Comparing the Financial Hole in the Delta Water Tunnels Plan to High-Speed Rail

A comment I made comparing the tunnels to high speed rail was printed in the San Jose Mercury News, "The financial hole in this is at least as large as the financial hole in the high-speed rail plan."  People are interested in the comparison between these so-called legacy projects, so here are some of the simple calculations behind the statement.

In both cases, the "hole" in the capital financing for the project is an unrealistic projection of funds provided from a key source.  In the case of high-speed rail, the hole comes from federal government appropriations that are unlikely to materialize.  In the case of the tunnels, the hole comes from the unrealistic expectation that farms will pay the majority of the costs since the majority of the water is for irrigation.

The high-speed rail business plan estimates capital costs for the full blended system at $68 billion.  It estimates of non-federal sources of funding at $26 billion, mostly from 2008 Prop 1A bond funds and a defensible estimate of private capital contribution.  The big problem is $39 billion of the $68 billion is projected to come from Federal funds, but only $3 billion has been committed and there is no reasonable expectation of more in these days of sequester.  So that is a $39B hole in a $68B cost, or 57% of the capital costs. [The recent court ruling against HSR was partially based on the financial hole in the initial operating segment of the HSR line which is estimated to cost $31 billion, and unrealistically assumes $20 billion in additional federal funds.]

As for the tunnels, construction costs are estimated at $15 billion in 2012 dollars.  (Note: The HSR cost estimate is in year of expenditure dollars and accounts for inflation, and tunnel costs have not been.  A similar adjustment to tunnel construction costs would increase capital costs to $19 billion.)

Urban agencies have committed to paying for about 1/3 of the tunnel costs for 1/3 of the water.  (I have heard anything from 25% to 40%, so I will go with 1/3 to keep it simple.)  Their leaders have repeatedly vowed they won’t subsidize the agricultural costs, and all the statements they have made about ratepayer effects depend on this assumption. 

That leaves a 2/3 share for agriculture.  What can we reasonably expect them to pay?  What is it worth to them?  BDCP’s optimistic modeling shows that SJ Valley agriculture will see gross revenue increases of about $130 million per year if the tunnels are built.  If I assume a 40% profit margin on growing these crops, that would be about $50 million in increased profits. San Joaquin Valley farmers also get some water quality and purported seismic risk benefits from the tunnels, that might push up the willingness and ability to pay for the tunnels to a total of $100 million per year.  Under the optimistic scenario in a recent presentation on Delta tunnel finance to the Westlands Water District board, debt service and operating costs for the tunnels will be $1.3 billion per year.  Thus, it is only reasonable to assume that agriculture should only be willing to pay about 8% of the tunnel debt service.  Thus, if urban ratepayers pay 33%, farmers pay 8%, the hole is 59% of the tunnel capital costs which is a little bit more than the 57% hole in the HSR capital funding plan.

Another quick way to look at the agriculture benefits from BDCP is to consider the value of land that would be fallowed without it.  BDCP would keep between 0 and 200,000 acres of marginal cropland in production (the tunnels do not help water supply in dry years, and farmers rationally fallow the worst land first, so BDCP isn't impacting the best land).  That marginal land might sell for $6,000 an acre, so if we optimistically value keeping that land in production at $6,000 per acre, it comes to $1.2 billion of the $15B tunnel costs, or 8% of the total.  Add that to the 33% urban share, and there is still a 59% hole.

There are fancier ways to measure this financial problem, but it will not change the conclusion that there is large hole in the tunnel financial plan that will have to be filled with a massive subsidy of farmers by urban ratepayers or taxpayers.  

P.S.  I should mention that there are actually two holes in the BDCP financial plan, and the funding shortfall for the habitat components typically get even more attention.  BDCP habitat plans depends on water bonds passing and uncertain federal funding.  That's a major problem too.

Detroit bankruptcy process moving much faster than Stockton

Municipal bankruptcies are rare, so I don't know how long the process takes.  Former City Manager Bob Deis said Stockton's bankruptcy was progressing at "warp speed," but it looks like a turtle compared to Detroit... so far. 

Stockton filed for bankruptcy in late June 2012 and its eligibility trial was 9 months later in late March 2013.  It was found eligible shortly after the trial in April 2013. 

Detroit filed for bankruptcy in mid-July 2013 and its eligibility trial was in early November, about 3.5 months later.  The eligibility ruling was issued yesterday, about 4.5 months after the filing and the ruling covered more ground than Stockton's case, specifically on the issues of pension protection.

Thus far, Detroit has been moving twice as fast.

Furthermore, Detroit plans to file its plan of adjustment within 2 months of the eligibility ruling, while that process took Stockton over 5 months.  Stockton negotiated deals with most of its creditors during that time, and Detroit's case appears headed for appeals.  So appeals could slow down Detroit, but the Detroit ruling could also slow down Stockton's process.

Articles in today's NY Times and Sac Bee suggest that the one creditor who has yet to settle with Stockton, Franklin Templeton, may be newly emboldened by the Detroit ruling to fight the plan of adjustment rather than reach a settlement of their own.

(from NY Times) Even before Tuesday, Franklin was warning that it would challenge to Stockton’s plan. Documents on file with the court suggest it was planning to argue that no plan could be “fair and equitable” if Calpers were paid in full while Franklin received less than a cent on the dollar.

“Their argument just got strengthened,” said Karol K. Denniston, a bankruptcy lawyer at Schiff Hardin in San Francisco who has been advising a taxpayers group that formed after Stockton declared bankruptcy. Referring to the judge’s decision in Detroit, she said, “Franklin Templeton is going to have a lot to say about this ruling.”

(from Sac Bee)  Denniston said the Detroit ruling could also affect the Stockton bankruptcy. Even though Stockton left its CalPERS payments untouched and made debt-restructuring deals with most of its other creditors in October, the city still hasn’t reached agreement with one major lender, Franklin Templeton. The Detroit decision could give the Franklin firm an opening to demand that Stockton officials treat CalPERS like every other creditor, according to Denniston. (from Sac Bee)

Read more here: http://www.sacbee.com/2013/12/03/5966594/bankrupt-detroit-can-cut-pensions.html#storylink=cpy

Both cities are still in bankruptcy, so it is still to early to know who will emerge the fastest. But Detroit certainly has come out of the gates faster.

Is the Bay Delta Conservation Plan Blog Proposing an Urban Subsidy of Agricultural Users in BDCP?

Recently, I have heard Mark Cowin and other state and local water agency officials repeatedly state that there will be no urban to agricultural subsidies for water supplies from the twin tunnels.  They have dismissed the notion as a "rumor".

How do these rumors get started?  Why won't they go away?  Look no further than the latest pro-tunnel propaganda from the Bay Delta Conservation Plan blog,  "Mature Choices for a Mature State."

In the piece, the tunnels are described as an affordable choice by comparing its per capita cost to the per capita cost of the Hetch Hetchy upgrade that only serves urban customers in the highest income area in the United States. 

In contrast, the vast majority of water that would be delivered through the tunnels is for irrigating crops, not urban use.  And state and water agency officials continue to vow that the tunnels will be paid for on an equal basis per bucket of water, not on a per capita or per household basis. 

If water leaders want to stop those urban-agriculture subsidy rumors, then they need to stop repeating this idiotic argument that compares per-capita costs of the tunnels to the per-capita costs of urban water infrastructure.   

The second obvious problem with this blog post is that it assumes that the tunnels are the only solution to the seismic risk of levee failure.  In fact, in all the other infrastructure examples in the blog post, the post describes seismic upgrades to the existing infrastructure - not outrageously expensive bypasses to the existing system.  The common sense, "mature" approach to addressing this risk is to invest in seismic upgrades of the levees themselves.  This is much cheaper and most importantly, it protects many more things from the seismic risk, including public safety which the Resources Agency has described as their top priority.  Thus, seismic levee upgrades both cost less and provide more benefits than the tunnels. 

Pushing the tunnels as a solution to seismic risk and ignoring seismic upgrades to the Delta levee system is not mature.  It is economically and morally wrong.

BDCP Statewide Economic Impact Results Illustrate Why BDCP Is a Disaster for California Agriculture

According to the BDCP Statewide Economic Impact Report, implementing BDCP would have the following effects on crop revenue in California. 

Revenue Gain to SJ Valley Farmers From Improved Water Supply:  +$134 million (page 5.1-21)
Loss to Delta Revenue From Agricultural Land Retirement for Habitat:  -$89 million  (page 5.1-16)
Loss to Delta Farm Revenue From Salinity: -$2 million  (page 3.1-13)

Thus, the total net change in farm revenue according to the BDCP statewide economic impact report is $41 million annually. 

