Managing California’s Cash

Managing California’s Cash GABRIEL PETEK LEGISLATIVE ANALYST SEPTEMBER 3, 2019 analysis full gutter AN LAO REPORT LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Executive Summary The budgetary situation of the General Fund is the primary fiscal focus of the Legislature each year. The budget contains a plan for how much the state will spend in expenditures and receive in revenues over the course of the next fiscal year. This budget situation differs from the state’s cash situation. The state’s cash situation involves when these expenditures and revenues will occur. In particular, on any given day, the General Fund might be disbursing more expenditures than it is receiving in revenues (thus, facing a cash deficit) or receiving more than it is disbursing (a cash surplus). Cash deficits are a normal part of any fiscal year and occur even during the best of budgetary times. The General Fund cash situation is managed by the executive branch—in particular, the State Controller and the State Treasurer. The State Controller oversees the General Fund’s daily cash position and uses a variety of techniques to manage cash flow deficits, ensuring the General Fund is still able to pay its bills on time. When the General Fund has a surplus, the State Treasurer’s Office invests the surplus cash in the state’s liquidity pool—the Pooled Money Investment Account (PMIA). A Brief History of California’s Cash Management California Has Faced Significant Cash Problems in the Past. While the state’s budget and cash situations are distinct, they are related. In particular, when the state faces more difficult budgetary times, it often also faces larger and more persistent cash deficits. Over its history, the state has faced three key periods of prolonged cash difficulties: following the recession in the early 1990s, after the dot-com bust in the early 2000s, and most notably, throughout the Great Recession of the late 2000s. During each of these periods—and in particular during the Great Recession—the Controller and Legislature both needed to take extraordinary actions to ensure the General Fund could pay its bills. California’s Cash Position Is Now Very Good. After a long history of budgetary problems and a fluctuating cash position, California is now enjoying both healthy budget and cash situations. There are several reasons that the state’s cash situation is so positive. In particular, in recent years the state has built sizeable budget reserves and these monies are available to the Controller to manage the state’s cash flows. The state has also created new state funds that are available for General Fund cash flow borrowing, and balances have increased in other existing funds. California’s Cash Position Will Not Always Be This Good. As with the state’s budget situation, California’s positive cash position is unlikely to last forever. When a recession occurs, it will mean lower revenue receipts, larger cash deficits, and declining balances of internal borrowable resources. Moreover, these risks are correlated—when one condition deteriorates other conditions also are likely to deteriorate. A Framework to Evaluate Future Cash Loans The state’s cash situation has been so positive in recent years that the Legislature has been able to commit a small part of its liquidity pool to make loans to fund other priorities. In particular, www.lao.ca.gov 1 analysis full gutter AN LAO REPORT the Legislature made two loans: (1) SB 84 (2017), which reduced the state’s long-term pension debt, and (2) AB 1054 (2019), which addresses utilities’ liabilities arising from wildfire claims. While we are not aware of any plans for another similar loan in the future, more proposals are possible. This section outlines some criteria that the Legislature might want to consider should it need to evaluate a future proposed loan. These criteria are: • Size of the Loan. The first consideration in evaluating the risk of a future loan is its size. Larger loans involve more risk. • Duration of the Loan. In the case of a large loan, its duration becomes an important consideration. That is because these loans become more significant problems if they are still outstanding when the next recession occurs. Loans with longer durations involve more risk. • Dependability of Repayments. Another key consideration for the Legislature in making future cash loans is the degree of certainty with which the loan will be repaid. Loans made with a dedicated revenue or resource stream are more likely to be repaid promptly than loans repaid using all-purpose General Fund or other fund resources. Loans without a dedicated repayment mechanism involve more risk. • Fiscal Benefit. In evaluating any future cash loan, we would finally encourage the Legislature to consider the loan’s potential fiscal benefit using high-quality, rigorous quantitative analysis. Loans that result in substantial fiscal benefit to the state are more advantageous than those which do not. Each of the two recently made loans meet some of these criteria. For example, SB 84 has a long duration, but is not very large. It also carries a significant fiscal benefit and has a dedicated stream of