Tag Archives: James A. Bacon

UVa Fund Is Legal and Proper, State Auditor Finds

Source: Auditor of Public Accounts

Source: Auditor of Public Accounts. (Click for more legible image)

by James A. Bacon

In morning testimony before the General Assembly, a state auditor provided a detailed breakdown of how the University of Virginia cobbled together its controversial $2.2 billion Strategic Investment Fund: UVa was in full compliance with the Code of Virginia, and all of its monies have been properly accounted for over the years.

To label the Strategic Investment Fund a “slush fund,” as former Rector Helen Dragas had done in a Washington Post op-ed was “a little bit of a mischaracterization,” said Eric M. Sandridge, the audit director in charge of higher education programs for the Department of Public Accounts. “The university was allowed to do what it did.”

While the term slush fund has a connotation of illegality, Dragas said in submitted remarks, she did  not mean to imply that UVa had done something illegal or “nefarious.” Rather, she said, “It was in view of these facts … that a small group of people went behind closed doors to discuss how to spend large sums of public money for other-than-originally-intended purposes … that the term slush seemed to fit.” (Dragas did not deliver her remarks in person because of a personal commitment of long standing.)

While Sandridge’s account supported the narrative maintained by UVa officials about the origin of the fund, he stated that his audit did not inquire into the legality under the Freedom of Information Act of a closed Board of Visitors session in which the fund was discussed, nor did it address the appropriateness of the university’s policy.

From the beginning of the controversy, which originated when Dragas first revealed the existence of the Strategic Investment Fund, UVa maintained that the fund was created by aggregating discrete reserves of money plus the investment returns on that money. By moving the money from miscellaneous pots where they were generating little income, the university consolidated them into a pool that could be invested more profitably in longer-term holdings by the University of Virginia Investment Management Company (UVIMCO).

Sandridge provided the first detailed breakdown of those money sources:

  • Capital Renewal program. UVA bills university departments on a regular basis to cover future lump-sum bond payments rather than bill them at the last minute when the payments come due. This source added up to $545 million in 2015.
  • Health plan reserves. The university sets aside a multimillion-dollar reserve as part of its health care self-insurance program. This amounted to $45 million in 2015.
  • Internal bank. The university maintains a fund to balance the daily cash flow needs of all its operations. In 2015 this amounted to $916 million.
  • Ivy Foundation. This money, a $45 million gift, was set aside for three major building projects. Upon completion of the projects, any remaining monies will be used to set up an endowment and moved out of the Strategic Investment Fund.
  • Aramark Dining Services. In a 20-year contract with Aramark Dining Services, the university received a $74 million grant to use at its discretion. However, the university must repay an unamortized balance should the agreement terminate before 2034.

None of these funds came from cost-cutting initiatives as I had improperly deduced from a reference that Rector William H. Goodwin made to “efficiencies in operations.” Rather, it appears that the university administration identified funds that were sitting around collecting dust and pooled them in such a way as to create a large, investable pool of capital. Over nine years, the university has earned $575 million through this strategy.

Where does the $100-a-year number come from? University officials have said that they expect the Strategic Investment Fund to generate about $100 million a year that could be spent on university advancement. Sandbridge explained how that number was devised. UVIMCO’s long-term investment pool has returned more than 10% annually over five-, ten- and twenty-year periods. Assuming a comparable return on investment on $2.2 billion in the future, UVIMCO could earn more than $200 million a year. Using the same policy as the university endowment of spending no more than 4.6% a year, that would provide $100 million to spend while retaining a somewhat larger amount in order to grow the investment pool.

Bacon’s bottom line: University officials deserve praise for devising a way to maximize the value of more than a billion dollars in under-utilized cash. The financial engineering, which entailed lining up $300 million lines of credit from four banks, is a genuine financial innovation that other universities may be able to emulate.

Two issues remain. The first is transparency. It has taken two months and a state audit to provide a full explanation to the public. What took so long? As Dragas asked in the testimony she submitted:

As the board took actions to restructure debt, authorize lines of credit, and modify liquidity policies — all of which were typical governance activities in large, financially complex institutions — never were we told that these actions were related to directing $2.3 billion to rankings pursuit or given the alternative of considering them in the service of tuition reduction. … The University has yet to produce documentation or recordings showing otherwise.

