Aiding and a-bedding? Part 3, Being spied on

January 22, 2015 | Airbnb, Apartments, Cities, Global news, Hotels, Housing, Innovations, Markets, New York City, Paris, Rental, Speculation, Urban issues, US News, Zoning | No comments 240 views

[Continued from yesterday’s Part 2 and the preceding Part 1.]

By: David A. Smith

Dr. David Kibner: Elizabeth, could you please tell me, in your opinion, what is going on?

Elizabeth Driscoll: People are being duplicated. And once it happens to you, you’re part of this… thing. It almost happened to me!

Invasion of the Body Snatchers

At the conclusion of yesterday’s Part 2, we saw that when a building or even a small neighborhood is infested with Short Stay Rental tenancies, the social ecosystem is disturbed, and not always for the better.


Once it happens to you, you’re part of this … thing

Sources used in this port

(and previous AHI posts on Airbnb and flat-renting)

Prohibition and the rent-easy (August 13, 2010)

Chez Reductio ad Gotham (August 5, 2013)

Outbreak of informality, Part 1, Part 2 (September 18, 2013)

We know where you live, Part 1, Part 2 (October 16-17, 2013)

The enemy of my enemy, Part 1, Part 2, Part 3 (November 18-20, 2013)

New York Post (October 16, 2014; brick-red font)

BBC News (December 26, 2014; black font)

Boston Herald (January 17, 2015; olive-green font)

Yet that localized effect has to be seen against the larger city, which like any other complex organism is divided into areas that are specialized organs whose functions serve the whole city – in this case, all those tourists bring more money to the city than they take home, and with all that money comes new jobs for locals.

So perhaps the city’s leadership needs to look beyond the localized complaints at the bigger voting patterns picture:

5. Short Stay Rental can be symbiotic with a healthier city

Elizabeth Driscoll: There’s nothing to be afraid of. They were right. It’s painless. It’s good. Come. Sleep. Matthew.

[Matthew begins to back away]

Elizabeth Driscoll: Matthew. Matthew!

Invasion of the Body Snatchers

At the heart of the ‘sharing economy’ business models is an indisputable reality: things that we possess as ours are used infrequently. 

Many things are used for only part of the day.  Cars are used perhaps two hours in twenty-four even by heavy commuters; offices hum ten hours in twenty-four; homes are occupied perhaps eighteen hours in twenty-four.

Most spaces are under-occupied.  When was the last time every seat in your car was taken?  Or every bedroom in your apartment or home slept in?

At Airbnb – by far the biggest internet site dealing in holiday lets – they say that the vast majority of their business is with people legally letting primary residences.

The figure offered by Airbnb’s Paris director Nicolas Ferrary is 83%.


Invest in France … so we can ban your investment?

Underuse is an acceptable and accepted consequence of ownership, because we want the thing ready for our use whenever we want it. 

(Urban slums are the counterexample: there poverty is so extreme that everything is stressed: construction costs are minuscule, operating costs likewise tiny, and every available space is used for sleeping.)


This over-ownership is natural, even efficient, because compared with the cost of acquisition (including construction and maintenance), the marginal cost of use drops dramatically when the asset is idle, and our planet is (in general) rich enough that we can afford this investment in our built environment.

That figure is disputed by Francois Plottin, who says around half of properties advertised on Airbnb are not primary residences.

Frankly, I would expect the figure of pure-SSR properties to be even higher, because once an owner has configured an apartment to be in the business of being rented, he or she wants to maximize its rental use.

We do everything to comply with the rules, and it is clearly signposted to users of our website what those rules are,” says Mr Ferrary.

Mr. Ferrary is being doubly disingenuous:

1. Posting to the web site isn’t compliance, it’s covering one’s posterior, like those ubiquitous ‘I have read’ disclosures.


You didn’t, we know you didn’t, we know that you’ll deny you did, but we feel better anyway

2. “We do everything.”  Nonsense: Mr. Ferrary means his company does the minimum things necessary to be out of direct liability to the Paris government.  If Airbnb wanted to do everything, it could inspect flats listed on the send; send mystery shoppers to flats; offer rewards (of, say two free nights’ lodging) to whistleblower guests who reported their landlords – and that’s only three things I thought of in ten seconds. 


You’ll never rent from Airbnb again

No, Mr. Ferrary and Airbnb are rent-easy pushers, as is Ms. Leeds:

Many of her clients bought pied-a-terres which they visit occasionally, but rent out the rest of the year to pay off the mortgage.

‘To pay off the mortgage’ is more self-justifying rationalization– as if without the Airbnb money the mortgage would go into default. 

It’s inducing violation of the law, pure and simple.



Like other epidemic, over time an outbreak of law-violation ends up in one of only three possible end states:

Extermination, where the violations are wiped out or at least reduced to a negligible population.


“I don’t know who you are … but I will look for you, I will find you … and I will fine you.”

Overrun, where the law drowns in universal non-compliance, and a new order emerges.