When interpreting this $41 million, remember this is gross revenue, net revenue or profit is significantly lower.  Also, this is the BDCP's estimate based on their optimistic water supply and delta salinity scenarios.  I believe the outcome will actually be worse.

How much will the state's agriculture industry pay to receive these miniscule benefits from the tunnel plan? 

Although the BDCP has not finalized an ag/urban cost allocation, the heads of the urban agencies have been repeatedly promising their boards that there will be no agricultural subsidy and every water user will pay the same amount per unit of water received.  Since BDCP is estimating debt service and operating costs at $1.2 billion annually (their figure, this understates likely financing costs) and agriculture receives at least 2/3 of the water, the farm share of the tunnel bill looks to be at least $800 million per year according to the leaders of the water agencies who pledge to pay for the tunnels.

Thus, the BDCP documents suggest the financing cost of BDCP to the statewide agriculture industry will be roughly 20 times higher than the net gain in statewide agricultural revenue.

With those kind of numbers, I don't think it is an exaggeration to call BDCP an economic disaster for California agriculture. 

While there may be a few individual farmers who could benefit in some way, I don't see how anyone who claims to be representing the statewide interests of California agriculture can possibly support BDCP. 

Finally, I should note that there are some agriculture impacts missing. 
On the negative side, it leaves out the land retirement for tunnel construction and the potential upstream impacts on upstream farmers in the Sacramento Valley and San Joaquin tributaries (I have been told that the reason BDCP predicts low salinity impacts in the Delta is that those farmers will be giving up water).
On the positive side, there are some water quality benefits to SJ valley production that are not reported separately in these reports, and some potential to reduce groundwater pumping costs for some farmers receiving exports in the SJ Valley.

None of these missing impacts would be remotely large enough to change the BDCP disaster for agriculture.  No wonder Dr. Rodney Smith is predicting a 90% probability that the agricultural contractors drop out of BDCP by June 30, 2014.

What happens if Measure A fails?

Measure A and the bankruptcy exit plan are directly linked and have some flaws (my discussion of those flaws has been highlighted by opponents on a flyer).  The question to voters is will the alternatives that emerge if Measure A fails be better or worse for the City?  

There are several clear short-term impacts if Measure A fails:  1) the hiring of cops for the Marshall Plan on crime will be delayed, 2) Stockton taxpayers will save about $27 million (about $90 annually on per capita basis, although sales tax is paid by residents and non-residents).

Other impacts are less clear and direct.  Here is my take on some key questions.
 

1)   Will a tax proposal on the ballot next year be better or worse than the current proposal?  Will it be an unrestricted or restricted tax? Will there be competing tax proposals on the 2014 ballot?

As I listen to the debate around Measure A, a lot of the opposition is that it isn't a restricted tax, and if it fails - there will probably be a big push for a restricted tax.  It is possible there could be competing tax proposals (restricted and unrestricted) on the ballot, a situation that was avoided this November when the Safe Streets initiative faded and the Mayor compromised and supported Measure A.

A restricted tax is a bad idea for a City in bankruptcy, as well as one that has recently emerged from bankruptcy and has a really thin budget.  While in bankruptcy negotiations with creditors, a restricted tax is simply bad faith, and the City clearly needs some additional funds to finance a plan of adjustment and taxes legally restricted to police would make the path out of bankruptcy very difficult.

If the Plan that replaces Measure A looks like the Safe Streets restricted tax initiative, the City is worse off.

It is also possible that an unrestricted tax could be significantly worse than Measure A.  Some alarming recent evidence of this is in the Stockton Police Union's statement of neutrality on Measure A.  The Union wanted a salary floor, based on a salary surveys of other cities, placed into the fine print of the ordinance.  That is really poor fiscal practice reminiscent of what drove Stockton into bankruptcy in the first place.

I fear that some of the alternatives to Measure A could lock some negative budget choices into the tax measure itself - as evidenced by both the former Safe Streets proposal and the salary floors the Police Union tried to negotiate into Measure A. 

It looks like future tax alternatives are likely to be worse, not better than Measure A as I had hoped.  Thus, this is a reason to vote for Measure A.

2)  How will passing Measure A and B affect the bankruptcy case?

Until recently, I didn't think that Measure A and B would have a major impact on how a judge would rule on the bankruptcy plan of adjustment.  In fact, one of my concerns about Measure A/B has been that they would pass and then the judge would subsequently rule against the City's plan of adjustment.  This outcome would have put the City in a very tough political and financial bind.  I thought it was a strong argument for delaying a tax vote until next year when more bankruptcy issues would have been sorted out.

In a big surprise to me, the City and Assured Guaranty, the City's largest and most antagonistic bond creditor reached a settlement deal that depends on the passage of Measure A.  This settlement and others recently announced by the City means that we know a lot more about the bankruptcy exit plan if Measure A passes, and that there is an extremely high probability that the plan will be approved by the court if Measure A passes.

I have reviewed the settlement with Assured Guaranty, and I think it is reasonable.  The City was never going to get a creditor loss as large as their original ask, and I think this deal will result in a 30%-50% loss for the creditor that is comparable to the loss by City retirees and is thus pretty close to what would have eventually been approved by the court. 

Contrary to my original expectations, it appears that passing Measure A will directly lead to a bankruptcy exit plan approved by the court, and the City would formally exit bankruptcy some time next year.  This will directly save the City millions in additional legal costs, and I doubt it could have done much better with creditors if it pushed for a "cram down" in court.  Less directly, getting rid of the bankruptcy stigma will be good for the City's image, and I think it will be good timing that makes it more likely that the City will  benefit from the improving economy.   Thus, this is a reason to vote for Measure A.

3) Can the City be trusted to keep all the promises in Measures A/B: including hiring 120 cops, sunset the tax measure in 10 years, and finance a plan out of bankruptcy that is acceptable to creditors and employees? 

It is exceptionally hard for the City to keep all these promises, and that has been my concern about Measure A/B from the beginning (but restricted taxes are not the answer).  Something has to give.  As discussed in previous posts, that something appears to be sunset measure in Measure A.

It is bothersome to me that the City puts the sunset clause prominently in the ballot measure, and then hides the City Council's option to extend it in the fine print.  And as I have pointed out, their bankruptcy exit plan and even their settlement with their largest bond creditor assumes Measure A is permanent.

Although it is not reflected in their current plan, even if Measure A passes, the City Council can take actions to hold down cost increases (primarily through the negotiation of new employee costs) and put the City on track so that Measure A can sunset, and if it is extended in a decade, the City should be financing additional service recoveries, not just maintaining bankruptcy levels.  In my earlier blog post when I said the City Council should reject the plan of adjustment, I was saying that they should revise their financial plan filed with the court to show greater cost control so that Measure A can expire.  Even though many of those future costs are uncertain, revising the plan would set more reasonable expectations for employee unions and other stakeholders. 

While the City Council did not reject/revise the financial plan, it is clear to me that they heard the message and the projected increase in costs are not obligations.  It is up to them and the citizens of the City to stay engaged in the long-range financial projections and demand that the City keeps a tight lid on its costs.  This is true whether or not Measure A or any future tax measure passes or fails.

The City's bankruptcy exit plan is financially tenuous, does not account for a Measure A sunset, and by assuming employee compensation (not counting increasing pension costs) grow faster than projected revenue, the plan seems to prioritize employee compensation over restoring City services.  This is a reason to vote against Measure A.

4) Will the City have to shut down libraries and fire stations if Measure A does not pass?

Only if the City Council chooses these options to balance the budget, and if they do, they should be voted out.  I don't think this will be necessary for two reasons 1) the real estate rebound will boost property tax revenue in the short-run, and 2) the City has other less unpleasant options to reduce costs, and has used them in the past when facing deficits.

How much will property taxes rebound?  Earlier this week, the state Board of Equalization released an estimate of a 5% increase in valuations for San Joaquin County as a whole as of 1/1/13.  The City budget assumed less than a 1% increase this year, and assumes a 2.5% increase next year.  Assuming City property taxes actually increase 5% this year and next year, the City could expect about $5 million more over this year and next than its current projections.  That would address about half of the anticipated deficit, and that would be enough to balance the budget at current levels if the City were not incurring bankruptcy legal costs or if CalPers were not increasing its rates.  The budget would be very bad, but I am not convinced it would require closing libraries and fire stations below the current low level of services.  

However, there will be a significant impact on City Services if Measure A fails, the hiring of additional police for the Marshall Plan will most definitely be delayed.

Getting more police on the streets now is a reason to vote for Measure A.  Concern that the City might have to close its libraries is not a reason to vote for Measure A.

