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October 22, 2009Name, Title and AddressSubject: Finances of the City of HoustonDear :Enclosed is our partial analysis of the very serious financial situation at the City of Houston.We would be derelict if we failed to share this financial analysis with you. This financial headsup will assist you in meeting your fiduciary responsibilities to Houston voters, taxpayers,readers, viewers or investors---as the case may be.We feel a public discussion of the City’s financial situation is necessary and firmly believe thataddressing the City’s financial condition is in the best interest of the Houston economy andHouston taxpayers. We believe the sooner the City of Houston addresses the financial shortfallthe better.Please bear in mind that the Houston City elections are on November 3, 2009, with early votinghaving commenced on October 19, 2009. Recent history has shown a large portion of votingoccurs during early voting.We trust that the attached article is of significant assistance to you.We may be reached atboblemer@sbcglobal.net.Respectfully,Bob Lemer, CPA Aubrey M. Farb,CPA Tom Roberts, CPARetired PartnerRetired PartnerRetired PartnerErnst & Young Grant ThorntonFitts RobertsCC:
City of Houston---Incumbent Mayor, City Controller, and City Council MembersCity of Houston—Non-Incumbent City CandidatesGreater Houston Partnership---Board MembersHouston Chronicle---Editorial Board MembersHouston TV Stations---CEOsHouston Business Journal---EditorHouston Community Newspapers-EditorHouston Press-EditorMunicipal Bond Rating Agencies---CEOsWall Street Journal---EditorBarron’s-EditorInvestor’s Business Daily-EditorUSA Today-EditorTexas Monthly---Executive EditorDeloitte & Touche LLP---Houston and New York 
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City Of Houston
Disturbing Financial Facts---October 2009By: Bob Lemer, Aubrey M. Farb and Tom RobertsExecutive Summary
The City of Houston is financially broke
and it appears that the mayor who takes office inJanuary 2010 may have to captain the City through bankruptcy procedures.The
City’s unrestricted assets were $1.2 billion short
of the already recordedcorresponding liabilities these assets were needed to pay as of fiscal year end June 30, 2008,according to the City’s latest publicly available audited Comprehensive Annual Financial Report(CAFR). The $1.2 billion shortfall was
a result of operating losses totaling $1.5 billion
for fiscal years 2004-2008, applying the full accrual basis of accounting used in the private sector.Apparently the City has no idea as to what has transpired financially since June 30, 2008 or willtranspire this fiscal year ending June 30, 2010, on the full accrual basis of accounting.But even on the modified accrual basis of accounting (essentially cash basis) followed by the Cityand all other municipalities, the $236.8 million fund balance in the City’s general fund as of July1, 2009 (the beginning of this current fiscal year) would not exist except for the City havingdeposited the proceeds of pension obligation bonds into the City’s general fund instead of depositing them in their legally required immediate destination, the pension plans’ bank accounts.The City is in this dangerous financial position because its total spending since fiscal year 2003has greatly outstripped its total revenues in that period. And the rate of growth in the City’stotal revenues since 2003 has, in turn, greatly outstripped the City’s rate of growth in populationplus inflation.
Thus the City’s problems are a result of greatly overspending and not a result of insufficient revenues
.All of this occurred before the current severe recession. Now the City has the added burden of the recession.The City is in a real financial dilemma, because now its two principal sources of general fundrevenues are in trouble---sales taxes and property taxes. Sales tax revenues already aredropping significantly and property tax revenues will commence dropping at an even more rapidrate after the next annual appraisal and assessment process. And the City will have to go to thevoters for any contemplated rate increases in either the sales tax rate or the portion of theproperty tax rate allocable to operations.It appears to us that
there may be no viable alternative to bankruptcy proceedings
andthereby positioning the City to regain control over its overspending, through addressingstructural spending problems such as overstaffing and overly generous employee benefits.
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Following are our detailed findings and observations.1.The City incurred operating losses (“Change In Net Assets”) totaling approximately $1.5billion for the five fiscal years ended 6/30/08--- per the latest (fiscal year 2008) publiclyavailable audited Comprehensive Annual Financial Report (CAFR), page 199:Thousandsa.(312,790)b.(531,465)c.(131,893)d.(221,452)e.(281,556)TOTAL (1,479,156) ---or--- $1.5 BILLION2.The City’s deficiency in unrestricted assets [“Unrestricted (deficit)”] was $1.2 BILLION($1,174,429 thousands) at June 30, 2008--- per 2008 CAFR, page 15. In other words, theCity’s unrestricted assets were approximately $1.2 billion less than the already recordedliabilities that they will be required to satisfy.3.The $1.2 billion deficiency in unrestricted assets as of June 30, 2008 (which was createdessentially during fiscal years 2004-2008-see item 1) was basically financed, per page 15 of the2008 CAFR, by: (a) the $347,728,000 collateralized note payable to the municipal employees’pension trust; (b) the $643,413,000 combined accrued liabilities to the employees’ pensiontrusts (municipal-$285,462,000, police officers’-$318,567,000, and firefighters’-$39,384,000);(c) the $219,755,000 pension obligation bonds payable; and (d) the $272,941,000 accruedliability for other post employment benefits-----less, per pages 17 and 74 of the 2003 CAFR,(d) the $54,395,000 net accrued liabilities to the employees’ pension trusts at June 30, 2003(municipal-$92,386,000, police officers’-$19,221,000, and firefighters’-asset of $57,212,000).4.Thus, as of June 30, 2008, the City’s elected officials essentially had transferred financialownership of the City from the taxpayers to the City’s employees, about 43.7% of who do notlive in the City, according to documentation we have received from the City’s humanresources department. Very troubling, 63.3% of first responders (police officers andfirefighters) do not live in the City, versus just 30.0% of civilian employees, according to theCity’s human resources department.5. The City’s deficiency in unrestricted assets is so severe that in their yet to be completed auditfor fiscal year 2009 the City’s independent auditors apparently will have to address the auditreporting issue as to whether the City was a “going concern” as of June 30, 2009.6.Apparently the City has no idea yet as to what its operating loss (“change in net assets”)was for the fiscal year just ended June 30, 2009 or what its deficiency in unrestricted assetswas at June 30, 2009, and has no idea as to what is in store fiscally for fiscal year 2010. Thatis because the City does not keep its books on the full accrual basis of accounting (fullyaccruing its assets and liabilities) but once a year, via the audited Comprehensive AnnualFinancial Report (CAFR). And the CAFR cannot be completed until the (nearly always verysubstantial) annual audit adjustments are booked.
 
7.In recent years, the City has been taking up to almost a year to issue its annual CAFR.See Exhibit A. In comparison, the SEC requires that large publicly-held companies, who
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