“There are no more than 100 or so owners every year who are going through these compulsory steps, and acquiring the compensatory property,” says Francois Plottin.


We can use the law to stop them

“That means 20,000 people breaking the law. But now we are slowly starting to levy fines. This year 50 people have been fined 10,000 euros (£8,000; $12,000) each.”

In other words, the odds of getting away with it are 1 to 400 (99.75% success rate).

Elizabeth Driscoll: Matthew, we’ll never be able to stop them!

Matthew Bennell: Yes, we will.

Elizabeth Driscoll: We can’t! Look it, they control the whole city.

Matthew Bennell: We’ll find a way somehow.

Invasion of the Body Snatchers

Redefinition, where both the law and the behavior are changed and a new symbiosis emerges.  When policy and power clash, there are always at least two critical questions:

1. What should happen? 

2. What will happen?

6. What should happen?  What’s the right answer?

Like many organisms, when Short-Stay Rental (SSR) proliferates, it permanently changes its environment:

The repercussions on the Paris residential market are severe, according to Ian Brossat, Director of Housing at City Hall.


Hearing tourists’ footsteps? Ian Brossat

“There is already a serious shortage of flats in Paris, especially studios and two-room apartments where couples might start a life together,” said Mr. Brossat.

While Mr. Brossat’s statement may be true, he’s not seeing the whole system. 

Some cities are magnets for transients, who can be immigrants:


We’re just passing through, heading for the hinterlands

University students:


Every dot is a magnet

Or tourists:


Get your picture taken with the shoe


Photo by Philip Gould

People-magnet cities are also jobs magnets: all those tourists visit the museums, go to the restaurants, climb the Eiffel Tower, take the taxis or the metro, ride the Air France planes, and fill up the hotels,


Discharging loads of rubes heading into town

“Now we have this growing problem of holiday lets, with investors moving in and buying up as much as they can.  It has become a business, and the result is fewer properties on the market for ordinary Parisians, and higher prices for what is available.”

There are fewer homes for rent because the jobs and population are growing, but the city isn’t adding supply – and probably for the same reasons that two other Airbnb-popular cities, San Francisco and New York, are likewise running short – development restrictions and development disincentives (rent control).

Paris is an urban disneyland.  So are the Italian hill towns.  So is Venice.

Venice, Basilica di San Marco

A gorgeous tourist trap …


… since at least 1730 (Canaletto)

So is downtown Charleston, South Carolina.


Charleston, South Carolina

Because tourist attractions have higher foot traffic than residential neighborhoods, they have higher real estate value.  So tourist neighborhoods inevitably tourist-ify, and that means apartments are replaced by transient-occupancy dwellings, by demolition and new construction, or by retrofitting small flats into extended stay hotels, or by simple SSRs facilitated by Airbnb. 

“When [Short-Stay Rental takes over] a whole neighbourhood, then the life just drains out of it,” said M. Guillot.

‘Life,’ for M. Guillot, means the rhythms of residential living, the place where people know your name.  everyone is familiar, because everyone is known, and because everyone is known, everyone is familiar. 


Some Parisians worry that holiday lets are changing the character of neighborhoods

But in cities, by contrast with neighborhoods, strangers live companionably side by side, sharing streets, entries, corridors, walls, floors and ceilings.  What distinguishes a good city from a bad city is the ability of people who do not know each other to become neighborly; in a bad city, those anonymous flats can become handy entrepots for drug deals, pied-a-terres for call girls, or staging areas for terrorists.

Ms. Leeds says inspectors are following people with suitcases on the street to see what apartments they go to.

“We feel like we are being spied on. It’s like World War Two. And they have the right to enter apartments without the owner even being there. It is incredible!”

It may be incredible, Ms. Leeds, but you are a fool if you equate occupancy checkups with Nazi police.


The cost of anonymity

The hotel industry is also watching the accelerating spread of Paris holiday lets with misgiving.

“We are not against competition per se, just distorted competition,” says Alexandre Loisnard-Goyeau of the hoteliers’ union Synhorcat.


“The distortion comes because on our side we have all the taxes and the legal obligations concerning security and access for the disabled and so on.”

“And the flat-owners have none of it.”

Ah, but should they?

In some ways, yes: the flat-owners should be regulated.  While the consumer-protection aspect of renting a room is less essential with the power of social media to report and ostracize bad landlords, issues of habitability, wiring, safety and so on.

Conversely, cities have long used
hotels as a convenient source of soak-the-tourist revenue streams, and a single apartment isn’t a hotel; it’s much less and there is at present no standard for what it is and what is the appropriate level of regulation – and hence, the policy-justifiable level of taxation or assessment of the cost of that regulation.

Dr. David Kibner: We came here from a dying world. We drift through the universe, from planet to planet, pushed on by the solar winds. We adapt and we survive. The function of life is survival.

Invasion of the Body Snatchers


We adapt and we survive

[Continued tomorrow in Part 4.]