5) If Measure A fails, does that mean the City will take on CalPers and cut pensions?  Will it walk away from the Arena and give it to creditors?

No, the City has clearly indicated it will not go down either of these paths.  There are good financial reasons not to even though I think it is clear that building the arena and approving more generous pensions were past financial mistakes.

Politically, it isn't going to happen either.  Did you see the Stockton mayor or any members of the City Council with Chuck Reed when he turned in his pension reform initiative?  It is possible that blocking the City's negotiated settlements with a No vote, could result in the CalPers issue being raised by creditors in court as a reason to reject any "cram down" the City may try to impose on them.  But the court can't impose a CalPers cut on the City and I would guess the City would sweeten its offers to creditors even more before going after CalPers.  As I discussed in an earlier post, even Stockton's anti-pension crowd is just proposing a cap, and even if it is successful, it is unlikely to yield budget savings worth the cost.

If you are a pension reform advocate in Stockton, you should support Chuck Reed's statewide pension reform initiative and try to get Stockton to take advantage of it if it passes. 

Voting against Measure A will not lead to meaningful pension reform or savings.   

6) If Measure A fails, are there better options for Stockton to exit bankruptcy other than a sales tax increase?

Sales taxes are regressive, encourage poor land use and policy choices by city (subsidize retail!), and are an overall lousy way to finance local governments.  But in California, that is just about the only tax that cities can adjust.  The only other real option would be to raise the utility users tax, which is arguably even worse, and Stockton's utility users tax is already much higher than other comparable cities, while there are nearby cities that have sales taxes higher than Stockton. 

The City needs a tax increase to exit bankruptcy and improve public safety.  There are not any better options than an unrestricted sales tax.


My bottom line:

When the City released its bankruptcy plan of adjustment, I moved from leaning slightly in favor of Measure A to a neutral position with consideration of not supporting it.  This was primarily due to reason #3 above, and my concerns were discussed in detail in this September 30 blog post that has become a favorite of Measure A opponents. 

Since September 30th, three developments have changed my thinking a little and I am now leaning in favor of Measure A.

1.  Assured Guaranty made a reasonable settlement with the City a few days later, contingent on Measure A passing.  The deal is beneficial to both parties and was the key to paving the way out of bankruptcy.  The deal seems to eliminate most of the risks to Stockton of passing a tax increase before the bankruptcy case is resolved.

2.  I have done some more thinking about what kind of tax we might see to replace Measure A, see the discussion under #1 above.  Listening to Measure A opponents push a restricted tax and seeing this letter where the Police Union tried to negotiate a salary floor into the Measure A fine print convinced me that economics professors would not be writing a future tax measure, and that there is likely to be something worse than Measure A on a future ballot if it fails.

3.  Concerns about escalating costs and the projections in the financial plan of adjustment have been heard, if not acted upon yet.  I am concerned that the City's financial plan sets unrealistic expectations about the ability of the City to provide COLAs and raises for its employees going forward.  But these projections are just planning assumptions, they don't reflect contracts.  I have been assured that City leaders understand the long-run budget reality and will hold the line on costs.  It is up to the citizens of the city to remain engaged and ensure that they do.

Speech at the Restore the Delta Event

Last week, I gave the keynote speech at a Restore the Delta event.  Below is the speech I wrote for the event.  For context, it was a party and I was following a comedian whom I had been informed in advance was doing a routine titled "the Plan", hence my references to "the Plan" and attempts to be funny.  Also, I was accepting a "Delta Advocate" award and thus the premise of the speech is about how I was originally uncomfortable receiving an "advocate" award, but after studying these issues for several years I am now comfortable with the term.

I recall my first contact with Restore the Delta.  It was 2008, I was new to the area and attended a water issues forum held at Pacific.  I was expecting a small crowd, but the University Center was packed, and on the way out I picked up this bumper sticker – Restore the Delta: Fishable, Farmable, Swimmable, Drinkable (hold up sticker) 

What a nice positive message.  I put the bumper sticker on my car.  I didn’t even know Restore the Delta was an organization, I thought it was just a nice sentiment – like “Practice Random Acts of Kindness” or “I love puppies.”  Not long after that, I heard Barbara Barrigan-Parilla on the radio and I realized Restore the Delta wasn’t about hugging puppies.  

I was told by leaders that Restore the Delta was a tiny, self-interested, NIMBY group that was going to be rolled over for the “greater good” of the State’s economy… and I scraped that offensive bumper sticker off my car. 

I didn’t know if “the Plan” was the best thing for California or not.  But it was clear that there was misinformation in the media, and that there had not been any real attempt at benefit-cost analysis.  After 4 years and 3 significant economic studies I have now come to the conclusion that “the Plan” is bad for the state, and that there are better, less costly solutions.  At the same time, I have watched Restore the Delta grow from a noisy NIMBY group to a statewide organization that has a compelling vision that benefits the Delta and the entire state.

I have been asked to briefly describe my conversion into a Delta Advocate without using too many boring economic numbers.  So here goes.     

In 2009, the nation was in the worst economic crisis since the depression, and the Central Valley was the center of the storm in its worst crisis ever.  We had a new President with a 3-prong plan for the economy: stabilize the banks, help homeowners and stop foreclosures, and stimulus.  The President was able to get 2 of the 3 actions through Congress and did little or nothing to address the foreclosure crisis devastating the Valley.  Part of the blame goes to misinformed Central Valley Congressional representatives who were blaming their rising unemployment rate on a 2-inch fish, the Delta Smelt.
In 2009, California was in the 3^rd year of a severe drought, and 5% of irrigated agriculture was fallowed due to lack of water.  But the owners of that 5% of farmland have political influence, and the news media was lapping up the “Fish or Families” campaign, flying in from New York, driving right past the 70,000 people in the Valley who had lost their jobs due to the foreclosure crisis, to blame the rising unemployment rate on a 2-inch fish.   

I was finishing up my first year at Pacific, and that summer my Center put out our first special report on water, “Unemployment in the San Joaquin Valley: Fish or Foreclosure?”  It laid out the facts about job loss and what caused it.  The report got some attention, Restore the Delta asked for an interview for their documentary film, and most importantly – and to their credit – economists from another University corrected their mistake and recalculated their estimates of job loss to something very close to our numbers.  That report established our credibility, and it slowed – but did not stop the flow of economic misinformation.

In 2011, I was hired by the Delta Protection Commission to lead a team of experts to develop their Economic Sustainability Plan for the region.  The best decision I made in that process was to hire Dr. Robert Pyke as my chief engineer, you will hear from him a little later.  Up until that point, all of my water research had been focused on the rest of the state, I was woefully ignorant of the Delta itself.  I had never seen it from a boat; I believed the news stories of crumbling levees and the inevitable earthquake disaster; I didn’t know the communities or think there was much out here but crops. 

Dr. Pyke educated me about the levee system, but I wasn’t about to go out on a limb with a crazy, old Australian so I consulted other engineers and sources.  We uncovered other unreleased DWR consulting reports that had come to similar conclusions, and published levee data the state had been sitting on for 4 years.  Then, “the Plan” brought in national experts to publically review our recommendations for investing in levees and not in tunnels.  Their expert panel said our levee strengthening recommendations were too weak for public safety needs.  Their expert said the earthquake risk to water exports did not justify the multi-billion dollar investment in a tunnel or canal.  And their review panel echoed our call for a full benefit-cost analysis of the tunnels.

Soon thereafter, calls for benefit-cost analysis of the tunnels were coming from everywhere: Congress, the state legislature, academics and the editorial pages.  By the summer of 2012 I had grown tired of the state’s inaction and drafted my own benefit-cost report using the Plan’s data.  I found $2.50 in costs for every $1 in benefits to the state; a very bad investment.  “The Plan” has now responded with some unconvincing new economic reports, but they have done little to change the growing doubts around California about the financial viability of “the Plan.”

This research has convinced me that Restore the Delta’s common sense call for levee investments and freshwater flows through the Delta is the best approach for California as a whole.  It is clear that Southern Californians are better off spending their money on modern, sustainable water supply alternatives, and that farmers can’t afford the tunnels.
So tonight I am going to be an advocate and put this sticker on my car [display stop the tunnels], and after the tunnels are stopped, I will replace it with this pretty one [display swimmable/fishable/farmable].

In closing, I would just like to say what it means to me to be a Delta advocate.A Delta advocate cares about this special place, and wants future generations to enjoy a Delta that is fishable, farmable, swimmable, and drinkable.  But being a Delta advocate is more…

It means being an advocate for facts over fear in policy debates. It means being an advocate for good government.  Demanding government agencies follow their own rules, and act responsibly with taxpayer and ratepayer dollars. It means being an advocate for enduring values like environmental sustainability, fairness, democracy and the rule of law.

