Category Archives: Budget

We Weren’t Hiding Anything, Says UVa’s COO

What would T.J. say?

What would T.J. say?

by James A. Bacon

University of Virginia officials vigorously dispute allegations by members of the General Assembly that the university was less than transparent with its $2.3 billion Strategic Investment Fund, a pot of gold that critics have characterized as a slush fund. Patrick D. Hogan, chief operating officer of the university, supplied records yesterday from a Board of Visitors subcommittee meeting showing that members had discussed using investment earnings to invest in projects approved as part of the long-term plan in 2014.

Said Hogan: “We have absolutely nothing to hide.”

Reports the Daily Progress:

The investment fund originated with more than $1 billion in investment returns that had accumulated between 2009 and 2014. Officials had talked about using this money to pay for some of the projects outlined in UVa’s strategic plan, passed in 2013. The Cornerstone Plan, as it’s called, lays out a broad series of goals, including improvements to UVa’s technological infrastructure and a wave of faculty hires.

The plan — initially priced at $564 million over five years — was not completely funded when it was passed, and there was concern that costs could be passed on in the form of tuition. The idea was to take some of the investment returns that had accumulated over the years and use them to pay for these improvements.

The investment returns were combined with other reserves to create the fund, which could pay out up to $100 million annually, Hogan said.

“We recognized then that the Cornerstone Plan needed long-term support,” he said.

Hogan said the creation of a permanent fund will allow UVa to improve the student experience without passing the cost on to students. This fund will pay for the improvement projects UVa hopes to undertake — hiring new faculty and providing them with research startup money, for example — without straining operating funds.

Bacon’s bottom line: Changes to the fund apparently followed normal bureaucratic procedure, moving quietly through a Board of Trustees subcommittee before surfacing before the full board. I’m prepared to believe that UVa administrators thought they were being transparent. But there was a breakdown somewhere if some board members were caught by surprise and it’s taken this long for UVa to explain in a way that people can understand how the fund came to be. What Hogan did not address in the Daily Progress article was why the board felt compelled to discuss the issue in closed session. Such an action does prompt people to wonder, “What were they hiding?”

At the end of the day, the controversy is over how to use an investment windfall amounting to $100 million a year — whether to invest in initiatives to make UVa a more prestigious institution or to lower costs for Virginia students. Clearly, the administration and a majority of the board favor advancing the university’s institutional interests over its historic mission of providing an affordable, quality education for all Virginians. All the rest is window dressing.

New Criticisms of UVa Investment Fund

Slush

Slush?

by James A. Bacon

Lawmakers have raised new concerns about a $2.3 billion University of Virginia investment hoard that critics have characterized as a “slush fund.”

The controversial pot of cash was originally labeled as “University Operating Funds.” Then it was marked “Strategic Investment Fund” in a Jan. 31 document — two weeks before the Board of Visitors formally authorized the naming of it as an investment fund, reports the Daily Progress.

“It’s almost like the board is there to rubber-stamp [administrative decisions],” said Sen. William R. DeSteph, R-Virginia Beach.

“In light of this cash reserve, why are we raising student tuition and acting like we’re broke?” asked Sen. J. Chapman Peterson, D-Fairfax City.

The university has designated the fund to recruit new faculty, build new lab space, and provide financial aid to high-achieving students from low-income schools around Virginia in support of its “affordable excellence” program.

The magnitude of the controversy has grown in recent days. DeSteph, Peterson and other legislators also allege that the university gave conflicting reasons for opening up a $300 million line of credit. Summarizes the Daily Progress:

In November, the board gave the administration clearance to take out up to $300 million in operating lines of credit.

According to previous university statements, this cleared the way for the university to transfer $480 million in operating cash to the Strategic Investment Fund — providing it with a boost while keeping UVa’s bond rating strong.

But according to minutes from the November meeting, during which Chief Operating Officer Patrick D. Hogan addressed the board, the purpose of these new lines of credit was to meet different “stress scenarios” facing the university, such as an inability to fund operating expenses or convert assets into cash “without significant losses.”