Aiding and a-bedding? Part 2, No one is complying

January 21, 2015 | Airbnb, Apartments, Cities, Global news, Hotels, Housing, Innovations, Markets, New York City, Paris, Rental, Speculation, Urban issues, US News, Zoning | No comments 194 views

[Continued from yesterday’s Part 1.]

By: David A. Smith


You’re next!  You’re next!

Running man: [panicked shouting] Help! They’re coming! They’re coming!

Elizabeth Driscoll: Maybe we should help him.

Running man: Help! Help! They’re coming! They’re coming! Listen to me! Listen!

Invasion of the Body Snatchers

In yesterday’s Part 1, the invaders had arrived; starting from their landing spot in San Francisco, they’ve swiftly scattered to the world’s major tourist-destination cities, and they show no signs of stopping, despite the hastily-organized defenses being mounted by the local governments, and their ill-advised efforts to wipe out each site one by one:

From now on, the second – commercial – property acquired under the compensation rules has to be in the same arrondissement, or district, as the buy-for-let property.

What a strategy – take a law that people are widely flouting, and make it harder to comply with!


Yeah, that’ll work

Sources used in this port

(and previous AHI posts on Airbnb and flat-renting)

Prohibition and the rent-easy (August 13, 2010)

Chez Reductio ad Gotham (August 5, 2013)

Outbreak of informality, Part 1, Part 2 (September 18, 2013)

We know where you live, Part 1, Part 2 (October 16-17, 2013)

The enemy of my enemy, Part 1, Part 2, Part 3 (November 18-20, 2013)

New York Post (October 16, 2014; brick-red font)

BBC News (December 26, 2014; black font)

Boston Herald (January 17, 2015; olive-green font)

More problematic for Paris, as so often happens with housing-related issues, it seeks to force a public burden (need for more affordable housing) onto some private people.

This is to stop people buying a residence for let in an expensive central area like the Marais, and then the compensatory commercial property in a cheap area near the ring-road.

That reasoning is akin to a double-image optical illusion. 


Two ways to look at it

On the one hand, it’s seeking to retard the natural gentrification that would otherwise take place in the Marais and other trendy areas of Paris; on the other hand, it’s guaranteeing that new housing which might otherwise be built won’t be.  The enhanced law merely sharpens the divide, and while it may discourage some potential short-term landlords from converting their flat, once an owner has decided to convert, it actively discourages the landlord seeking to earn any form of amnesty.

If it all sounds ludicrously complex and expensive, that is exactly what it is.

After all, it’s French.


But just as laws you don’t enforce are worse than useless, stupid enforcement activities signal that a law itself is stupid:

Mr Plottin’s inspectors have the right to enter properties to find if they are being used illegally as holiday lets.

If one is going to regulate occupancy within a property, then one must have the right to inspect within that property.

Where owners declare that the flat is let out legally, inspectors can ask for documentary proof that the lease is for the minimum of a year.  If owners produce fake leases, they face criminal prosecution for fraud.

Escalating the crime – in this case, from illegal renting to fraudulent certification – is a common bootstrap tactic to raise the stakes for lawbreakers.


It works in the comics

That might work if lawbreaking was rare … but it’s epidemic


Only the baby is safe

3. Property owners are flouting the law en masse

Making the enforcement problem worse is that the law itself already allows owners to do, in small and rarely, what Airbnb and the SSR model encourages them to do in large, and routinely.

Under French law you can rent out your flat for short periods to holiday-makers – as long as it is your primary residence.

It’s easy enough to understand how such a law would have come to be.  For decades, in August Parisians have headed to the beach, emptying the city for the tourists, who love it in the summer – so what would be more natural, more voter-friendly, than helping the hard-working Parisian household afford its vacation in the sun by letting them let their flat?


And to think the tourists are underwriting our holiday

That leads the typical illegal landlord to adopt what I’ve long called the ‘mulligan violation’ – The first time you catch me, I’ll claim I didn’t know I was doing anything wrong, and you’ll let me go.


Oh, is that out of bounds?

However, so far few property owners have complied with the new rules.

Why would they?  The observant herd takes comfort in numbers.

City Hall in Paris believes that as many as two-thirds of properties being rented on very short lets are not primary residences.

Until the city creates a visible, probable, painful downside, clandestine disobedience will multiply – and already the violators dramatically outnumber the regulators.

As a result it is estimated that a staggering 20,000 people – foreigners as well as French – are today liable for fines of thousands of euros.


Every one of them illegal?  Bercy Arena, with 20,000 spectators

And – despite repeated warnings – that is something that only a tiny fraction of owners have bothered to do.

Which explains why virtually no-one is complying.

It’s as if they have been taken over by an alien force – money.


Why do we always expect metal ships?

All of which is beginning to create panic among the 20,000.

“The people I advise didn’t think they were doing anything wrong when they bought flats in Paris as an investment,” says American Marais-based property consultant Adrian Leeds.


She doesn’t mean to Ms. Leeds … or does she?

