Government accounting 101

The following news article describes the mounting debt crisis at the local government level:

http://www.staradvertiser.com/news/nyt/20101005_Options_dim_cities_in_debt_seek_havens.html

There are so many disturbing facts and quotations in this article that I do not know where to start commenting.  The primary focus of the article is on Harrisburg, Pennsylvania.  The recent actions by Harrisburg are symptomatic of the financial mismanagement at the local government level worldwide.  Consider the following facts from the above article:

Harrisburg, the Pennsylvania capital, dodged financial disaster last month by getting money from the state to make a payment to its bondholders.

It did so even though the state warned that the money had to be used for city workers' pensions.

Now Harrisburg is calling on the state again. On Friday, the city said it could not meet its next payroll without money from the state's distressed cities program.

In the private sector borrowing money to pay bondholders and to make payroll is the path to liquidation. But in the government sector accounting has mysterious properties:

Using the pension money to pay bondholders last month has increased the city's total debt burden, by the state's calculation. The city's audited financial statements are a year late, and the most recent one gives four-year-old pension data, showing a surplus before the recession and the financial crisis took its toll.

Officials in Harrisburg said they saw no harm in using this year's state pension money to pay their bondholders because they thought the municipal pension funds had a surplus.

But they see a surplus only because they are looking at a five-year-old number, said Bernard S. Kozlowski, deputy director of the state Public Employee Retirement Commission, which administers the state pension law. He said the state would eventually come after Harrisburg, demanding the missing money with interest. But not for at least two more years, he added, because of the lags built into the state system.

If you are considering the purchase of municipal bonds, beware; if you own municipal bonds, you have been forewarned.