But the best part of being a Delta advocate is the great Delta wine, food and good friends.  Thank you for your support, and I hope you all have a great time tonight.

As always, the speech as delivered varied a little since I was trying not to read and was interacting with the audience.

How Much Would Capping Pensions Help Stockton?

I participated in an issue forum on Measures A and B, Stockton's proposed 3/4 cent sales tax increase, last night.  I was the economist pointing out pros and cons of the tax plan, but not taking a stand one way or the other. 

The most outspoken opponents of the tax are generally opposed to the City's approach to bankruptcy and want the City to cut pension benefits in bankruptcy.  They score a lot of points when they talk about six-figure pensions.  The enhanced pension benefits that allowed safety employees to retire at 90% of their highest salary levels certainly created some ex police chiefs who are collecting nearly $200,000 per year while retired in their fifties. 

The tax opponents' solution: cap pensions at $100,000 per year.  It's an appealing idea, especially when one considers the inequitable impacts of the City's approach to cutting retiree benefits entirely by eliminating healthcare benefits.  That hit lower income retirees the hardest, and if the City was going to take more from retirees by addressing pensions, I would agree that these high pensions or "spiked" pensions would be the first place to look.

But how much would that solution save?  And how hard would it be to implement?

I pondered that after the forum, and looked up some numbers to get a rough ballpark estimate.  Before quoting these exact numbers, I would reemphasize the word rough.

Pension reform advocates have posted the names and pension payments of the 98 Stockton retirees receiving over $100,000 on the web.  In FY 2012, those 98 folks received $12.2 million in benefits from CalPers.  If they were capped at $100,000 each, they would have received $9.8 million from CalPers, reducing CalPers payments by $2.4 million.

I looked up the City's CalPers actuarial reports for FY 2011 (most recent available).  CalPers made a total of $66.3 million in benefit payments to the City's retirees that year.  If there had been a $100,000 cap in effect, that total would have been reduced to about $64 million or only about 3.6%.

But that $2.4 million in benefit reductions should not be confused as an annual savings to the Stockton budget, as CalPers is not a pay as you go system like the discontinued retiree health benefit.  CalPers is making these payments from their investment portfolio.  Saving that $2.4 million payment, and a similar amount in subsequent years, would reduce the City's liability to CalPers which would then translate into lower CalPers contributions from the City.  But the annual savings to the City budget, would be substantially less than $2.4 million, probably no more than half that amount.

So the tax plan opponents have only offered up about $1-2 million in annual savings from this measure, less than 1% of the City's general fund spending.  (Yes, the City needs to find all the savings it can, but the benefits of this action shouldn't be overstated.) 

What would it cost for the City to gain that savings?

The City would have to change its approach to bankruptcy and take on CalPers to reduce pension benefits, and thus invite the precedent setting case that would pit federal bankruptcy laws against state law protecting pensions.  The outcome of that effort would be uncertain, the City could lose.  The only two certain outcomes is that Stockton would end up paying millions of dollars more for lawyers, and that the City would be stuck in bankruptcy for a much longer time.  Even if Stockton prevailed in an effort to cap pensions, it isn't clear that City would have gained much more than it spent in legal costs and time. 

Thus, I see the proposal that the City should try to cap pensions through bankruptcy as a feel good measure that would cost the city more in the short-run than it saves, and may not even accomplish much net savings in the long-run.  The main beneficiary of the City's efforts would be other cities who might benefit from the precedent if Stockton succeeded.  But a City in bankruptcy needs to focus on how to solve its own problems.

Stockton's pension reformers should team up with other like minded people around the state to try to change state law.  For example, the San Jose mayor is working on a statewide initiative that would give Stockton and other cities new powers to adjust pensions.  They should put their energies towards those reforms, and then press Stockton to take advantage of it if they succeed.

For Stockton right now, that energy can best be directed at making sure new employee contracts that will soon be negotiated are sustainable in the long-term.  Pensions are a burden, but they are only part of an overall compensation package, and pension reform is only one way for a City to control its costs of delivering services. 

A No-Tunnel BDCP, Optimizing Through Delta Water Conveyance

A few follow-up notes on the no-tunnel BDCP op-ed I authored in today's Sac Bee.

1.  All the calculations in the article assume the BDCP economic analysis has correctly valued the cost of future water shortages (the economic benefit of the tunnels is preventing these shortages).  However, the BDCP uses a high future growth scenario and a dim view of alternative water supply technologies to blow up the costs of shortages (benefits of the tunnels).  If they had adopted a growth forecast that matches the state's and most forecasters' consensus projections, they would have estimated 5 million fewer people in Southern California in 2050.  If they would have combined this with modest cost reductions in water supply alternatives, the study would have found that paying for the tunnels is even worse for ratepayers than the water doomsday scenario (as low as 3.4 maf of exports) they used for comparison to the tunnels.

2.  The BDCP economic analysis did consider 1 no-tunnel alternative, a highly engineered Delta corrirdors plan that uses $5 billion of modifications of Delta channels (a dozen or more barriers and gates, dredging, fish screens, etc.)  to isolate San Joaquin River flows from the Sacramento river water conveyed through the Delta to the pumps.  The BDCP economic study finds that this alternative has a significantly higher benefit-cost ratio than the tunnel plans and some benefits for fish.  And the economic study forgot to include $2-4 billion of water quality benefits to the exporters from this plan that I am told will be in the final revised study.  That will put the benefit-cost ratio of this alternative significantly over 2, which blows away the tunnels plan on an economic basis.  There are problems with this alternative too, but it certainly looks better than the tunnels using the BDCP's own studies.

The bottom line is this.  The BDCP has ignored a number of viable and less costly no-tunnel alternatives.  As today's op-ed said, a reasonable conclusion from their own studies is that simply removing the tunnels from the current BDCP is almost certainly better than the tunnels plan.  The BDCP study also found that a plan with super extensive modifications to Delta channels is better than the current plan.  In light of this evidence from their own reports, the continued tunnel vision of BDCP is inexcusable.  

There is a lot of space in between these two visions of through Delta conveyance.  Since the BDCP analyzed a bunch of different size and configurations for the tunnels to find the optimial isolated conveyance facility, they should make a similar effort for the through Delta options to find the optimial through Delta option.  These options would include different levels of channel modifications, different levels of seismic levee upgrades (from as little as 100 to up to 600 miles), different fish screen options for existing conveyance, and explore the possibility of new intakes in the West Delta as proposed by my friend Dr. Pyke (I'll call this through Delta conveyance too since the freshwater gets most of the way through the Delta).

Wow, Assured Guaranty and Stockton Reach a Settlement. The Deal Improves the Case to Voters for Measure A (sales tax increase).

The City was hinting at a deal, but I guess I didn't believe it given how antagonistic Assured Guaranty has been with the City.  I will reserve final judgement until seeing the fine print, but the outlines of the deal seem reasonable.  I don't think the City would have been able to get anything substantially better in court, as their original ask on the pension bonds of an 84% loss was highly inequitable.  In other posts and writings, I have suggested an appropriate loss for the Pension Bonds would be about 40% whether viewed from the perspective of equity with retirees or the damage the pension bond deal did to the City's finances.  This deal appears to be in that ballpark.

The City will start making small payments on the pension bonds from the general fund in 2023 and extend those payments an additional 15 years out to 2052.  Combined with the portion of the bonds paid from sources outside the general fund, that puts the haircut from the fixed payments at around 50% in net present value basis. However, Assured will do better than that because they will keep a share of Stockton tax revenue over current projections - and Stockton will definitely exceed their projections for at least the next couple of years.  It's hard to know exactly where it will turn out in the end, but the deal definitely gives Stockton's general fund significant short-run relief and the scale of the loss and shift of risk to Assured seems fair and roughly proportional to the loss to retirees.

All these creditor deals have definitely been made easier by the recovering real estate market.  Several of the bonds had pledges of property tax increment, and the loss of property tax increment is why they fell back on the general fund in the first place.  Improving property values and tax increment is making some of the deals possible, such as the settlement on the Arena bonds.  The improving market also helped the deal on the 400 E. Main building as Assured will take title to that office building and sell it.  My rough math says they will break even if they can sell it for about $165 per square foot, and my understanding is that office buildings are selling for $125-150 per square foot in the Stockton area.  With the City leasing up more of the building's space and the market improving, the creditors loss won't be too enormous from taking over the building.  Finally, the improving market makes it very likely that tax revenue will exceed the City's projection over the next few years, and thus will help improve Assured Guaranty's payments on the pension bond deal as well.