“The operating lines of credit will be a new source of liquidity and are being considered only as back-up liquidity,” according to a summary of the action item provided to the board in November.

DeSteph said the administration acted inappropriately. It appears administrators told the board — and the public — it would use these lines of credit one way and then decided to use it another way, he said.

“What they told the public was they were going to set up lines of credit and only use them if needed,” DeSteph said. “It looks like they set up the lines of credit and maxed them out.”

The legislators also charged that the Board of Visitors went into closed executive session last month to talk about the fund. “I feel like they’re trying to do as much of their business beyond the public’s eye [as possible],” said Peterson. “A $2 billion cash reserve? How can that not be a public issue?”

When Balanced Budgets Aren’t Really Balanced

hide_the_peaby James A. Bacon

The politics of fiscal implosion are ugly. Just look at what’s going on in Petersburg and Richmond.

  • Confronted with a massive budget deficit last year in contravention of the state constitution and the prospect of a deficit in the year ahead, Petersburg City Council bravely agreed to cut the compensation of the city’s 600 employees — but carved out exemptions for senior city officials and themselves.
  • Another trustee has resigned from the board of the city of Richmond’s severely under-funded retirement fund, which has been embroiled in governance issues over who calls the shots over investment decisions.
  • City of Richmond officials say they have nearly completed their comprehensive annual financial report for 2015 — seven months late! The city has not completed the required report on time since 2014. City officials blame IT issues.

That’s just in the Richmond region, which I am familiar with because I read the Richmond Times-Dispatch as my daily newspaper. Who knows what’s happening elsewhere? While Virginians pride themselves for their fiscal rectitude, it is increasingly clear that some jurisdictions don’t hew to standards much higher than Chicago, Cleveland or Detroit.

In theory, the state constitutions requires the state government and each political jurisdiction to balance its budget each year. Virginians should be concerned that Petersburg failed to do so in fiscal 2016, that it shows every sign of failing to do so again in fiscal 2017, and that there appears to be no sanction or penalty in sight. Likewise, we should be concerned of the various tricks the state and its localities can use, if so inclined, to hide long-term structural budget deficits. Here are three:

  • Under-fund employee pensions. The Commonwealth drastically under-funded the Virginia Retirement System in the last recession, although it is now doing penance by accelerating repayments. The City of Richmond has under-funded its government-employees pension, which it operates independently of the VRS.
  • Slow pay creditors. This tactic comes straight out of the Illinois Fiscal Irresponsibility Playbook. Petersburg, it has been revealed, delayed payments of millions of dollars not only to the VRS but schools and the regional jail.
  • Defer maintenance. Rather than properly maintain roads, streets, buses, water systems, sewer systems, school buildings and the like, save money by scrimping on maintenance, even if it means even higher costs down the road.

To what extent do local governments rely upon these and other budgetary sleights of hand to balance their budgets? Nobody knows. Let me rephrase that: The public doesn’t know.

The bottom line here is that citizens cannot take at face value that their local governments are truly balancing their budgets. Some might be. I have faith that my home county of Henrico, whatever its other failings, runs a tight fiscal ship and doesn’t play bookkeeping games. But I don’t know it for a fact. Speaking generally, not specifically about Henrico County, government administrators are subject to the temptation of hiding bad news. And in most cases, local elected officials are either too timid or too untutored to ask tough, probing questions about how money is being spent.

Citizens unite! There are active taxpayer groups in Arlington, Fairfax County and Virginia Beach that I know of. I hope and pray that there are others of which I remain ignorant. Rather than fight lonely fights, they need to pool resources and expertise. I invite like-minded citizens to join Bacon’s Rebellion to create a platform to share knowledge and hold state and local governments more accountable than our elected officials seem able to do on their own. If anyone is interested in such a collaboration, please contact me at jabacon[at]baconsrebellion.com.

The Seven Percent Assumption

U.S. Fed Funds Rate. Source: Trading Economics

U.S. Fed Funds Rate. Source: Trading Economics

by James A. Bacon

The Virginia Retirement System earned an estimated 1.5% return on its $68 billion portfolio of investments last year, spurring discussion over whether state and local governments are contributing enough to maintain the long-term financial integrity of the retirement plan for Virginia school teachers and government employees.

