Caprioglio suggests he was deceived by City Hall in 2008

Posted by George Hostetter on March 27, 2014 

Fresno City Council Member Paul Caprioglio at Thursday’s council meeting came close to accusing officials in the accounting and financial worlds of fraud.

The target of Caprioglio’s outrage — the city’s anemic general fund reserve and how it got that way — is old news. But how he expressed his outrage raises a question: Is he on to something, or is he making a mountain out of a molehill?

Mayor Ashley Swearengin’s 2015 general budget was the topic at hand. She plans to deliver her proposed spending plan to the council in mid-May. She and City Manager Bruce Rudd gave the council a look at what’s heading their way.

Swearengin anticipates a general fund budget of about $287 million. The mayor and council must decide how to spend an unexpected pile of discretionary cash. Swearengin wants to pay off internal loans, pay off negative fund balances, hire more firefighters, maintain the police force at 717 sworn officers and begin building a reserve. It was clear from council members’ comments that she’ll have a fight on her hands. Council members were especially concerned with staffing in the code enforcement division and funding for street maintenance.

As Rudd often says, budgets are about priorities.

Rudd at one point told the council that for the past four years Fresno had suffered through a budgetary “hell.”

Let’s circle back to those “negative fund balances” for a minute. They go a long way toward explaining why Fresno’s half-million people went through so much pain.

Fresno is a relatively poor town. Politicians don’t like to say no to constituent demands for service or employee demands for compensation. Put those together and the result is a City Hall always scrambling for money.

We all know the legacy of the last 20 years: Pension obligation bonds; The Met; Granite Park; downtown baseball stadium; No Neighborhood Left Behind; parks bond; Fresno Falcons/Selland Arena; periodic raises for labor and management and politicians.

On and on it went.

Wall Street didn’t give a hoot. Every time City Hall went to the bond markets, cold-blooded credit analysts looked hard at the city’s books, deemed the bottom line to be as solid as the Rock of Gibraltar and speedily gave the city a credit rating with lots of upper case A’s. Investors couldn’t buy the bonds fast enough.

Then the Great Recession hit, the worst pain beginning in 2009 when Swearengin took office. Revenues plunged as obligations soared.

The pre-recession, pre-Swearengin spending spree included the borrowing of tens of millions of dollars for, among other things, construction of a multi-story parking garage on the Convention Center parking lot. Parking fees was to cover the bond debt. Revenue never came close to covering the bill. What was City Hall to do?

City Hall went into long-term debt to pay long-term debt — just about the dumbest thing possible for a government that doesn’t have ability to print unlimited fiat money.

City officials dipped into the city’s treasury pool. This is where cash from places as diverse as government grants, tax allocations and utility payments are banked until spent on things like employee salaries, operations and capital projects. Borrowing from the treasury pool for a month or two is common practice in city governments. Fresno officials dipped into the treasury pool to cover the parking-garage bond bills. They left behind IOUs that supposedly would be paid off real soon.

However, “real soon” never came. The city’s debt to its own treasury pool grew and grew. No one at City Hall was in any hurry to trumpet this situation to the good people of Fresno.

You can see the time-bomb ticking away here. Fresnans like services. Politicians like to oblige. Recession hits. Revenues drop, which nobody likes but at least everybody knows about. Debt obligations remain, which nobody likes but at least everybody knows about. And just below the surface, out of almost everyone’s sight, is this ever-growing internal debt — the so-called “negative fund balances.”

Then, in the budget hearings of May-June 2010, the existence of the negative fund balances became public knowledge. How that came about is an odd story, but I won’t go into it here.

Suffice it to say that in mid-2010 Swearengin and then-City Manager Mark Scott made a point of publicly discussing the negative fund balances disaster. Then City Attorney James Sanchez said his office would investigate any possible wrong-doing. I don’t know what happened in that search.

It turned out that long-term treasury-pool borrowing had been going on as far back as the 1990s, though not at the levels of the post-2000 era. When all the borrowing got added up, City Hall owed itself about $36 million.

By this time (mid-2010), Wall Street had gotten religion. Credit analysts were stunned when they uncovered Fresno’s shaky finances.