With all of these deals, the City can make a strong case that the judge will likely accept the settlements, and thus avoid a protracted bankruptcy.  The creditor deals depend on Measure A.  I would say that exiting bankruptcy in a timely fashion and saving millions in additional legal costs seems like another tangible benefit to passing Measure A that did not seem likely to me a few days ago.  The City definitely strengthened its case for the sales tax to voters tonight.

As discussed in the previous post, I still have significant concerns about the City's long-range financial projections that showed deficits in 8 of the next 10 years despite passing the sales tax and bankruptcy savings.  This was driven by the high growth rate of costs (mostly employee compensation).  Given the extremely low levels of non-police services for projected for decades to come, and the suggestion that Measure A revenues could sunset in 10 years, the City needs to control costs more than this projection suggests.  However, I was assured today by the City's consultants that the growth in employee compensation is not in contracts, it is just a planning assumption they have been using.  (They defended the assumption and why they thought those raises are needed, but I wasn't convinced.)  The bottom line is that the City can't afford to put 2% COLAs (cost of living adjustments) back into employee contracts in 2015 like its financial projections do if it plans to let Measure A expire or start restoring any non-Safety services in the next 20 years.  Since this financial plan of adjustment does not represent a commitment to those costs, this debate can be postponed for a short while.

Update 10/7:  I have had a chance to review the details.  I was concerned about the "contingent" payment formula that is based on whether and how much city revenues exceed a forecast, but it looks o.k.  I am comfortable that the ultimate loss on the pension bonds will be in the range of 30-50% and thus be proportional to the loss of benefits to retirees.

I did have one item wrong, there are more general fund payments on these bonds than I stated above.  General fund payments start at about $1.3 million annually in 2018, and will increase to about $2.9 million per year in 2023, and $3 million from 2042 to 2052.  There will also be the payments allocated to restricted funds (i.e. water and wastewater) for their share of costs, and the potential for additional contingent payments if the City's revenues are high.  For the next 5 years, this will save the City's general fund about $7 million per year, and about $3-5 million per year for the next 20 years.  Then there is 15 years of additional payments because the term has been extended.


 

Stockton's Proposed Plan of Adjustment Assumes Sales Tax Increase is Permanent. City Council Should Reject Draft Plan.

I believe a 3/4 cent sales tax increase is necessary, if not an obligation, for the City to emerge from bankruptcy.  Throughout the process, I have been supportive of the decisions by City Manager Bob Deis and the City's approach to bankruptcy, including the controversial decision to fully pay its CalPers liability. The City has made a lot of progress, and that deserves recognition.

However, after spending a good bit of my weekend reviewing the plan of adjustment released late Friday afternoon, this is the first time where I think it is appropriate for the City Council to dissent with the City Manager's bankruptcy plan.  If they don't and this plan is unchanged when the sales tax comes up for a vote, I can see cause for taxpayers to vote down Measure A (sales tax increase) this year.  The City can come back and ask for taxes again next year with a long-range financial plan that matches the promises they are making in the tax measure.

I have had concerns about the pairing of Measure A with Measure B, the advisory measure expressing that 65% of the proceeds will be spent on law enforcement and crime prevention, because of doubts of whether the City will be able to keep that promise as the bankruptcy case progresses.  This concern remains, but at least that promise is kept in the plan of adjustment.

However, Measure A has another promise written directly into the ballot question stating "it shall sunset in ten years or when economic recovery occurs."  This isn't an advisory measure, it is clearly stated in the tax measure.  The City Manager's plan of adjustment ignores this promise, and presents a budget projection with a razor thin fund balance in 2024 if the tax is extended, and will fall to a $38 million deficit if the measure expires as planned.  The huge deficit would occur even though the City will still be operating at current levels of non-police staffing and services despite a decade of population growth.  This $38 million 2024-25 deficit if the tax expires as promised is at least as large as what put the City into bankruptcy in the first place, even after accounting for inflation.  In fact, the projection shows the City's fund balance shrinking in the years leading up to the scheduled tax expiration, all the way down to a meager $8 million or 4% of expenditures. Thus, it looks like this plan sets up the City Council and management ten years from now for failure.  Not a good legacy.

If questioned on this, I suspect the City's staff response would be that their projections are really conservative, and they think positive surprises to revenue are more likely than negative.  The projections did not look overly conservative to me, but maybe I missed something.  Regardless, the City ought to go back and make reasonable revisions to their revenue and spending projections that show a balanced budget when the tax expires in 2024.  

Without getting into the details of every budget line, I will point to five issues that jumped out to me.

1.  Property Tax Projection:  This is the one revenue stream where I think the City is too conservative, at least for the next year or two.  Given the rapid recovery in the real estate market, I expect property taxes will increase significantly more than the $1.1 million (2.5%) projected for next year.  However, this short-run bump is just moving forward future appreciation, so increasing the short-run growth assumption would reduce the long-run growth levels.  Thus, I don't think the long-run projection is too conservative, in fact it projects property taxes recovering their pre-recession peak in 2022, so I don't think there should be an expectation that property taxes will close much of the 2024-25 budget hole.

2.  Employee Compensation (Non Pension): This is the biggest problem in the projection.  It assumes employee salary costs grow at a 3.2% annual rate (above inflation) even without adding any additional staff or accounting for increased pension costs.  At the same time, the City's revenue is projected to grow at a less than 3% rate.  I don't know the details of the new employee contracts, but if they call for average salaries growing faster then revenue, they are unsustainable and need to be revised down to grow below revenue growth (no more than per-capita revenue growth).  If total salaries only grew at expected inflation, individual employees could still get step and promotion increases above inflation, as higher-salaried employees retire/separate and are replaced with people lower on the salary scale.  The city presents no evidence that current salaries are too low, just that they have done a lot to curb the excesses of the past.

3.  Pension (CalPers) Costs:  These are projected to make a large $3 million (17%) jump for 2014-15, after a $3.5 million (25%) leap in 2013-14. But the killer is in 2 years,2015-16, when pension costs soar $8 million, then growth is projected to moderate after that.  Significant savings from pension reform is decades away.  I think it is fair to say the 35% of the tax increase that isn't going to police is going to cover these increased pension costs.

4.  "Mission Critical":  The plan has $8 million for the next two years for short-term "mission critical" expenses, which it describes as "an allowance for unmet needs", then it gives some examples of what those unmet needs might be.  The list of examples is notably missing what I think is the most likely unmet need, paying the bankruptcy lawyers for another 1-2 years.  I would like to see a line-item contingency for bankruptcy costs, noting that the funds can go to restore the City's withered fund balance if unneeded.

5. Wishful Thinking:  There are a few smaller elements that seem to include some wishful thinking.  $3 million in unspecified efficiency savings that will be identified in current studies, and that revenue enhancements from parking garages will suddenly make these structures able to pay their bond debt and operating costs.

In short, I agree with the City's long-run need for a general 3/4 cent tax increase.  But it is more important to get the City's long-term budget in balance, and to keep the promises made to voters.  This plan fails to keep the promises made to Voters in Measure A, and thus needs significant revision.

I believe the warnings about dire cuts next year if the tax is rejected are unwarranted.  It will mean getting by for another year without a needed investment in public safety, but I think budget cuts from current service levels would probably not be necessary next year as long as the city maintains bankruptcy protection/savings since property taxes should improve.  Without new tax revenues, more cuts would be necessary in 2015-16 when pension costs spike $8 million.  It would be preferable for the City to make a better plan of adjustment now, but if not, I think it can manage to take one more year to improve its long-range budget plan and pass a clean tax increase in 2014.

Update/Postscript: This discussion is based on an assumption that the City gets what it wants from its creditors, that they will either accept the settlement offers by the City or that the City will prevail over creditor objections in court.  That's a big if, and that assumption should not be interpreted as a prediction.  A discussion of the City's offer to creditors will come in future posts as more of those details emerge.

Update 2 (10/1, 5 P.M.):  I listened to the City Manager's press conference, and he answered the question about the non-expiring tax as I guessed; by referring to the conservative revenue projections.  Pondering his answers and the spreadsheets a little more, this issue can be resolved.

I might concede that property tax revenue and maybe some small items like hotel tax could be a little higher than they project.  But I don't see that growth doing much more than offset $3-5 million in what I have described as wishful thinking like unspecified efficiency savings.  The $38 million budget hole I describe in 2024 might not be as terrible as it sounds.  If the City can just restrain spending growth by $1.5 million each year, it will have $15 million less in expenditures by the time the tax expires (covering almost half of the deficit), and will have built up a $90 million fund balance it can use to cover a potential $20m deficit when the fund expires and cushion the transition to a lower tax rate.  If the City chooses to extend tax increases at that time, there should be some significant restoration of services over the minimal bankruptcy levels.