The second question is how the $100 million a year should be used. The Board approved using the funds to advance the strategic goals outlined in the Cornerstone Plan, essentially a strategic plan to bolster the prestige of the university. Dragas suggests that the money could have been used to offset aggressive tuition increases. Many legislators and members of the public would agree.

Dominion to Recover $140 Million for Burying Electric Lines for Outage-Prone Customers

A screen capture from a Dominion video shows the machinery used to bury electric lines.

A screen capture from a Dominion video shows the machinery used to bury electric lines.

by James A. Bacon

The State Corporation Commission ruled earlier this week that Dominion Virginia Power can recover up to $140 million on what it has spent to bury about 400 miles of electric distribution lines. By putting the overhead tap lines of the 6,000 most outage-prone customers underground, the electric company hopes to significantly reduce time spent restoring electric power after hurricanes, ice storms and other widespread service disruptions. The benefit to improved reliability will cost customers an average of fifty cents to the monthly bill.

The General Assembly had passed enabling legislation in 2014 but the State Corporation Commission (SCC) turned down Dominion’s first proposal to bury 4,000 miles of overhead lines serving some 150,000 customers on the grounds that there was insufficient data to show a positive cost-benefit ratio. But the SCC approved the pilot program, which will apply retroactively to overhead lines that Dominion has already buried, with the expectation the Dominion will regularly provide data on outages and restoration times to use in evaluating the program.

“If we were to get the full 4,000  miles of underground line, it would cut the typical hurricane outage period of seven to ten days in half,” says spokesman David Botkins. There is no way to estimate what difference the pilot project will make until the data comes in, but he said Dominion targeted “the most outage-prone and most difficult to repair tap lines” in its service territory — “the worst of the worst.”

In granting approval, the SCC wrote, “We find that the [project] satisfied statutory requirements, and is reasonable, prudent, and in the public interest.”

Even with the kind of automated equipment shown in the photo above — Dominion will not be handing the job over to ditch diggers — the expense is considerable. The cost of $140 million spread over 6,000 customers is $23,000 per customer. Dominion’s long-term vision, covering about 150,000 customers, would cost an estimated $2 billion.

But Dominion contends that cost-per-customer is not a relevant metric. Payback will accrue to all customers when restoration is shorter following large weather events, allowing the Commonwealth to return to normalcy sooner, says Botkins. In fact, an industry expert estimates that the economic benefits of the first 400 miles of undergrounding exceeds the cost by a ratio of over 2 to 1.

Stated the SCC ruling:

Dominion should be prepared to establish, with specificity, how the [Strategic Underground Program] has resulted in demonstrated system-wide benefits, as well as documented local benefits to the neighborhoods in which distribution lines have been placed underground. The Company has the burden to collect the data necessary to measure … “whether the SUP can be a cost effective means of ensuring reliability for its entire system.”

The buried lines are scattered throughout more than 80 cities, towns, and counties in Dominion’s service territory. In a typical example, The company placed 11 miles of overhead lines to underground in King George County; 24 separate projects impacted 68 customers.

In major outages, Dominion has a hierarchy of response. First, it attends to hospitals, water pumping stations, emergency centers and other critical needs. Next it tackles major circuits where a single repair job can put a large number of customers back on line. Then the company works its way down to subdivisions with a few customers, and finally to individual houses.

“The overhead lines in the back lots are very labor intensive,” explains Botkins. “It’s hard to get the truck back in there. The crew has to do a lot of the work by hand. It’s very time consuming.”

A Free Market Alternative to Payday Lenders

sasha_orloffby James A. Bacon

Most everyone recognizes that payday lenders create a poverty trap for poor and working class Virginians. While the lenders do provide a valuable service by extending short-term loans for emergency situations, the annualized interest rates are extremely high, and borrowers often find themselves rolling over their loans from month to month at considerable expense. On the other hand, half the U.S. population has a FICO score below 680, meaning they can’t be approved for credit by most banks. Say what you will about payday lenders, they aren’t as bad as Vito the Loan Shark. Even payday lenders don’t break borrowers’ kneecaps when they fall behind on their payments.

That’s why I have always opposed legislated restrictions on the lending of payday lenders. Taking away poor peoples’ only credit alternative, as unpalatable as it may be, may satiate the outrage felt by crusading social reformers, but it doesn’t actually do the poor people any favors. If the social reformers want to help, I have long suggested, perhaps they should get into the business themselves and provide a better deal.