Exactly why the analysts were stunned to discover what they helped create has never been made clear. City officials in the months after the mid-2010 negative fund balance revelations said they weren’t really revelations at all. City officials said the growing negative fund balances were in plain sight all along, right there in the city’s comprehensive annual financial reports (CAFRs) for all to see and digest.

I took that to mean one of two things.

One, Wall Street analysts knew every year for the last 20 years, thanks to close reading of the city’s CAFRs, that Fresno was borrowing like crazy from itself to pay for operations and conveniently forgetting to repay itself. Despite this, the analysts decided City Hall’s credit merited the very highest ratings because this was a city addicted to bond deals (which, coincidentally, Wall Street is as well). Therefore, there was no reason to derail this gravy train (and perhaps save the city from itself) by making a big deal out of huge negative fund balances itemized in the CAFRs.

Or, two, Wall Street analysts didn’t pay a bit of attention to the CAFRs yet gave Fresno super-high credit ratings because, well, everyone loves bond deals and nothing could go wrong.

I don’t know which option is correct. I do know Wall Street analysts for the past four years have been hammering Fresno’s credit ratings, blaming the city for long-ago failings that supposedly were plain as day in CAFRs routinely landing on the desks of those same analysts.

It’s not just Wall Street analysts who have some explaining to do.

About a year ago, as City Hall was gearing up for the Measure G special election, Fresno’s outside auditors issued a “going concern” warning for the city’s finances. “Going concern” is accounting-speak for the death watch. It was the first “going concern” warning in Fresno history.

One of the auditors’ worries was the negative fund balances.

Fresno gets its books audited every year. The negative fund balances had been growing for years. If big negative fund balances are a big deal, the kind of big deal that might scare Wall Street into taking a second look at Fresno’s borrowing/loan-guarantee binge, wouldn’t a “going concern” warning have been wise early in the Alan Autry era rather than in 2013 when, for all practical purposes, it was too late?

Of course. Why didn’t Fresno get an early warning rather than a worthless warning? I don’t know.

The Swearengin Administration since mid-2010 has consistently pushed one theme regarding negative fund balances — they must be paid off. The city in 2010 reduced its general fund reserve to almost zero by spending $10 million on negative fund balances. The city has whittled the amount owed to itself to about $4 million.

Exactly why the city should rush to repay the negative fund balances when Fresno is “service insolvent” has stumped some council members. Their logic, if I understand it correctly, makes sense.

To wit:

* The city over many years took in money from various sources.

* The money was earmarked for specific purposes.

* The money was put in the treasury pool.

* The city borrowed $36 million from the treasury pool for things that weren’t among these “specific purposes” and has been slow in repaying the money.

* There’s no sign that Fresnans or other government agencies suffered from the underfunding of these “specific purposes.”

* No one of importance in the financial world had the foggiest idea for many years that the city was dipping into the treasury pool.

* Or, if they knew, no one gave a hoot. Either way, the world moved along smoothly.

* If people of importance in the financial world had known, or if they had given a hoot, they could have raised such a stink years ago that a Fresno City Hall intent on pursuing an eight-year borrowing binge may have been forced to be more prudent.

* Instead, people of importance in the financial world let Fresno dip into the treasury pool to its heart’s content at the same time they encouraged Fresno to go on an eight-year borrowing binge.

* Then the Great Recession hit and, as City Manager Rudd said, the people of Fresno went through “hell.”

* And then, midway through the recession, people of importance in the financial world suddenly decided Fresno’s borrowing from the treasury pool was very bad.

* To eventually leave hell, people of importance in the financial world told Fresnans they must quickly repay all this money to the treasury pool or suffer a total lack of confidence from the same financial people who were supposed to have known all along what Fresno was doing with the treasury pool and, as part of their professional duty, give a hoot.

* Someone might suggest that the solution is for everyone to recognize the multi-faceted culpability in this mess and pretend for a few years (or decades) that this treasury-pool mess is no big deal. To which people of importance in the financial world say: Bad idea.

All of this is context for today’s budget workshop and District 4 Council Member Paul Caprioglio.

Caprioglio is a long-time lawyer in town. He’s also a man of few words. He was elected to the council in 2012, but arrived at City Hall with some legislative experience under his belt.