The city could achieve something close to this level of saving by holding employee compensation and program support to about 2% rather than the 3.2% growth in the financial plan.  I don't know what kind of raises the current employee contracts call for, but 2% growth in non-pension employee costs seems very reasonable and appropriate, especially given that the City is protecting CalPers.

It would be good to see a very robust discussion of employee salary growth at the City Council meeting, and for their to be a close look at revising this aspect of the plan.  Fixing the deficit problem I referred to may be as simple as revising down the salary growth assumption.  Of course, the contracts must support that revision, so it may not be that simple.

Update 10/4: See next post.  The deal with Assured Guaranty is a big surprise, and substantially improves the case for voting for Measure A since it is contingent on its passage.  Given this news, I don't have a problem with the City Council's vote to approve the bankruptcy plan of adjustment tonight.

Police Car Purchase Argument in Stockton

Why all the complaining about the City of Stockton's purchase of 48 new police cars from Tracy Ford instead of Big Valley Ford in Stockton?  (See here and here).

Tracy Ford underbid Stockton Ford by $10,333 for the 48 cars, so the City will buy from the Tracy dealership.  The purchase is criticized, because $10,446 according to Scott Smith's blog or "about $12,000" according to city staff of the sales tax revenue goes to the City of Tracy instead of the City of Stockton.

Thus, if you take into account the sales tax transfer, buying from Tracy cost Stockton a few hundred dollars more instead of $10,000 less.  It also has local upset that a $1.4 million went out of the City, although 90%+ of the money on a special order manufactured car is going directly to Ford Motor Company whether it is purchased in Stockton or Tracy.

The thing that concerns me with this episode is that some people interpret it as if the City's local buy ordinance is too loose by allowing bidders within the County, not just within the City.  Presumably, they think it should be further tightened to either exclude bidders from outside the City limit or provide some other preference to local bidders. 

The logic here seems to assume that the bids the City would receive would be the same if the rules were changed to favor bidders from within the City.  I doubt it. 

Big Valley Ford is the only Ford dealership in the City, and my guess is they would have bid even higher if their were no competition within the County.  Heck, the City might have gotten even lower bids than this if they wouldn't have limited the bids to inside the County.

Although it looks like Stockton has "shot itself in the foot" and unnecessarily lost a few hundred dollars, I think living with a few situations like this is inevitable if you are going to have competitive bids.  If Stockton tries to tighten up its local bid ordinance to prevent this apparent loss in revenue, it could wind up paying a lot more for everything it buys, not just cars. 

I like to buy local, and I appreciate the community spirit that motivates local bid preferences.  But you could argue that community spirit should motivate local businesses to give their police force a good deal.  The movement of cities in this direction can be a self-defeating zero sum game if it becomes too strict and every city in the region follows the same strategy. 

An Illustration of How Regulatory Assurance Under the BDCP is Risk Shifting, Not Risk Reduction

Bettina Boxall's article in Monday's LA Times is excellent. 

While most of her article is about the likely cost shift of the tunnels from agricultural to urban ratepayers, she may have also clarified the mysterious "note to readers" in Chapter 8 of the BDCP that suggests taxpayers might have to pay even more for BDCP environmental benefits.

Project backers are also broaching the possibility that federal and state taxpayers may be asked to buy water from irrigation districts upstream of the delta in the San Joaquin and Sacramento River basins to increase flows through the delta and out to San Francisco Bay. 

Whether that program would be a part of the tunnel proposal or stand alone is unclear. But either way, it would make the tunnel project more attractive to users because it would — at public expense — essentially increase the volume of water they could take from the delta and still meet endangered species protections. 

Cowin called the idea "very conceptual at this point." The reasoning behind public water purchases, he said, is that if the planned habitat rehabilitation work doesn't sufficiently boost the delta's imperiled native fish populations and more flows are needed through the delta, federal and state funding could be shifted from restoration to water purchases.

My initial interpretation of the "Note to Readers" was that it opened the door to taxpayers paying for the tunnels, but that appears to be the wrong interpretation. The response of Dr. Meral to questions in public meetings and this passage suggest that it means that taxpayers would agree to pay for even more habitat or water flows from upstream sources if needed to achieve BDCP recovery goals and comply with the ESA. This is due to the regulatory assurances in BDCP limiting additional contributions of water or money from the water contractors.

So this conceptual idea is a nice illustration of how the BDCP reduces regulatory uncertainty for the water contractors by increasing regulatory uncertainty for taxpayers, upstream water users, and the environment. And that transfer of risk is why I have not included any value for regulatory certainty in statewide benefit-cost analysis. If you want to count the value of this risk reduction benefit to the contractors, you also have to value the cost of the risk increase to upstream interests, taxpayers, the environment and the Delta. The BDCP economic studies released this summer do not provide this balanced assessment.

Listen to the Hydrowonk

Is the Hydrowonk (Dr. Rodney Smith) legit?  In a word, yes.  I highly recommend his series of posts on BDCP finance and economics.

He has been posting detailed commentary on BDCP costs and benefits on his blog faster than I can respond.  His perspective is strictly evaluating the prospective investment from the point of view of a water agency.  Unlike me, he isn't worrying about fish, in-Delta or statewide impacts in his analysis. 

The only serious critical comment I have had about Dr. Smith's commentary until now is that he takes the exaggerated water yield estimates in the BDCP economics reports at face value.

I delivered that comment to him in San Diego last week in person, and he immediately responded with his most recent post and its very handy list of costs under different water yield assumptions.  Now, my only criticism is that his table assumes all the water yields are positive!  The EIR tables show a negative water yield under one scenario, and the biological opinions are still being litigated.

The cost per acre foot is really important.  It is why I rudely butted in for the last word at the legislative hearing last month.  I couldn't let the last word be Dr. Sunding saying the cost of water from the tunnels would only be $300 af. 

Anyway, I have been telling people for some time that my best guess for the cost of the water is around $1,700 af based on the EIR yields which looks reasonably accurate according to Dr. Smith's table.  And as the Hydrowonk notes, you shouldn't compare BDCP water to desal. (Desal is super expensive, but it is treated, drought-proof water, delivered someplace much closer to you than Clifton Court forebay, uses proven and improving technology, and doesn't require you to become business partners with dozens of other water agencies who may not be as trustworthy or financially strong as your local agency.) 

After making some calls for knowledgeable opinions about BDCP water yields, the Hydrowonk concludes that the yield is lower than Dr. Sunding's assumption but potentially more than my EIR-based assumption.  [Thus, my first question for Dr. Smith's ingenious idea for a water policy prediction market:  What are the combined SWP/CVP in 2025 if there is no BDCP and the tunnels are not built?]

His conclusion/advertisement is priceless:

For Hydrowonk, I’m concluding (as of today) that the cost of BDCP water will cost in excess of $1,000/AF (inflation adjusted).  Since this is a non-firm supply of untreated water in the Delta, I urge all parties wishing to acquire non-firm supplies at these prices to contact me immediately.  I’m sure that my firm can help meet your water needs well in advance of 2025.

The NRDC Portfolio Proposal and The Cost Allocation Problem

There is much to recommend in Kate Poole's response to the Natural Resource Agency's weak attempt to dismiss the NRDC Portfolio alternative to the Bay Delta Conservation Plan (and the first comment by Dr. Gartrell is also a must read).  The core of the portfolio plan is to save several billion dollars by building a smaller 3,000 cfs tunnel instead of the BDCP's preferred 9,000 cfs tunnels and invest the savings in alternative water supplies, storage and levee improvements. 

I agree with NRDC that alternative water supplies, storage, and levee improvements have a better return on investment than the tunnels.  I agree with NRDC that the extremely costly tidal marsh restoration with uncertain environmental benefits is another area where BDCP can produce a better return on investment by shrinking in size.  Their proposal is a major step in the right direction, and has sparked a useful discussion.

But the NRDC portfolio proposal still has tunnel vision.  I am unconvinced that the smaller tunnels have a positive benefit-cost ratio, although it may be better than the big tunnels.  Even more important, I think the proposal exacerbates the cost/benefit allocation issues between urban and agricultural contractors that doom a viable finance plan for the big tunnels.

Just like the BDCP, the NRDC tunnel plan can only demonstrate financial viability if it moves beyond the macro analysis of total cost and water supply and get into the allocation issues.  The alternative water supplies that would be paid for with the savings are all urban water supplies, so how much of the little tunnel savings will accrue to urban agencies?  It isn't the total cost reduction that matters. 

For the sake of argument, assume the small tunnels cost $9 billion and the big tunnels cost $15 billion(the state argues the cost difference is much lower).  Now apply cost allocations.  If urban agencies pay 40% of the cost of either plan, the urban costs are $3.6 billion for small tunnels versus $6 billion for big tunnels and the savings to urban agencies is only $2.4 billion.