“And now suddenly they are being turned into criminals!”

Actually, they always were criminals, at least under Parisian law, but to be an unprosecuted criminal is to be innocent, isn’t it?


No one … is innocent

In fact, the landlords did know or should have known, and for that matter, Ms. Leeds should not have allowed them to be misled or misinformed.  Somewhere along the value chain, the government must intervene, decisively, to motivate the observant herd, or surrender entirely.

4. The public interest is legitimately at stake

They are flats that are being used solely for making money via year-round holiday lets, the authorities say.

Dealing with Short Stay Rental is not simply a question of enforcement, it goes to fundamental urban-public-policy issues as to what type of city Paris (or New York, or London, or a half-dozen other cities) want to be, and whether they can in fact be that.

In the vast majority of cases their owners are flouting the law.

Would you trust the French tax system, and its tax brackets?


Not that moving to Russia is a good idea, Gerard

As I calculated earlier in this post, transforming an apartment into an SSR replaces a den with a hive; instead of a family of three or four habitual Parisians, the flat will be home to perhaps 65 different newcomers a year. 

But French law says that the minimum period for letting out a residential property is one year.

Even in isolation, that is an enormous change in building load on corridors, elevators, and front door traffic – so the zoning law now on the books has a logic to it:

To let out a flat for shorter periods requires registering it as a commercial property.

Aside from the zoning distinction, which limits what property may be built where – commercial property will be differently taxed, because elected officials believe in subsidizing voters’ residences, and differently inspected, because of the vastly increased the potential for overcrowding and unsafe or unsanitary housing – and well as the possibility of dead-drop housing and other types of clandestine occupancy.


Binland Lee died in this fire …

Overcrowding and the slum-ification of existing dwellings is further much more likely when the property is entirely given over to short-term rentals.

The holiday let phenomenon is concentrated in big tourist areas like the Latin Quarter and the Marais. Here it is possible to find buildings where multiple flats are being permanently let out to short-stay visitors.


…because her means of egress were blocked

“We feel that our apartment building is being turned into a hotel,” complains Jean-Claude Guillot, who lives on rue Vieille du Temple in the Marais.


He didn’t buy into a hotel: Jean-Claude Guillot

M. Guillot is right; to all intents and purposes, it has been.

“There are the regular incivilities like the cigarette ends and the constant parties. But more than that, it is destroying the sense we used to have of the building being a shared space where we all knew and respected each other.”

Yes, for a resident, someone who has long lived in the same place, to have a constant flow of strangers would be unsettling at the minimum, to say nothing of the potential for noise, cluelessness, and strangeness.  If it were my building that had undergone such a transformation, I too could well be mightily disturbed.


That’s disturbing

At the same time, the local disturbances have to be compared against longer-term and larger urban consequences. 


Maybe we should help him

[Continued tomorrow in Part 3.]


Aiding and a-bedding? Part 1, A boon for tourists

January 20, 2015 | Airbnb, Apartments, Cities, Global news, Hotels, Housing, Innovations, Markets, New York City, Paris, Rental, Speculation, Urban issues, US News, Zoning | No comments 183 views

By: David A. Smith

Elizabeth Driscoll: I have seen these flowers all over. They are growing like parasites on other plants. All of a sudden. Where are they coming from?

Nancy Bellicec: Outer space?

Invasion of the Body Snatchers

The fabric of our cities is under an existential threat by an invasion of apartment-snatchers that spreads invisibly, through the ether, infests individual properties and then infects their occupants.  And the authorities seem powerless to stop it.


It started in San Francisco?

That, at any rate, is the conclusion one reaches about the invasion of Airbnb into cities around the world as it spread out from its San Francisco launching pad (landing pad?) to the globe’s hot spots, such as Paris, spotlighted in this God-ain’t-it-awful story from BBC News (December 26, 2014:

The Airbnb internet phenomenon is a boon for tourists, who find accommodation in popular destinations at a fraction of the cost of a hotel.

Airbnb and all the ‘sharing-economy’ models like it – Uber/ Lyft, Zipcar, and even the ubiquitous urban-bike rentals – are a new disruptive business model made possible by a disruptive technology (broadband wifi) and the resulting homegrown global network of connectivity. 

Sources used in this port

(and previous AHI posts on Airbnb and flat-renting)

Prohibition and the rent-easy (August 13, 2010)

Chez Reductio ad Gotham (August 5, 2013)

Outbreak of informality, Part 1, Part 2 (September 18, 2013)

We know where you live, Part 1, Part 2 (October 16-17, 2013)

The enemy of my enemy, Part 1, Part 2, Part 3 (November 18-20, 2013)

New York Post (October 16, 2014; brick-red font)

BBC News (December 26, 2014; black font)

Boston Herald (January 17, 2015; olive-green font)

All such disruptive innovations – whether sailing ships, railroads, automobiles, or the telegraph – both rapidly accelerate the flow of information and explode prior business or even social models that were built and sustained because until the new innovation they were the least-bad solution. When the new thing arrives, after an initial observant-herd period of wariness, the market can take it up exponentially.

