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.

Changing the Baseline: The Biggest Problem in the New BDCP Economic Rationalization of the Tunnels

Both environmental assessments and economic assessments of proposed major infrastructure critically depend on a baseline or no-action scenario.  This scenario defines the conditions that are expected if the project is not built and is used as the basis of comparison for the projects impacts.  The same no-action scenario should be used for environmental, economic and financial feasibility assessments.  However, the latest BDCP documents use a different baseline for the economic analysis than the environmental impact report (EIR).  When analytical consistency gets in the way of rationalizing the tunnels, BDCP just switches the baseline.   

The BDCP EIR no-tunnel (i.e. no-action) scenario makes the reasonable assumption that through-Delta operations would continue under the current pumping constraints imposed by the Endangered Species Act through "biological opinions."  The EIR no-action scenario estimates average water exports at initial operations of about 4.7 million acre feet (MAF) per year at initial operations declining to 4.4 MAF towards the end of the 50 year permit.  The EIR estimates that with the tunnels, water exports would be 4.4MAF to 5.3 MAF in the "late long term", a change of between 0 MAF and 0.7 MAF per year.

In contrast, the economic analysis assumes that without BDCP, additional ESA regulations would bring even tougher restrictions on water exports between now and 2025 such that average water exports at initial operations would be 3.4 MAF to 3.9 MAF.  Thus, building the tunnels would increase water exports by between 1.3 MAF and 1.7 MAF per year compared to no action.  In other words, the economic analysis assumes that without the BDCP tunnel plan, ESA regulations would add another 20-25% cut to water supplies on top of current limits.  Never mind that no such plan has been proposed, and that the California Department of Water Resources (DWR) and the water contractors are trying to weaken the current restrictions in court.  Clearly, DWR has no sincere intention of implementing this more restrictive scenario, they are just conveniently adopting it for the economic analysis to rationalize building the tunnels.    

This switch of the no-tunnel baseline is probably the most serious of several problems with the BDCP economic analysis, and it will create some very practical headaches for the BDCP.  The fish and wildlife agencies that have to approve BDCP will certainly ask why the financial feasibility analysis depends on assumptions that are inconsistent with the EIR, and if DWR is actually proposing such restrictive operations on exports in the absence of BDCP.  The inconsistency also gives BDCP opponents another issue to use in lawsuits, and it could even undermine the water contractors case in their existing litigation over the biological opinions.

Considering all the problems the state is creating for itself with this shift in baseline, why would they do it?  Because they can't demonstrate financial feasibility without it.  Using the BDCP's own estimates of costs and benefits, I demonstrated a year ago that the tunnels can not be financially or economically justified by comparing them to the no-action scenarios of the draft EIR.  The sleight of hand with the shifting baseline is simply a clever, hidden way to bring back the "value of regulatory certainty" argument the state attempted last summer (see this blog post from last July, and this one from January where I worried that they might try this baseline shifting stunt). 

The shifting baseline creates problems for the BDCP environmental approval.  Why?  If this more restrictive baseline were used for the EIR, the tunnels would almost certainly fail the EIR analysis.  The tunnels could not be justified as a Habitat Conservation Plan (HCP) under the ESA since the no-tunnel scenario would be more protective of endangered and threatened species than the proposed tunnel project.  [See Matt Weiser's article in Sunday's Sac Bee for a discussion of how the EIR finds the tunnels are not even anticipated to benefit endangered fish species compared to current conditions (i.e. the EIR baseline).] 

In addition to the EIR, the tougher baseline assumption would create problems for a true statewide benefit-cost analysis.  The recently released economic analysis only considers the benefits and costs of the tunnels to the water contractors.  In contrast, a statewide benefit-cost analysis would include benefits and costs to the environment and to other effected parties in-Delta, upstream, and fishing.  While the baseline shift creates water supply benefits from the tunnels for the contractors, the increase in water supplies raises the tunnels' costs to the environment and these other parties.  Thus, the change in assumption that increases the tunnel's water supply benefits helps financial feasibility to the contractors, but would hurt the tunnels comprehensive benefit-cost justification. 