If urban agencies pay 80% of the cost in both cases, the cost difference to urban agencies is $7.2 billion versus $12 billion and the savings to urban agencies is $4.8 billion.  It is no wonder that the urban agencies that are most interested in the portfolio, like San Diego, are those that are most concerned about a cost shift towards urban users, especially if it causes other urban agencies to further cut reliance on Metropolitan's imported water.

However, a shift to a higher urban cost share is even more likely for the smaller tunnels.  In fact, many people interested in the small tunnels have suggested 100% financing by urban agencies.  If the urban agencies pay 100% of the cost of a $9 billion small tunnel, the urban savings drop to only $3 billion even if you assume they pay 80% of the large ones, and the savings drop to zero if you assume they pay 60% of the cost of the large tunnels. Whatever cost allocations you assume, the urban agency savings are a lot less than the total savings.  And thus, the funds available to invest in alternative local water supplies are less than NRDC states.

Similarly, what about the water supply allocation?  Overall, NRDC argues that the portfolio will generate a higher total water supply than BDCP.  But it appears that it will generate a lot more water for urban areas, and result in less water for agricultural users even if the total water supply is higher.

The bottom line is that I don't believe there is evidence that peripheral tunnels are financially viable at any size.

NRDC is on the right track, but they don't go far enough.  The tunnels need to be entirely eliminated from BDCP.  A smart portfolio of alternative water supplies, levees, storage, habitat and flows will provide far more benefits at lower cost than tunnel-centered proposals.  And this no-tunnel portfolio could be a habitat conservation plan under the ESA, and thus provide the more stable regulatory environment that the water contractors seek.

Substituting technology for labor in Valley agriculture

This is a good article.  http://www.sfgate.com/news/article/Agricultural-technology-use-growing-in-California-4796028.php#page-1

With agricultural prices high and farmers increasingly comfortable with technology, it would be great for the Valley economy to see some of these profits invested to modernize the agriculture industry and help farmers adjust to a changing labor market.  In addition to these immigration and demographic patterns, farmers are adjusting to increasing responsibility for their employees healthcare costs due to the implementation of Obamacare, and California appears poised to raise the minimum wage.

For economic development in the Valley, the focus needs to shift from counting the number of agriculture jobs to a focus on raising the quality, pay and skill requirements for Valley agriculture jobs.  It would be useful to see policy to support this adjustment.  Philip Martin's ideas for modifying the Ag jobs immigration proposal is an example of a policy approach that could support this transition (link).

Comparing Benefit Cost Estimates of the Tunnels

Last week, the State Water Contractors' sent out an odd news release and "fact sheet" comparing estimates of the benefits and costs of Delta tunnels that have been prepared by me and David Sunding.  I guess I have got their attention.  I'm surprised that the fact sheet didn't mention that Dr. Sunding is also older, taller, thinner, and drives a cooler car than I do.  That would have been just as relevant to benefit-cost analysis as many of their comparisons.

What you will not find in the SWC releases are any numbers from the reports except the "bottom line."  Thus, I pasted a handy table below that actually compares the benefits and costs.  As you can see (click here if image is too fuzzy), almost all of the difference is in the top line, export water supply.

As discussed elsewhere on this blog and other venues, the difference in export water supply benefits is driven entirely by the BDCP economic studies' assumption about no-tunnel water supply that is completely at odds with the water supply estimates in the BDCP's EIR, and is much lower than any regulation proposed or considered by any regulatory agency.  Dr. Sunding got over $10 billion in water supply benefits and over 1 million acre feet of additional water by assuming a massive tightening of regulations will cut water exports another 25% by 2025 if the tunnels are not built.  Then, he conveniently omitted the environmental, fishing and in-Delta benefits that would occur in the unlikely case of such a dramatic reduction in water exports.

In contrast, I was much less creative and simply used the BDCP EIR estimates of water supply without the tunnels, and also used the EIR to estimate the environmental benefits generated by the tunnels themselves (nil).

If you would like more elaboration on the numbers in this table, the differences between the reports, and some comments on SWC's fact sheet, click through to this document.  (Warning! The document is only 6 pages, so it is obviously a piece of amateur garbage that does not meet BDCP consulting standards for depth.)

BDCP Officials Continue to Inaccurately Describe Their Economic Study

In recent testimony to the Delta Stewardship Council, Karla Nemeth misrepresented the economic analysis of BDCP, perpetuating confusion over what this report found.  Ms. Nemeth's statement is typical of the confusing and inaccurate descriptions of this report by various state officials, including Jerry Meral and John Laird.

According to Maven's notebook meeting summary, Ms. Nemeth explains that BDCP will stabilize water exports at a level of at least 4.7 million acre feet (MAF) annually using the high-outflow scenario.  She then describes the results of the economic analysis as follows,

“With BDCP stabilizing existing water supplies with a yield of about 4.7 MAF, our most recent economic analysis demonstrates about a $5 billion economic benefit that is mostly the result of reducing the risk of future shortages." 

Given how much the Delta Plan expounds on the subject of risk, I am kind of surprised Phil Isenberg or another member of the Delta Stewardship Council didn't interject right there to ask Ms. Nemeth if her use of the term risk was consistent with the Delta Plan, especially since she said most of the benefits come from risk reduction.  The Stewardship Council's Delta Plan goes to great lengths to define risk as probability times consequences, it even has graphics illustrating the concept.  But the BDCP Economic Analysis doesn't treat a future reduction in water exports without BDCP as a risk with a probability, it treats low probability risks as certainties with 100% probability.  

In fact, the positive result of the BDCP economic analysis is not "the result of reducing the risk of future shortages."  It is the result of comparing BDCP to an alternative that is extremely bad for the contractors and extremely good for the fish, and then having an analysis that counts the harm to water exporters and ignores the benefits to the fish.  An accurate statement from Ms. Nemeth would state, "With BDCP stabilizing water supplies with a yield of about 4.7 MAF, our most recent economic analysis demonstrates about a $5 billion economic benefit for the water contractors compared to a scenario where tougher environmental regulations reduce average exports to about 3.4 MAF by 2025."

You might think I'm nit-picking, but Ms. Nemeth's misstatement is about a $10 billion error, meaning that the difference in the value of water supply reliability in the scenario used by the Brattle Group and a risk analysis implied by Ms. Nemeth is likely to be in the neighborhood of $10 billion. 

What is the probability that by 2025, exports would be reduced below 3.5 MAF due to regulations?  While this scenario is the water contractors' worst nightmare, the probability of this occurring is very very low.  Thus, the value the Brattle Group has assigned to avoiding this outcome should be multiplied by a very low probability, which is the approach they took to valuing the reduction in earthquake risk where they multiplied the loss from a year-long earthquake outage by an assumed 2% annual probability of it occurring.

A journalist recently sent me a link that shows implementation of the State Water Board's draft flow criteria would reduce water exports to 3.7 MAF to 3.9 MAF (see Appendix B here), and most observers believe the chance that those criteria are implemented is extremely low.  Thus, it seems to me that 3.7 MAF is a reasonable lower bound for future water exports without the BDCP, and this lower bound is even higher than the 3.4 MAF the BDCP used as the basis for comparison in their Economic Analysis.  No wonder Dr. Sunding and BDCP are getting so much flak for making this ridiculous assumption.

If 3.7 MAF is a resonable lower bound on future operations, what is a reasonable upper bound?  Given the barrage of legislation and lawsuits against the current biological opinions and the ESA itself, it seems to me that a reasonable upper bound on future operation would be a return to 2000 - 2005 conditions where water exports exceeded 6 MAF per year.  At the outset of BDCP, many water contractors said their goal was to restore exports to 6.5 MAF.  Thus, I would say a probable range of future outcomes is 3.7 MAF to 6.5 MAF, and the current biological opinions are in the center of that range.

That doesn't mean that the BDCP doesn't have some regulatory risk reduction value to the water contractors.  But a proper valuation of that risk would put likely put its value in the millions, not billions of dollars.  It would be similar to the valuation of seismic risk reduction of the tunnels which the BDCP economic analysis values at around $400 million.

Speaking of economic risks, there also other important components of economic risk that the BDCP ignores, especially on the cost side.  What is the risk that the tunnels take more than 10 years to build as assumed in the analysis?  What is the risk that BDCP costs more than currently estimated?  The BDCP warns that their regulatory assurances aren't guarantees, so what is the regulatory risk that remains even with BDCP?

I remain very confident that BDCP results in a net economic loss for the water agencies' ratepayers of around $7 billion compared to the status quo.  