Well, it appears that someone is doing just that.  LendUp, a lending institution backed by Silicon Valley money, has introduced a new approach to extending credit to the poor. The company came to my attention because it is opening an East Coast office in Chesterfield County to serve Eastern and Central time zones. The description provided by the Richmond Times-Dispatch article and the company website shows how the combination of innovation and competition is the best social reform one could ask for.

“We started LendUp because the traditional banking system wasn’t working for more than half of Americans and the payday market was fraught with abusive practices,” LendUp CEO and co-founder Sasha Orloff said in a statement. The RTD explains how the company works:

The company provides short-term loans to consumers with low credit scores through its LendUp Ladder product….

The process is handled entirely online — not at a store like most payday lenders operate — and decisions are usually made within five minutes, the company said on its website. If approved, consumers could have money in their account in about 15 minutes.

The company offers a single payment loan of between $100 and $250 that has to be repaid in seven to 30 days. It also offers an installment loan of between $260 and $500 that requires two payments and a credit check.

Annualized interest rates still can amount to 250%. LendUp offers the same justification as payday lenders: “Some customers do not pay us back and, like insurance, the interest covers what we lose.”

The difference is that LendUp allows borrowers to earn points to get larger loans at lower interest rates over time by making on-time payments, taking free financial education courses and referring friends to LendUp. The business model is built upon improving borrowers’ financial literacy, helping them build their credit scores, and ultimately charging them lower rates.

Ironically, although LendUp is locating its East Coast office in Virginia, the Old Dominion is not one of the states listed on the company’s website where the service is offered. The RTD article offered no explanation why that would be. Perhaps the company has more regulatory hoops to jump through here. If the social reformers want to accomplish some good, perhaps they could lend LendUp a hand.

Stick It to the Hedge Fund Managers!

VRS_management_fees2
by James A. Bacon

One of the voices urging reform of the Virginia Retirement System (VRS) is a semi-retired University of Virginia economics professor, Edwin T. Burton III, who served 18 years on the board. He argues that the VRS pays too much in management fees to outside investment firms that pursue labor-intensive strategies and should rely on low-overhead funds that index stock and bond markets.

In fiscal 2016, the VRS generated a 1.9% return but lagged the 3.99% return on the S&P 500. The year before, the VRS generated a 4.7% return compared to a 7.4% return for the S&P. “We haven’t come close” to the 7% rate of return assumed by the VRS in reaching its calculation of $22.6 billion in unfunded liabilities, he told Michael Martz with the Richmond Times-Dispatch.

Getting a higher rate of return is the best way to boost the financial health of the state retirement fund. Of course, that’s easier said than done. Everyone would like to boost returns on their financial investments, but very few investment managers have outperformed the market consistently. While pension funds can tinker with their portfolios, shifting funds between stocks, bonds, real estate, private equity and hedge funds, often chasing yesterday’s hot categories, they can’t control their returns. But they can control how much they pay outsiders to generate those returns.

As it happens, the VRS paid $362 million in management fees in 2015, according to its 2015 Comprehensive Annual Financial Report. (The 2016 report is not yet online.) That sum is divvied up between ten major investment categories such as U.S. and foreign equities, fixed-income, real estate, hedge funds and other alternative investments.

Hedge fund managers stick out like a sore thumb — they collected $87 million in management fees. Hedge funds delivered outstanding returns for many years, which justified their sky-high management fees, but they have stubbed their toes in recent years. With some 10,000 funds playing in the sandbox, typically betting on movements of currencies and commodities, competition has squeezed industry profit margins to nothing. After years of sub-par returns, there is no justification for the overly generous fee structure.

VRS also paid exceptionally high fees to “alternative investment” managers and for its “strategic opportunities portfolio.” Taxpayers might wonder if those fees are worth the returns they generate.

Remarkably, the VRS staff, which manages one third of the portfolio, cost one-tenth that of the hedge-fund and alternative-investment managers.  If the entire portfolio were managed that efficiently, management fees would have cost only $81 million in 2015 — a savings of about $280 million! Over the years, that could amount to billions of dollars.

So, why don’t we fire the hedge fund managers?

It gets complicated. First of all, you don’t mind paying higher fees to managers who outperform the market averages. Unfortunately, the VRS annual report doesn’t tell us the performance of its individual funds, and even its discussion of investment categories (stocks, fixed-income, hedge funds) doesn’t match up with the categories listed in its table of management fees. So, there’s no way the public can tell if the management-fee differentials are worth it or not.

