers of the bond could benefit from a 35% tax credit. Thus, in effect, reducing the cost of the munis, in order to make them more attractive to investors.