District 4 Council Member Larry Westerlund in April 2008 was called to active duty in the Navy. The council selected Caprioglio to take the seat until Westerlund returned or until a new District 4 representative was chosen in the 2008 elections.

Westerlund, despite being gone, won a second term. Caprioglio served 11 months until Westerlund returned in early spring 2009.

That meant Caprioglio was representing District 4 in spring 2008 when the council held hearings on the Fiscal Year 2009 budget.

Caprioglio today began his brief comments by thanking City Manager Rudd for the excellent budget workshop.

Then Caprioglio said he was “disappointed.” He said the council back in 2008 had set aside $3.5 million for the general fund reserve. But, Caprioglio said, he had learned in today’s workshop that the general fund reserve was only $1.5 million.

Caprioglio said he was disappointed with City Hall accounting habits.

“I kind of feel like I was the victim of a shell and pea game,” Caprioglio said.

Then he yielded the floor.

“Victim.” “Shell and pea game.” Those are powerful concepts in light of everything that has happened at City Hall over the past 10 or 20 years. I’ve never heard anyone of responsibility use them in reference to past accounting and financial decisions.

If Caprioglio is a victim, then what about the employees and former employees of the city of Fresno? Even more important, what about the residents of Fresno?

Financial victims often have standing in court to seek justice. The Wall Street Journal every day if full of such stories in the wake of the Great Recession.

The shell and pea game is a powerful image. Look up the term in the dictionary. It’s a metaphor for fraud and deception.

I asked Mayor Swearengin after the workshop about Caprioglio’s comments from the dais.

Swearengin said she didn’t think the political and accounting decisions that led to $36 million of negative fund balances were made with “malicious” intent.

With that beginning, I thought she was going to give her thoughts on who made those decisions. Instead, she shifted back to my question — Caprioglio’s “shell game” comment.

The city’s lack of cash when she took office in January 2009 “required us to look at every single account in the overall treasury pool,” Swearengin said. “Prior to that there was never really a need to evaluate each and every account and find out what the balance was. So, the recession required us to pull the covers all the way back and see what was going on. In that process, we uncovered $36 million of negative fund balances that offset the positive general fund balance of $17 million.”

I thought: That statement raises more questions than it answers.

Then I thought: The $36 million in negative fund balances, the bond-buying binge, the “hell” that Fresno went through over and above what the Great Recession caused — an awful lot of professionals with ethical mandates and specific legal responsibilities were involved in what could easily be called a major systematic failure.

I asked the Mayor if she thought there was any criminal wrong-doing at any point in this long chain of negative fund balances and multi-million-dollar bond deals.

Swearengin began by saying she’s not a legal expert in such matters. Then she said: “From my administrative purview here at the city, my observation is that there was no malice. There just wasn’t the type of careful evaluation of every single aspect of the city’s finances when things were OK. There was enough cash in the system to accommodate the negatives, and that changed very, very quickly. Once we were in that circumstance, we had to dig through absolutely everything.”

In my view, Caprioglio’s statement about “victim” and “shell and pea game” needs to be addressed in more detail by city officials and perhaps others as far up the food chain as Wall Street.

But with the negative fund balances about to be repaid in full, the issue in Fresno probably is on its deathbed. But maybe not in the state.

Swearengin, a Republican, is about to embark on a campaign to run for state controller — the top financial official in the world’s ninth largest economy. She arrived at City Hall five years ago just in time for the financial disaster to fall into her lap. Her opponents in the controller’s race won’t get any political mileage by blaming her for the mess. She has had to clean it up. Ashley Swearengin has served Fresno well.

But Swearengin’s opponents could get political mileage if she persists in using a passive voice (to use a writing term) in explaining how Fresno got into the negative fund balance “hell.”

True, the woe didn’t begin on her watch. But the passive voice suggests, at the least, a willful indifference to who specifically should be held accountable. The state of California’s controller no doubt gets much pressure to be willfully indifferent to the root causes of complex and unpleasant financial matters. I’m assuming the controller’s duty is to get to the bottom of financial messes and hold people accountable, regardless of who might be involved.

In a round-about way, Caprioglio on Thursday may have given Swearengin some good campaign advice.

 

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