The Airbnb internet phenomenon is a boon for tourists, who find accommodation in popular destinations at a fraction of the cost of a hotel.

In fact, for cities and municipal governments, Airbnb has got too big too fast to control, and with its newfound political-voice muscle, the company has been using its faster OODA loop to propagate itself across multiple cities.  The strategy must be deliberate, and it’s certainly brilliant because it’s carried out through proxies (people) and hence is both deliberate and deniable.


I have seen these flowers everywhere

But the suddenness and scale of the phenomenon have taken city authorities by surprise. And they are struggling to react.

It’s also reached the point of being unstoppable, and therefore we can ask the question, what happens after it wins?  The consequences are far-reaching.

1. ‘Small short rental’ is a proliferating life-form 

The business’s proponents call it the ’sharing economy’, which is brilliant marketing because it’s judgmental (designed to make you instinctively agree) and factually inaccurate.  Nowhere does the business model involve sharing, as in selfless co-ownership – instead, to keep things politically neutral, at least for purposes of analysis, I’ll call it Short Stay Rental (SSR)

And it’s spreading like wildfire:

Very short term internet flat rentals have seen a vertiginous increase in the last three or four years, in Paris as well as in cities like New York and Barcelona.

The last study, carried out in 2011, put the number of Paris apartments being let out to tourists at 20,000. Today officials say it has risen to 30,000.

That growth, 50% in three years, actually understates the boom globally, because Paris has always been a tourist disneyland with an active pre-Airbnb market of sublets, and for the most obvious reason – at any given time, perhaps one-quarter of the population of urban Paris consists of tourists,

“Holiday lets are an extremely profitable business,” explains Francois Plottin, who runs a team of 20 inspectors at City Hall.  “Because of the popularity of Paris as a tourist destination, the occupancy rate is very high. Flats are typically let out for 75% or 80% of the year.”


Plottin to protect the locales of habitation

Aside from the macro-level implications for global cities, especially people-magnet cities like Paris (or New York, Washington, London, or Tokyo), the micro-level social and economic consequences of changing a flat from rental to Short Stay Rental are dramatic.  If the typical tourist (couple or family) stays in a holiday let for an average of (say) ten days, that means in the course of a year roughly 25 rentals (365 / 10 x 75%) comprising maybe 65 people will pass through one apartment.  That’s an enormous change in building elevator and corridor and front door traffic, a subject to which we’ll return. 

“A small flat can make in a week what it would normally make in a month if it was let out to locals.”

That’s probably an overstatement for dramatic effect. 


For the sake of discussion, assuming 75% occupancy at (say) €150 a night; that’s €785 a week in gross income.  There will be operating costs, bedding and cleaning and utilities, plus management fees or fees to the rental agent, so perhaps the flat will generate €500 a week in cash flow, which is the appropriate comparable.  So if the flats rent, as normal apartments, for less than €2,000 a month, then the owner/ landlord is better off.  And if the nightly rate is (say) €250 instead of €150, then the arithmetic really spikes up, because that extra €100 a night is 95% GOP, and the cash flow is €4,000 a month.  That’s economically irresistible pressure.


Simply irresistible

In short, though the implementation mode is individual flats scattered throughout the city, the aggregate impact is as a plague of tourists.


Where’s the Eiffel Tower, anyway?

And it overwhelms the ability of government to respond.


We’re off to play locust against the crickets … or something like that

2. Municipal governments are in a full-blown panic

The SSR revolution and its active evangelism by Airbnb and the like has thrown municipal governments around the world into a full-blown panic.  Now, government is a factory that produces only two products – money and laws (hot air being merely a byproduct).  Of the two, laws are cheaper, hence better political vaporware, and government always starts with them – often by making something illegal. 

Elizabeth Driscoll: We’ll never be able to stop them!

Matthew Bennell: Yes, we will.

Invasion of the Body Snatchers

Within lawmaking, these boil down to basically two types: prohibitions and mandates.  (We can include taxes as a form of variable prohibition, as for instance in the Affordable Care Act’s penalty being adjudicated a tax – and in that sense, taxes are an interesting and useful invention in analog governance.)  

But in some cities the explosion of holiday lets is beginning to cause serious concern.

The authorities in Paris are so worried about the drain on residential property that they have enacted drastic measures to bring it under control.

When in doubt, ban.


Yes, that’ll solve the problem

Faced by a growing number of complaints, City Hall has toughened its rules.

Early efforts at lawmaking, like other early efforts, are often crude, impractical, or poorly designed:

There was already a so-called “rule of compensation”, designed to maintain the stock of residential properties in Paris.

Under this, an owner who turns a residential flat into a commercial flat (by using it for holiday lets) has to compensate for the loss to the regular rental market by acquiring a commercial property and turning that into residential.

I’m sure that will totally solve the problem.