I think this maneuver is a major reason why the BDCP cancelled the benefit-cost analysis and postponed the planned release of chapters 8 and 9 by a month.  It is also a sign of how the BDCP is going to increasingly desperate measures to keep their sinking project afloat. 

Additional Note 6/18:  A BDCP steering committee presentation from March 2010 describes the requirements of the Alternative to Take analysis (ch 9 of the BDCP that contained the new economic analysis).   On the last slide of the presentation, the no-action alternative is described as the existing biological opinions, consistent with the EIR approach.  This further shows that the super-restrictive water supply scenario introduced in the new chapter 9 was a last minute change to increase the economic benefits attributed to the tunnels.  Using the EIR no-action assumption, the tunnels would have a negative net benefit and be judged as financially infeasible.

Will Fresno Follow Stockton Into Bankruptcy? I Don't Think So

The City of Fresno's budget for next year assumes millions of dollars in new franchise fees from trash privatization, but these fees depend on the outcome of last week's Measure Z vote.  The Measure Z vote is very close, provisional ballots are still being counted, and the outcome won't be known until next week.

Some people have been saying that Fresno is the next Stockton, and that failure of the trash privatization measure would push it towards a bankruptcy filing.  While I am not nearly as familiar with Fresno's budget as Stockton, I don't see a Fresno bankruptcy.  There are plenty of similarities between the two cities, but Fresno's financial situation doesn't appear quite as dire as Stockton, the level of services has not been cut as low as Stockton, and there appears to be resolve in City leadership to avoid bankruptcy.

There are some obvious similarities between the two cities.  Both are in the Central Valley and have similar economic statistics, although Stockton is closer to the bay area and had a bigger housing boom and bust.  Both cities have a lot of debt for similar things like ballparks and mammoth pension bonds, but Fresno issued its pension bonds a long time ago rather than Stockton who dumped its bond revenue into CalPers at the top of the market and took a much larger financial loss on the deal.  Fresno administers its own pension plan, whereas Stockton is in CalPers, and Fresno has somewhat lower pension costs (although they use different actuarial assumptions than CalPers so it is impossible to do an apples to apples comparison of pension liabilities) and does not offer the kind of unfunded retiree healthcare benefit that Stockton did prior to its bankruptcy filing.  Here are some additional high level comparison numbers I have gathered from the two Cities' budgets and other sources (there is a bit of rounding here for simplicity).

Fresno:

Population: 500,000

General Fund Revenue: $275 mil, about $550 per capita

Police: 717 (about 1.43 per 1,000 residents)

2012 Murders: 51

Stockton:

Population: 300,000

General Fund Revenue: $160 mil, about $533 per capita

Police: 330 (about 1.1 per 1,000 residents)

2012 Murders: 71

Since both cities are spending about half of their general fund on police, the police staffing and murder statistics provide some background on the level of services.  Both cities have cut police, but Stockton's cuts have been much deeper and had a larger impact on crime.  Stockton's murder rate in the year of its bankruptcy filing spiked to double the Fresno rate as police staffing dropped to arguably the lowest level of any major American city.  Fresno police staffing is not high, but they would have to lay off about 150 more cops to get to Stockton's level, and no one is contemplating those kind of cuts regardless of the outcome of the trash privatization measure.  Stockton had more excessive employee compensation and retiree benefits, and was unable to gain significant enough restructuring without bankruptcy protection.

Through the 1990s and 2000s, Fresno was similar to Stockton but did not quite go to the same extremes.  Its costs of delivering services, primarily driven by personnel costs, remained lower than Stockton.  I am not sure if this is due to better management or its greater distance from the bay area and smaller economic boom reduced cost pressure.  I was a little surprised to see Fresno had slightly more general fund revenue per capita, they might receive more sales tax since they are a regional service center and more isolated from alternative shopping opportunities.    

Fresno certainly has severe financial problems, and that City may well have to endure one more round of painful budget cuts to fully stabilize its budget.  I expect it will go that route rather than a bankruptcy filing. 

However, it should be noted that an escalating public safety emergency is what made additional cuts unacceptable in Stockton and made the bankruptcy filing inevitable.  Similarly, the bankruptcy outlook for Fresno could change if conditions, both financial and non-financial, change.