Stockton MSA tops the U.S. in home price appreciation according to FHFA

On page 48 of this morning's release of the FHFA home price index for the second quarter is the following list of areas with the fastest home price appreciation in the U.S. over the past 12 months.

National MSAs, 1 year home price appreciation ranking.

1. Stockton-Lodi, CA 19.40% 

2.  Phoenix-Mesa-Scottsdale, AZ 18.47% 

3.  Las Vegas-Henderson-Paradise, NV 17.59% 

4. Bend-Redmond, OR 16.73% 

5. Modesto, CA 16.01% 

6.  Sacramento--Roseville--Arden-Arcade, CA 15.45% 

7.  Vallejo-Fairfield, CA 15.42% 

8.  Reno, NV 15.09% 

9.  Madera, CA 14.78% 

10. Oakland-Hayward-Berkeley, CA 14.56%  

Of course, virtually all of these cities topped the price deprecation lists if you go a few years back.  For example, the Q4 2008 release showed Stockton at 291 out of 292 metro areas with -41% change in home values over 1 year. (Merced was last with -49% change in that release.)  Even people like me who felt local property values had dropped too far should be mildly surprised and slightly impressed to see the Stockton MSA at #1 on this list.

The BDCP Economic Impact Study

Between a family vacation and the University of the Pacific network meltdown (entering day 5 of no email), I am in both physical and virtual isolation.  I did see the press release and a few news articles about the release of the BDCP's statewide economic impact report.

A few quick thoughts.  This is not a valid benefit-cost analysis.  Without even getting into some of the deficiencies in the calculation details (e.g. overestimates future water demand, discount rate is too low, etc.), it suffers from three fatal structural flaws.  While the consultants are very capable economists, their report contains these flaws and ridiculous assumptions for the simple reason that the Delta tunnels can not be economically justified without them.  Below is my summary of the three big structural flaws.

1.  The $15 billion Delta tunnels must be subject to a separate analysis.  BDCP invalidly ties environmental restoration projects together with the tunnels into a bundle, although these conservation projects could be pursued without the tunnels. The principles of benefit-cost analysis, and the state's own guidelines are crystal clear here, the tunnels must be justified independently.  

2.  The BDCP analysis compares the project to a single ridiculous alternative, where export water supplies are cut another 25% below the current restrictions in the biological opinions.  While this might be an extreme scenario to bracket the analysis, and some environmental groups support such restrictions, it is disingenuous to portray it as the most likely outcome in the absence in the BDCP.  This is particularly true since the water contractors and the state Department of Water Resources are suing that the current biological opinions are too restrictive and unjustified by science, and they even won the last skirmish in court on this issue.  The Department of Water Resources can only argue that this is the most likely outcome if they think that the science and law supports an additional 25% cut in water exports, a position that is in direct conflict with the stance they have taken in federal court for years.  BDCP has to take this contradictory position to economically rationalize the tunnels since spending $15 billion on tunnels that don't increase water supply rather obviously doesn't make economic sense.

The EIR (environmental impact report) uses a completely different no-action alternative, a continuation of the current biological opinions, which can be justified.  Using this more realistic baseline as the basis for comparison, the tunnels fail the benefit-cost test by a wide margin.  I demonstrated this last summer, and the state's consultant, Dr. Sunding acknowledged this in response to a question at the Metropolitan Water District.

In addition to an alternative that continues current regulations, the tunnels should also be analyzed against a set of no-tunnel BDCP alternatives.  These would include options focused on seismic levee upgrades, as the Delta Protection Commission has advocated, and would include a version of the delta corridors plan which is the through-delta alternative discussed in the EIR.  These no-tunnel alternatives would be BDCP alternatives, meaning they would convey the same regulatory assurances to the contractors under the Endangered Species Act as the state's preferred project with the tunnels.  They would contain the environmental restoration elements of BDCP, so the environmental benefits of restoration would cancel each other out, and the benefit-cost analysis would focus squarely on the tunnels.

3.  The BDCP economic impact analysis does not place an economic value on the most important environmental impacts, particularly the endangered and threatened fish species that are driving the entire conflict.  This issue is critically important here, because the BDCP economic analysis uses a no-tunnel alternative that is an environmental activists dream, it is very likely to be more beneficial to the fish than the BDCP plan.  The BDCP statewide economic impact analysis makes an assumption to boost water supplies to increase water supply benefits, but does not account for the environmental cost on the other side of the ledger.

Valuing the environment is a sticky and controversial issue, but it is an issue that must be addressed.  You can't just waive your hands and ignore the economic value of recovering fish populations like this recent BDCP economic report.  In this context, I think the best approach is to define alternatives that are expected to deliver roughly equivalent environmental benefits.  Fortunately, this is possible to do for the tunnels, since the BDCP EIR analysis basically says that the tunnels alone provide no net benefit for fish relative to the current biological opinions.  In other words, ignoring the environmental effects could be justified if the current biological opinions are used as the baseline for comparison, as they are in the EIR.  Following the structure of the EIR is also highly desirable to maintain consistency across the various reports.  That is the approach that I took in the benefit-cost white paper I put out last summer.  The bottom line is that if the BDCP is going to use a baseline alternative that is more protective of fish than the tunnels, it is imperative that the value of those fisheries is explicitly included when they weigh benefits and costs.

Divergent Jobs Surveys: Household Survey Shows California Has Fully Recovered Pre-Recession Peak, but Payroll Survey Shows a Different Story

The BLS Household Survey released today reports 17.035 million employed Californians, finally exceeding its pre-recession peak of 17.023 million in January 2008. 

The BLS Payroll Survey reports, 14.612 million non-farm payroll jobs, still 600,000 jobs below its pre-recession peak of 15.213 million in July 2007.

Overall, economists view the payroll survey as more reliable due to a larger sample and its annual benchmarking to full payroll tax records.  However, they are different measures of employment (employed people versus jobs) and the household survey is more comprehensive in that it captures self-employment and agricultural work.

There are a couple of potential explanations for this divergence.  Of course, one possibility is sampling error, and one must never forget we are dealing with preliminary estimates from surveys that are subject to revision as more data becomes available.

Other explanations are a structural shift in the California economy away from payroll jobs and towards self-employment.  More people could be working as independent contractors rather than employees across a variety of different industries, and I have heard plenty of anecdotal stories to support that.  Self-employment is more common in professional services which has been one of the strongest growing sectors in California for some time.

In addition, some of the traditionally biggest sectors for self-employment are construction and finance (particularly real estate related finance), so the faster growth in the household survey could reflect the growing impact of the real estate recovery on the job market.

Interestingly, the household survey measure of employment did not decline as much as payrolls during the recession even though construction and real estate was the hardest hit sector.  That suggests that there is likely an on-going shift towards self-employment across sectors and the household survey is no getting a second boost from the real estate recovery.

Unlike Stockton, Detroit targets pensions on its way to probable bankruptcy

For Stockton residents depressed about their bankrupt city, I recommend a review of Detroit's emergency managers proposal to creditors of the losses they should take to help the city avoid bankruptcy.  Detroit defaulted on its pension bonds this month, a little more than a year after Stockton first defaulted on its bonds. Other parts of Detroit's dilemma will be familiar to Stocktonians: low levels of public service, high crime, and poverty.

But the driver of Detroit's municipal distress is quite different than Stockton.  Detroit's biggest fundamental problem is unrelenting large-scale population decline, as people abandon the City for its safer, lower tax suburbs.  Stockton continues to grow, albeit much slower than in the past.  Stockton also has lower current tax rates than Detroit, and is likely to use a tax increase to help itself escape bankruptcy.  Detroit can't realistically raise taxes any higher (property tax rates are about 6 times higher than California, there is a municipal income tax, and more) as there is evidence that its high taxes are part of what has been driving residents to the suburbs.

Also different is the proposed approach to the City for financial restructuring, and this is what will demand the most headlines and has the greatest potential implication for Stockton's case.  Like Stockton, Detroit's emergency manager proposed big losses for the unsecured bonds, but is taking a dramatically different approach in proposing significant cuts to vested pension benefits, which he views as unsecured debt.  Stockton has wiped out retiree medical benefits, but is not proposing to change pensions.  It should be noted that the proposal to cut pensions in Detroit isn't coming from its elected officials or a city manager hired by an elected city council.  The Governor of Michigan appointed an emergency manager for the City, and it is the appointed emergency manager that is targeting pensions.

Michigan's state constitution protects pensions, similar to California, so I doubt Detroit's unions will go along with this pre-bankruptcy proposal and will try to defend their pensions in bankruptcy court.  Thus, Stockton may not be the nation's largest bankrupt city for much longer.