For purposes of calculating the system’s financial integrity, VRS officials assume that the return on investment will average 7% annually over the long term — an assumption that is more conservative than many government pension plans. But is it conservative enough? After earning 1.5% the past year and only 4.7% the year before, is the 7% assumption still defensible?

VRS Chief Investment Officer Ronald D. Schmitz assured lawmakers that it is. “Over a 20-year horizon, we’re comfortable with a 7 percent return,” he said at the first meeting of the Virginia Commission on Employee Retirement Security and Pension Reform created at the urging of House Speaker William J. Howell, R-Stafford.

Getting that assumption right is no easy task. Investment returns fluctuate widely from year to year, losing money one year and then making spectacular gains the next. Investment performance varies considerably, depending on the time frame used. According to the VRS 2015 report issued a year ago (the 2016 report is not yet available), annualized investment returns averaged 10.6% over three years, 10.3% over five years, but only 6.7% over ten years.

The question is whether the past twenty or thirty years is a useful yardstick for predicting the next twenty or thirty years. The United States has benefited from a 35-year bond market boom, over which time interest rates have trended consistently lower to the near-zero rate that it has held steady for the past seven years (as seen in the graph above). All other things being equal, lower interest rates push stock and bond prices higher. Consequently, U.S. pension funds have enjoyed 35 years of rising prices for stocks and bonds (with short interludes of falling prices) in their portfolios. But as interest rates approach zero, it is impossible under conventional economic theory for them to drop any lower. Perhaps, as we are seeing in some places around the world, it is possible for central banks to engineer below-zero interest rates, but we have no historical experience by which to judge how economies, bond markets and stock markets will perform under such circumstances.

While no one knows with any certainty where interest rates, bond prices and stock prices are headed — perhaps changes in the global economy have repealed the laws of classical economics, and below-zero interest rates will do no harm — it is safe to say that a reversion of interest rates to historical norms would be disastrous for stock and bond prices, indeed asset prices of all kinds. And it is reasonable to say that there is at least a risk that such a reversion could take place. Whether such a reversion to historical norms takes places or not, is indisputable say that central banks cannot replicate the past 35 years of falling interest rates, and that the primary driving force behind the bull market era of the past 35 years has run out of steam.

It is almost inconceivable that the future 35 years of investment returns will match that of the previous 35 years, one of the great bull market eras of U.S. financial history. Therefore, the VRS (and other all pension funds) are reckless to assume that recent history will be any guide at all to future performance. Stretch out the frame of analysis for 50 years, 100 years, or longer, and the case for equities and bonds may be as favorable as ever. But the VRS cannot look out 100 years. Baby Boomers in the state workforce are retiring in large numbers now: One quarter of the state workforce will be eligible to retire within five years. Virginia will need the money in the next 20 to 30 years.

At least one state official in a position of responsibility, House Appropriations Chairman S. Chris Jones, R-Suffolk, is worried. As the Times-Dispatch quoted him: “I’m thinking that 7 percent might be aggressive at the end of the day.”

Jones is absolutely right. The VRS needs to lower its assumption, and the General Assembly needs to allocate more money to the VRS than in the past. Such an action surely will be painful, given all of Virginia’s other budgetary constraints. But Virginians will be grateful that the legislature acted with foresight when investment returns tank. It won’t get easier to do later what we should be doing now.

Boomergeddon Update: Medicare HI

Image credit: 2016 Medicare Trust Fund Board of Trustees annual report

Image credit: 2016 Medicare Trust Fund Board of Trustees annual report

by James A. Bacon

The Hospital Insurance Trust Fund, one of the four major components of the Medicare program, will run out of money in 2028 — two years earlier than previously projected. That appraisal comes from the Medicare Board of Trustees, which, the last time I checked, is not funded by the Koch Brothers.