Second, you shouldn’t judge a fund manager based on one year’s performance. Even the best can have a bad  year. What most interests me is the internal VRS performance. Does its track record over the years equal that of other fund managers? If so, why we paying the other fund managers?

Third, there is a benefit to diversifying a portfolio. The idea is to limit exposure to wide swings in any single investment category. Strong performance in one category offsets weak performance in another. A pension portfolio that invested only in stocks and bonds would be distressingly volatile.

Still, Professor Burton has a point. The VRS may be paying way more than it needs to. Saving $280 million a year won’t bail out a pension fund with $22.6 billion in unfunded liabilities (probably an optimistic assessment), but it sure would help, creating less pain for Virginia’s public-employee pensioners and taxpayers. The idea is definitely worth a closer look.

Digging into Rate-of-Return Assumptions

vrs_portfolio

by James A. Bacon

House Speaker William J. Howell is rightfully concerned about the long-term health of the Virginia Retirement System. The pension system’s own actuary estimated a year ago that the $68 billion retirement system has unfunded liabilities of $22.6 billion.

On Sunday, the Richmond Times-Dispatch’s Michael Martz described the debate over restructuring the VRS from a defined-benefits system to a defined-contribution system. Today, Martz reports how Howell is questioning the outsized fees paid to outside fund managers, who handle two-thirds of the system’s assets.

“My biggest concern is the unfunded liability and the fact that it’s just going to grow,” Howell said.

Howell has every reason to be concerned. Unfunded liabilities might turn out to be far bigger than the actuary’s estimate. As I have observed many times, the liability is based upon an assumed 7% annual rate of return on the $68 billion portfolio. If the system under-performs expectations, as the VRS has done the past two years, the unfunded liability can grow by tens of billions of dollars. Writes Martz:

For Howell and other lawmakers on the [Virginia Commission on Retirement Security & Pension Reform], however, the retirement system’s recent investment performance has raised questions about whether the 7% assumed rate of return is too optimistic for the longer term, especially with interest rates keeping bond yields low for the foreseeable future. …

The 7 percent return, lowered by the VRS board from 7.5 percent in 2010 is among the lowest in the country for public pension funds, said Katie Selenski, state policy director for the Pew retirement initiative. “At 7 percent, you’re in a good, prudent position.”

Prudent? Not really. The pie chart above shows VRS’s portfolio allocation. Some 17.6% consists of fixed income assets. Barring some bizarre experiment with negative interest rates in the U.S., there is no way in a zero interest-rate environment that these assets can generate a 7% return. Another 39.8% of the portfolio consists of equities. Insofar as the bull market in stocks over the past 30 years has been driven by lower interest rates and an expansion of earnings multiples, there is no way to replicate the stock gains of the past ten years. Indeed, earnings and earnings quality of stocks are deteriorating, not a good sign for near-term price performance. Meanwhile, the performance of hedge funds nationally has been dismal of late. There is no rabbit to pull out of the magic hat of alternative investments.

For another view on the outlook for long-term portfolio performance, it is instructive to turn to the University of Virginia, which, whatever one might say about the Board of Visitors’ strategic priorities, one must credit with doing an excellent job of managing its endowment. The 10-year return of the University of Virginia Investment Management Company (UVIMCO) has been 10.1 %, according to its 2014-2015 annual report. That compares to 5.8% ten-year performance calculated by the VRS in 2014-2105.

How much do UVa’s masters of the universe think they can earn on their portfolio looking forward? As best as I can tell from perusing UVIMCO’s annual report, they don’t say. UVIMCO doesn’t report that assumption because it isn’t relevant:  Although UVIMCO does have unfunded commitments, it is not a pension fund in which shortfalls must be made up by taxpayers.

Still, it is possible to get a sense of UVa’s expectations from comments made by university officials that they expect the controversial $2.2 billion Strategic Investment Fund to throw off $100 million a year to pay for programs to advance the university’s strategic goals. University officials have not explained what rate-of-return assumptions they are using. But a simple calculation reveals that $100 million is only 4.5% of $2.2 billion.

From that, one can draw one of two conclusions. Either UVa’s investment mavens are assuming a much lower rate of return than the VRS, or they expect a higher-than-4.5% rate of return but plan to retain a substantial fraction of the earnings, presumably in order to grow the size of the portfolio.

