Noteware: What the CAFR Does Not Say: When Your Head’s in the Sand, There’s a Lot Still Exposed

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The previous article demonstrated that the City of Houston is in deep financial trouble, losing population and jobs, while expenses grow faster than record revenues and while the pension problem (the greatest issue confronting the City) worsens rapidly. All of these conclusion are fully documented with the City’s own numbers presented in the FY2014 Comprehensive Annual Financial Report (CAFR).

But, what does the CAFR not tell us? As Sherlock Holmes said in the Hound of the Baskervilles, the most important clue in solving the crime was the dog that didn’t bark. What the CAFR does not say, compounded by the Parker Administration’s silence in explaining the CAFR, is more dangerous than what the numbers actually show. Perhaps the even more dangerous silence is because the public’s watchdogs – the City Council, the Controller, and the general media – do not understand, do not use and do not even comment on the CAFR.

The first and obvious conclusion is that the City’s operations and finances are not sustainable. The City’s expense structure, despite record revenues in recent years, results in deficits that can be funded only by borrowing. These deficits have occurred consistently since 2003, the annual borrowing is cumulating, and the City is running perilously low on cash (and at some point soon will be unable to continue to borrow).  The pension problem is growing at an accelerating rate that will result in even wider deficits. If the City were a private company, its auditors would be forced by accounting standards to issue a “going concern” opinion – in other words to warn investors of the severity of the situation.

The CAFR also does not elaborate on this important news: the City switched auditors in the middle of the year – from the “Big 4” firm of Deloitte to Atlanta-based Banks, Finley White & Company, supported by local firm, McConnell Jones. Interestingly the new auditors neglect to mention many critical items in the 2014 CAFR, such as:

  1. Even with its deficits, the general fund has become dependent upon transfers from the enterprise funds (put simply, water and sewer collections and the new “rain tax” are used to support public services that are intended to be funded by property and sales taxes or specific fees); there is no comment about the legality or desirability of these transfers.
  2. There is no analysis of the City’s compliance with the “Prop 1” or “Prop 2” revenue limitation amendments,
  3. There is no mention of the “management letters” that Deloitte issued, every year of its tenure, criticizing the City’s internal (financial) controls. What does McConnell Jones think about the way the City handles your tax money? Deloitte did not like it, said so and was quietly replaced.
  4. The process of deciding to switch auditors and the selection of the new firm was not disclosed; since the City has no independent audit committee, it is likely that the new firm was selected by the very people who they were engaged to audit!

Perhaps most important, there is no comment whatsoever about what the City administration’s plans are for the future. How much will it cost to fix our city streets and water system, where will this money come from and what are the plans to bring the infrastructure back to acceptable levels? How does the City plan to deal with the inevitable crowding out of essential public services resulting from growth in the required pension and retiree health insurance obligations? How does the City hope to pay back its currently outstanding debt, let alone the new debt incurred to fund the annual deficits?  How will the City address the unsustainable employee pensions? Does the City intend to enter bankruptcy to relieve itself of some of its obligations?

Finally, the CAFR does not address the effectiveness – and cost effectiveness – of the delivery of City services. How do we know that we are receiving good value for the cost of our services?  Are we using the best practices and most current technology? How do we measure and communicate our results?  Let’s start with the CAFR process itself – why does it take 180 days to produce a document that conveys the same information year after year?  The Securities and Exchange Commission and investor discipline require that publicly held corporations – including the largest and most complex multinationals with intricate operations in numerous countries, industries and currencies, like Apple or ExxonMobil – to produce their audited financial statements within 45 days (25% of the time required for the City to produce its CAFR).

After twelve losing years, we have to acknowledge that, whatever the City’s strategy and vision may have been, they are not working.  With all Houston’s advantages and with all the wonderful recent publicity for the area, we must recognize that ever higher taxes and ever lower service levels are taking away our people, our jobs, and our future; each pothole and broken water main reminds us that we are seeing the beginning of the end.

No business could survive with these results – and its executives would have been fired long ago. Why should the public have a different standard for political leaders than for its business leader?  It is clearly time to change how we have been doing (political) business.

A version of this article appeared in the Houston Business Journal on February 23, 2015.

Jim Noteware
About Jim Noteware 18 Articles
Jim Noteware is a Houston-based real estate developer, focusing on suburban master-planned and urban infill communities. He also specializes in the turnaround of distressed properties, portfolios and organizations. He has served two big-city mayors, in Houston and Washington, D.C., working to improve the performance of large troubled public agencies.