The news of the accelerating structural crisis in the nation’s health care safety net stirred only the slightest of ripples in the news media, which buried the story deeper than an Iranian nuclear research facility. One would think the news to be of more than passing interest to the program’s 55.3 million recipients and thus to major media, but the nation’s elite journalists are so obsessed with the latest Tourettes-like tweets by Donald Trump that they cannot bestir themselves to ask the presidential candidates how they intend to preserve the social safety net.

This news comes soon after Congress and the Obama administration avoided the impending depletion of Social Security’s Disability Insurance (DI) trust fund only through the expediency of folding it into the Old Age Survivors Insurance trust fund, thus accelerating by a year the impending breakdown of both by 2034.

Medicare and Social Security will not collapse when the trust funds run out, but the gap between spending and revenues will have to be covered either by a hike in taxes, a cut in benefits or an increase in government borrowing, each of which would be grievous in its own way. The magnitude of this gap, caused by the retirement of the Baby Boomer generation, will precipitate the nation’s greatest economic crisis since the Great Depression — what I call Boomergeddon.

And to what do we owe the accelerating crack-up of Medicare’s hospital insurance program (often referred to as Medicare Part A). Not to accelerating health care costs, ironically enough. “Since 2008, U.S. national health expenditure (NHE) growth has been below historical averages, despite having accelerated in 2014 mainly due to insurance expansions,” state the Medicare trustees.

But having said what the problem is not, the Medicare trustees fail to explain what it was. That is understandable, given the politically sensitive nature of what appears to be going wrong — weak job growth, the low labor participation rates, and less-than-expected payroll revenues. After real-world economic performance has under-performed forecast economic forecast every year for seven years running, the Obama administration appears to be adjusting its long-range forecasts for purposes of long-term budgetary planning.

Nobody wants to admit, least of all in an election year, that economic growth and job creation stink. But that is precisely what underlies the rush to ruin of Medicare, Social Security and the federal budget deficit generally. A weak economy means weak revenue.

Bacon’s bottom line. Boomergeddon is running right on track. The Congressional Budget Office projects a $534 billion deficit this year. (We don’t hear about that number from our journalistic elite either.) Were it not for monetary easing, ultra-low interest rates and multi-billion remittances from the Federal Reserve Bank, the deficit would be far bigger. In any case, CBO projects a cumulative $9.4 trillion in deficits, to be added to the existing $19 trillion national debt. The U.S. is on track to carry World War II levels of borrowing by the mid-2030s, the big difference being that in 1945 the war was over and the nation could demobilize its massive military, while in 2035 the nation will not be in a position to demobilize its social safety net.

Meanwhile, the structural budget deficit of the United States must be viewed in the context of chronic deficits of the European countries and Japan, and the massive over-leveraging of the Chinese economy. As McKinsey & Co. pointed out in a 2015 report, the global economy has added $57 trillion since the Great Recession; rather than de-leveraging, virtually every major nation has doubled down with increased borrowing. Systemic risk has never been greater. All it takes is a black swan event, and financial chaos will rip through the global economy, transmitted by financial linkages that public policy makers don’t even know exist. The Bear Stearns/Lehman Brothers financial panic will be a picnic by comparison.

The question, as always, for Virginians is this: How do we as citizens and taxpayers protect ourselves from the inevitable financial reckoning? Borrowing more is not an answer. (Somebody please tell Richmond Mayor Dwight Jones, who proposes raising the city’s debt limit in order to borrow $580 million more in bonds over the next 10 years.) Building new transportation mega-projects that require subsidies indefinitely into the future is not an answer. Expanding social welfare programs like Medicaid is not an answer. The storm is coming, and we must prepare.

Virginia’s New Road Funding Process — Less Political but Still Opaque

Project scorecard for

Project scorecard for improvements to intersection at Patterson Ave. and Parham Road.

by James A. Bacon

In a rare bipartisan achievement, Virginia is doing something that no other state in the union is doing: basing its transportation investments on an objective scoring system.