In theory this should be a major deterrent, because it means that an investor in holiday lets has to buy two properties instead of one.


I never said most of the things I said.”

In practice the rule was not being observed.


However rather than scrap it, the City Hall has now decided to make it even stricter.

While understandable, that’s only going to anger the swarm.

Elizabeth Driscoll: I keep seeing these people, all recognizing each other. Something is passing between them all, some secret. It’s a conspiracy, I know it.

Matthew Bennell: There can’t be a conspiracy!

Elizabeth Driscoll: Matthew, I’m telling you something is going on here.

Invasion of the Body Snatchers


I’m telling you something is going on here

[Continued tomorrow in Part 2.]


Doublethink pension funding: Part 10, “One would think that alert trustees”

January 16, 2015 | Actuaries, Bankruptcy, Bonds, Capital markets, Cities, Detroit, Housing, Municipal bankruptcy, Net present value, Pensions, Speculation, US News | No comments 243 views

[Continued from yesterday’s Part 9 and the preceding Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, and Part 8.]

By: David A. Smith

It’s merely a question of self-discipline, reality-control. But in the end there won’t be any need even for that. The Revolution will be complete when the language is perfect.

George Orwell, 1984

Finally arriving at the last part of this post on public-employee pension-fund fiscal management and the essential ethos of financial doublethink, yesterday’s Part 9 both sent Detroit on its happy post-bankruptcy way and raised the question, What happens to the cities that haven’t yet gone into bankruptcy?


We paint over the past as quickly as we can, that’s what

Sources used in this post

New York Times (August 8, 2006; forest green font)

Michigan Live interview with Joe Harris (February 21, 2013; brick-red font)

New York Times (September 25, 2013; siena font)

New York Times (February 24, 2014; navy blue font)

Detroit Free Press (April 10, 2014; purple font)

Michigan Live interview with Charles Moore (June 10, 2014; green font)

New York Times (October 28, 2014; cobalt blue font)

Society of Actuaries letter to the ASB (October 30, 2014; gray-blue font)

The New York Times (November 11, 2014; black font)

Detroit Free Press (December 10, 2014; red font)

Huffington Post (December 10, 2014; olive-green font)

An underfunded plan today – and make no mistake, virtually every public-employee pension fund in America is underfunded, some as much as 60% underfunded – has only three endgames:

1.     Insolvency and collapse, with plan dissolution and payouts at percentages of face.

2.     Continued underfunding and irresolution.

3.     Restoration of solvency through asset replenishment faster than liability accumulation, which can be done either (a) with radical surgery, as through electroshock recapitalization, or (b) over a forced-march of years or short decades of above-equilibrium contributions.

And really, Endgame 2 is no strategy at all, because as we’ve seen, a pension without a strategy becomes progressively more insolvent.  So, as Andy Dufresne put it in The Shawshank Redemption, “Either get busy living or get busy dying.”


Even if you have to crawl through a river of shit to come out clean the other side

Today, however, most doublethink pension funds are still busy dyin’. 

The widespread practice of lowballing pension contributions today so that people will pay more down the road comes from the actuarial standards of practice.

Lowballing contributions today is popular the way that overeating is popular, the way that credit-card spending and minimum-paying is popular, and like both it’s wholly unsound in the long run.

Virtually all states and local bodies of government use investment assumptions this way; it makes their pension obligations look more modest and affordable than the true economic cost.


The beginning of Detroit’s decline?

Nevertheless, this unsafe-at-any-speed approach is what the Actuarial Standards Board (itself a trade association, not a truly independent body) has doublethought its way into allowing states and cities to instruct actuaries to use. 

Public sector plans are almost unique in that, there is not typically an independent, third-party regulator governing the funding/solvency of public sector plans, as contrasted with most other situations where actuaries perform work (e.g., private sector defined benefit pension plans (private sector plans), insurance). While many states do have regulations guiding the funding of public sector plans in that state, time and again governments have set inadequate contribution levels or have decided not to make the recommended contributions.

Foxes counting the hens in the henhouse is no basis for fiscal discipline. 

The Securities and Exchange Commission bars private companies from reporting their pension liabilities that way, but it has little power over cities and states.

Observe that politicians and regulators, who have no compunction about imposing rigorous standards on others, are curiously unable to impose them on themselves.


I’ll reform tomorrow … or maybe the next day

Some of the actuaries, however – perhaps sensing the hot breath of class-action litigation bearing down on them – have proposed forcing plan sponsors to report both the over-optimistic doublethink assumptions set, and a more conservative and realistic set of figures:


The panel recommend[ed] that pension actuaries provide plan boards of trustees and, ultimately, the public with the fair value of pension obligations and estimates of the annual cash outlays needed to cover them. That means pension officials would disclose something they have long resisted discussing: the total cost, in today’s dollars, of the workers’ pensions, assuming no credit for expected investment gains over the years.

Imagine – reporting what is actually owed, without assuming fantasy gains from future earnings!