It appears that the second conclusion is true. Here’s what the UVIMCO annual report says: “Each year a portion of the endowment value is paid out to support the fund’s purpose, and any earnings in excess of this distribution help build the fund’s market value over time. In this way, an endowment fund grows and provides support for its designated purpose in perpetuity.”

For legislators digging into UVa’s controversial Strategic Investment Fund, which is managed by UVIMCO, it would be interesting to know what rate-of-return the university is assuming for its endowment and what percentage it figures on spending and what percentage it figures on retaining. The numbers should be equally interesting to Speaker Howell. It would send out a flashing yellow caution signal if the UVIMCO’s assumption about of future performance was more conservative than that of the VRS.

Another Example of Good Intentions Gone Wrong

Jennifer Doleac

Jennifer Doleac

by James A. Bacon

Last year Governor Terry McAuliffe signed an executive order to “ban the box” prohibiting employers from asking job seekers about their criminal history at the initial job stage. The goal was to “remove unnecessary obstacles” to felons seeking employment after incarceration. How could one object? Once felons have paid their debt to society, we should ease their transition back into the workforce, right?

It turns out that things don’t always work the way we expect them to. From the Daily Progress:

Research published recently by Jennifer Doleac, an assistant professor of public policy and economics at the University of Virginia, found that ban the box policies actually lowered the probability of employment by 5.1 percent for young, low-skilled black men and 2.9 percent for young, low-skilled Hispanic men.

According to Doleac, who conducted the study with the University of Oregon’s Benjamin Hansen, the lowered chance for employment comes from the unwillingness by employers to take chances on hiring someone without knowledge of their potential criminal history.

“Simply taking away information about whether someone has a record doesn’t stop employers from caring about someone’s criminal background,” Doleac said. “It just leaves them to guess based on the remaining information they do have.”

All too often, that “remaining information” is age, race, ethnicity and socioeconomic background. (Hat tip: John Butcher)

Bacon’s bottom line: Society is extraordinarily complex. Political ideologies (both on the left and the right) provide simplified models for how society works. Often those simplified models overlook important linkages and feedback loops that lead to very different results than anticipated. Individuals and private entities can quickly alter their behavior to adjust to reality; government adjusts much more slowly, if at all.

Will McAuliffe rescind his “ban the box” order? I’m not betting on it. The social engineer’s response to problems created by a law or regulation is to “fix” the emergent problem by enacting more laws and regulations… thus creating new problems. 

It’s fine to try new ideas, but we have to pay attention to whether they work or not. If they don’t, we need to reconsider them. Good intentions are not enough.

Yeah, It’s Probably a Good Idea to Update Your Zoning Code Every Half Century or So

Pouring whale oil. At long last, Henrico zoning code will leave the 19th century behind.

Pouring whale oil. At long last, Henrico’s zoning code will leave the 19th century behind.

News flash: Henrico County officials see the need to bring the county zoning code into the 21st century.  Although the zoning code has been amended 240 times, it was adopted in 1960 and has never seen a systematic overhaul since.

The code, Randy Silber, deputy county manager for community development, tells the Richmond Times-Dispatch, is “over 55 years old. It’s antiquated. … There’s disconnect in the uses in the zoning ordinance and the economic development that is being put before us.”

Regulations governing sperm whale oil and poison manufacturing remain on the books, notes Silber. The code also refers to bone distilleries. “I don’t even know what that is,” he says.

The 1960 zoning code shaped the “suburban sprawl” model that propelled Henrico County growth in the 56 years since. But the model has run its course, having saddled the county with vast expanses of low-density land use patterns that are costly to maintain and are beset by intractable road congestion issues. Moreover, businesses are reversing a decades-long migration from the central city to the suburbs as Millennials and Empty Nesters seek walkable, mixed-use communities found in the urban core, along with easy access to the city’s museums, festivals and cultural events. To avoid the same kind of hollowing out that central cities experienced a half century ago, Henrico must create walkable, urban places as well.

While Henrico has permitted a few such places, growth continues to be dominated by old-fashioned sprawl. An outdated zoning code is, in effect, mandating the county’s premature obsolescence.

The fact that county professionals see the need for change is encouraging — although the examples cited in the Times-Dispatch article suggest that they may be in more of a mind to tinker with the code than to embrace an alternative paradigm for development and re-development. It’s also unclear whether the citizenry, which is terrified of any change that might affect their homes’ property values, sees the need for change. But at least it’s a start.