Earlier this month, the Commonwealth Transportation Board (CTB) approved $1.7 billion to be spent on 163 projects selected through the System for the Management and Allocation of Resources for Transportation, or SMART SCALE. The process rates projects for their impact on safety, congestion reduction, accessibility, land use, economic development and the environment.

“SMART SCALE revolutionizes the way Virginia delivers transportation,” wrote Transportation Secretary Aubrey Layne in a Richmond Times-Dispatch op-ed Sunday. “Future administrations can’t develop wish lists on a whim. Projects must be scored and vetted through the data-driven system.”

The bottom-up process starts with a consistent set of standards by which localities select projects for scoring. All nominated projects are screened and scored and funding recommendations made on the basis of the scores. The scenarios are presented to the localities and the public for a round of input. Then the CTB has the final say.

The legislation setting up the new system originated with General Assembly Republicans and was embraced by Governor Terry McAuliffe. The reform is remarkable in that the governor and powerful legislators relinquished much of their power to reward friends and punish enemies through the doling out of transportation dollars and turning it over to a process-driven system.

“No longer are we allowing politics and wish lists determine what gets built. This process is critical to moving people, jobs, and commerce, all of which is essential to building the new Virginia economy,” said McAuliffe in a press release touting the CTB vote.

“With SMART SCALE, we are promoting greater accountability, safeguarding against waste and ending the politicization that has been rampant in our transportation process for so long,” said House Speaker William J. Howell in the same press release.

Bacon’s bottom line: So, I can visit the SMART SCALE website and find a list of 287 projects along with a breakdown of their scores. There, I can see that a project about a mile from my house — $5 million to make improvements to the intersection of Patterson Avenue and Parham Road, a miserable, stinking, soul-scorching abomination of a crossroads if there ever was one — ranked 92 statewide among all projects. And I can view the scores assigned to a variety of metrics, as seen here:

scoring_weights2

That’s all well and good, but none of this is intuitive. I don’t have the faintest idea what these scores mean. Are higher scores better than lower scores? I can imagine that a major benefit of the project would be improving “travel time reliability,” as reflected in its 24.6 score. But why would “travel time delay” be so meager at 0.6? Isn’t that closely related to travel time reliability? Is the same scale being applied to each criteria? Is the scale 0 to 1, 1 to 100, or something else entirely? The explanation on how to read a scorecard doesn’t help much.

And how about the data underlying this statistics? How many car crashes and injuries occur at this intersection? How many hours of delay occur, and how is that number measured? How does one calculate the increase in access to jobs? And how does one evaluate the impact of the project on land use?

The information available to me as a member of the public doesn’t allow me to evaluate much of anything. Further, I can’t imagine being a CTB board member and finding the data any more helpful — unless they are given special training in interpreting the numbers or have VDOT staff at their beck and call to answer their questions.

While SMART SCALE undoubtedly represents an improvement over what preceded it, the state might as well be publishing its scores in hieroglyphics. Transparency is not served when the the scoring system is so indecipherable as to be unintelligible as to defeat all efforts at understanding.

Virginia Ranks 19th for Fiscal Condition

Graphic credit: Mercatus Center

Graphic credit: Mercatus Center

Virginia’s state finances are nothing to brag about, according to data contained in the Mercatus Center’s 2016 edition of “Ranking the States by Fiscal Condition.” The Old Dominion gets below average scores for cash solvency (cash on hand to pay short-term bills), and middle-of-the-road scores for budget solvency and long-run solvency. The state scores above average in trust fund solvency (pension funds and long-term debt), and 5th best in service-level solvency (the ability to raise taxes and increase spending without damaging the economy). Summarizes the Virginia state profile:

Total liabilities are 30 percent of total assets. Total debt is $6.86 billion. Unfunded pension liabilities are $87.66 billion, and other postemployment benefits (OPEB) are $5.19 billion. These three liabilities are equal to 24 percent of total state personal income.

Virginians tend to think that the state’s fiscal condition is fine as long as the Commonwealth maintains a AAA bond rating. Mercatus, which admittedly is funded by the Koch brothers but has no particular ax to grind against Virginia, suggests otherwise.

— JAB