All hail the revolutionary agenda

[That] would not be the only number provided to the public, but it would provide new insight into the market risks for pension plans and the shortfall that might have to be made up by local taxpayers if investment returns did not measure up to expectations.

It will be ironic if the antidote to doublethink is to provide two realities and let the non-insiders choose which to believe:


Who are you going to believe, me or your lying eyes?

So far, the only public pension actuary who has publicly provided such numbers is Robert C. North Jr., who tracks the five funds that make up New York City’s vast pension system. He is also one of the 12 members of the blue-ribbon panel.


Looking North at the world through untinted glasses

Other members include New York’s former lieutenant governor, Richard Ravitch; the Pension Benefit Guaranty Corporation’s former executive director, Bradley D. Belt; and the Principal Financial Group’s chief executive, Larry D. Zimpleman.


And so many years to do it

Dick Ravitch, whom I’ve known off and on for twenty years, has for that whole interval (and for many decades before that) been a solon of New York fiscal management, who has somehow mastered the skill (which I’ve never learned) of simultaneously being utterly ambiguous in pointing out and opposing political shenanigans and yet doing so in a way that doesn’t get him exiled to the room’s dark corners. 

Instead of the usual formula, ‘Of so many people one is guilty,” I was faced with the problem that of thirteen persons one and one only was innocent. 

Agatha Christie, Murder on the Orient Express

When it comes to public-entity management and fiscal prudence, he has my proxy: if he’s for it, I’m for it.

“We are concerned that we see many public-sector plans using practices that have not been used by private-sector plans, or that have been abandoned by private-sector plans around the world,” Mr. Cramer said.

He said the Actuarial Standards Board should issue an entirely new standard for public pensions, but if it did not, then it should at least require actuaries to disclose that their standards “are not designed to provide specific regulatory oversight to the practice of plan funding.”

Imagine: forcing actuaries to force their plan sponsors to tell the plan beneficiaries was is really going on with their promised benefits:


Win Bob Stein’s money measurement?

“One would think that alert trustees would want to review this,” Mr. Stein said, “and evaluate how they should respond.”

That requires nothing less than eradicating pension-fund management and accounting doublethink

“Until they have gone bankrupt they will never rebel, and after they have rebelled they cannot go bankrupt.”

Paraphrasing George Orwell, 1984



Doublethink pension funding: Part 9, “The brains and the nuts and the bolts”

January 15, 2015 | Actuaries, Bankruptcy, Bonds, Capital markets, Cities, Detroit, Housing, Municipal bankruptcy, Net present value, Pensions, Speculation, US News | No comments 261 views

[Continued from yesterday’s Part 8 and the preceding Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, and Part 7.]

By: David A. Smith

Was it possible that they could swallow that, after only twenty-four hours?  Syme, too–in some more complex way, involving doublethink, Syme swallowed it. Was he, then, alone in the possession of a memory?

George Orwell, 1984

In this extensive post examining the doublethink empire of public-employee pension-fund fiscal management, yesterday’s Part 8 covered the radical ablative surgery on liabilities performed by the team assembled by emergency financial manager Kevyn Orr, whose activities serve as such a sharp contrast with the duck-and-cover regime that operated before.

Bomb Drill

Quick, the auditors are coming

Sources used in this post

New York Times (August 8, 2006; forest green font)

Michigan Live interview with Joe Harris (February 21, 2013; brick-red font)

New York Times (September 25, 2013; siena font)

New York Times (February 24, 2014; navy blue font)

Detroit Free Press (April 10, 2014; purple font)

Michigan Live interview with Charles Moore (June 10, 2014; green font)

New York Times (October 28, 2014; cobalt blue font)

Society of Actuaries letter to the ASB (October 30, 2014; gray-blue font)

The New York Times (November 11, 2014; black font)

Detroit Free Press (December 10, 2014; red font)

Huffington Post (December 10, 2014; olive-green font)

And with Detroit’s exit from bankruptcy, the political regime will be back in power, but aside from the change of mayors in the interim, the new elected government will be operating under three years’ court- and state-supervised probation:

Judge Steven W. Rhodes said on Friday that the state would have to serve a tougher pension watchdog role.

That’s important; during the next three years, the state will have strong supervision, which both gives new mayor Duggan a chance to take his own political actions to get the city’s government more oriented to investment and rebuilding of public infrastructure and public confidence; should establish the useful habit of keeping one’s promises; and will compel the beneficiaries (public-employee workers and retirees) to learn that their future goodies will depend on the city being economically viable enough to pay them. 

What about former Detroit Medical Center CEO and Wayne County Prosecutor Mike Duggan?

Mike Duggan? Yeah, he’s impressed me for years.

If you want to turn police around – and that’s by the way the greatest expenditure for the city, it’s about a third (of the general fund costs); police and fire about over half of the total general fund costs. If you want to find the deficiencies, you’re not going to find them going to the patrolmen or the firefighters or the people who work their way up the ranks.


Always talking, always selling

What Mr. Harris wished for (in February, 2013) came to pass, as Duggan was elected mayor, immediately set about seeking to build reinvestment confidence in Detroit, and seems never to have stopped.

Mike Duggan … what did he know about healthcare before he went over to the Detroit Medical Center (as CEO)? Not much, but he’s a leader, he’s a manager, he understands what it takes to make changes. But again, I don’t think (Duggan could manage the city’s finances as Detroit mayor – or anyone else – under these circumstances) because of the contractual arrangements; I do think he could make a good emergency financial manager, though.

You really think Duggan could?

Now Mr. Duggan has the control, and a post-bankruptcy Detroit to run.  If Kevyn Orr was the tight emergency financial manager, Mr. Harris pretty clearly believes Mike Duggan is the right mayor.

Oh yeah! Give him the control, put him in control. I think he would be the right choice (because of his business turnaround experience).

As I wrote before, Who owns the risk?  Whose risk is it, anyway?, underfunding in the current interval is fine if and only if should things go wrong, the retired city workers, police, and firefighters will agree to take less. 

Is the key to fixing Detroit’s financial problems really to reevaluate the contracts, break deals promised with the unions and start over?

Yeah, and re-engineering the seven city departments I mentioned:


Information technology



Public works



That’s where the money is and that’s where the city’s operations are – the brains and the nuts and the bolts and the motor and the engine to the city.

All of these departments are staffed by unionized employees who have previously been overcompensated (thirteenth month bonuses and the like) compared with their agreed pay, and whose pension expectations have now been significantly reduced and restructured. 

In its plan to exit bankruptcy, Detroit proposes to claw back certain overpayments [thirteenth month bonuses and the like – Ed.] that the pension system made improperly in the past. Ms. Estes said she received a letter telling her she would have to forfeit $25,000 when she reaches retirement age, without explaining how that would happen. She is now 50.

By now the rescission of future benefits will have been explained to Ms. Estes, and as the plan has been confirmed there is no point in her class-action attorneys suing Detroit or any of its bankrupt entities; their liabilities, including contingent ones, will have been discharged in the plan exit. 

The public employees will have heard union leaders denounce the plan; many of them will have voted against the plan; many of them will resent Kevyn Orr and Michigan Governor Rick Snyder.  But Orr and Snyder are no longer in charge; now Mayor Duggan and the city council are in charge (subject to court/ state supervision).  It’s a new day in Detroit. 

Rick Snyder, Mike Duggan, Kevyn Orr

Back in fiscal charge: Detroit Mayor Mike Duggan, governor Rick Snyder, former emergency manager Kevyn Orr

9. Reforming the industry, and eliminating doublethink

Public sector defined benefit pension plans (public sector plans) involve a unique intersection of stakeholders: individuals (who benefit from the plan), sponsoring organizations (state and local government entities that sponsor or participate in plans), plan trustees and administrators who run the plans, and the public (who fund these plans through taxes). The measurement and management of risk in public sector plans is vital to the interests of all of these parties.

Detroit, then, we may regard as a solved problem (at least for now), but where does that leave the hundreds of other cities and states that have doublethought plans?


A Studebaker Lark station wagon of the type my family had back in 1962 or so

Everything old is new again:

1960s’ collapse of the private-pension model and rise of ERISA

In one sense, everything taking place now in the public-pension arena is fifty-year-old news, as we are (unconsciously) replaying the 1960s’ collapse-and-recapitalization of the private-employee pension fund system.  Back then, private pension funds operated much as public ones do today: with defined benefits on retirement and a set of pension trustees (usually elected by the beneficiaries, including the infamous George Barasch who controlled Studebaker’s pension fund).  And if the business failed (like Collier’s magazine in 1956), the employees lost all their pensions (including my grandfather, who had to rescind his retirement and return to work).

When Studebaker went out of business (1963), the pension fund’s insolvency was exposed, and the company imposed, as it could back then, a semi-arbitrary three-tiered discount: workers 60 and up got 100% of their scheduled benefits, those 40-59 got a one-time bankruptcy-like cash payment of 15% of their expected value, and those under 40 got zero.  (Not for the last time, the old financially screwed the young.)

That scandal and others like it led to Congressional hearings, legislative proposals, an election-year 1972 NBC documentary Pensions: The Broken Promise, and that, coupled with the Watergate-era distrust of large institutions, led to the 1974 enactment of the Employee Retirement Income Security Act (ERISA), which required private companies to fully fund their pensions and to disclose their performance, and subjected them and their trustees to legal risk.  The result was the rapid extinction, among private companies, of defined-benefit plans, and the rise of defined-contribution plans of which the best-known and most-used are those under Section 401(k).



And the pensions went with it

If you confront anyone who has lied with the truth, he will usually admit it – often out of sheer surprise. It is only necessary to guess right to produce your effect.

Agatha Christie, Murder on the Orient Express

[Continued tomorrow in Part 10.]