repayments. Assembly Bill 1054, conversely, has the potential to be much larger, but is also likely to have a relatively short duration. As such, neither loan has fundamentally compromised the state’s internal liquidity. Future Loans From State’s Cash Pool Deserve Legislative Scrutiny. The state’s cash position is now very positive, but this has not always been—nor will it always be—the case. Given this inevitable change, we suggest the Legislature be cautious about approving any future proposals to make additional loans from the state’s cash resources. In particular, assessing a proposed loan using the criteria in this report may help determine whether its benefits exceed its costs. This scrutiny may help protect the state’s positive cash situation and ensure California is well-equipped for the future when cash challenges could occur once again. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT INTRODUCTION Through the annual budget process, the of California’s cash occasionally deserves some Legislature spends several months each year legislative attention. This attention can help protect making an expenditure plan that aligns with the the positive cash situation and ensure the state is state’s anticipated revenues for the upcoming well-equipped for the future, when cash challenges fiscal year. After this budget plan is developed, the could occur once again. executive branch has the responsibility to execute With these goals in mind, this report describes: it. Importantly, this means managing the state’s (1) how the state manages cash, (2) a history of cash situation—collecting tax revenues and paying the state’s cash situation, (3) the developments the state’s bills. that resulted in the state’s good position today, and At some points in California’s history, the (4) how the state’s cash position is likely to change state’s cash situation has become a point of in the future. Next, we describe some recent and intense legislative scrutiny. This occurred most novel actions to borrow from the state’s cash often during recessions—and ensuing budgetary resources. We conclude with some key takeaways, problems—when the state faced challenges paying including a framework for evaluating future its bills on time. Today, as with its budgetary borrowing of this nature, should a future proposal situation, the state’s cash position is very positive. to do so arise. Nonetheless, the executive branch’s management BACKGROUND State spending in California is organized into is measured over the course of a year, while the hundreds of different funds. Of these hundreds of state’s cash position can fluctuate on a daily basis. funds, the General Fund is by far the largest—with State’s Budget Situation Does Affect Its total state spending of $209 billion in 2019-20, Cash Position. While the state’s budget and cash it comprises $150 billion. This section provides situations are distinct, they are related. In particular, background on the General Fund’s cash position, when the state’s budget position improves as a in particular describing how the state manages and result of revenue collections exceeding growth invests General Fund cash. in expenditures, the state’s cash position also improves. When revenue growth declines and State’s Budget Situation and the state’s budget situation deteriorates, its cash Cash Position Are Separate Issues position also deteriorates. The budgetary situation of the General Fund, State Faces Cash Surpluses and which is the primary fiscal focus of the Legislature Deficits Throughout the Year each year, is different than its cash situation. Each year, the Legislature passes a budget, State Makes Disbursements Fairly Evenly which is a plan for how much the state will pay Throughout the Fiscal Year. The state disburses in expenditures and receive in revenues over the money throughout the fiscal year to a variety of course of the next fiscal year. In addition, the state entities. For example, the state transfers funds to must plan when these planned expenditures and school and community college districts, makes revenues will occur. The timing of these expenditure payments to Medi-Cal providers, and issues payroll disbursements and revenue receipts comprise the to state employees. Figure 1 (see next page) state’s cash position. As a result, a key distinction shows how these expenditures were disbursed between the budget situation and the cash throughout the 2017-18 fiscal year. As the figure position is the time horizon: the budget situation www.lao.ca.gov 3 analysis full gutter AN LAO REPORT of revenues and disbursements Figure 1 of expenditures do not perfectly State Disbursements Occur coincide. As such, on any given Fairly Evenly Throughout the Fiscal Year day during the fiscal year, the 2017-18 (In Billions) state is either receiving more in than it is disbursing (and therefore $25 has a cash surplus) or disbursing All Other Medi-Cal more than it is receiving (and 20 Schools has a cash deficit). Cash deficits typically occur early in the fiscal 15 year before the major revenue collection months. Then, later in 10 the fiscal year, particularly in April and June, the state tends to have 5 cash surpluses. Figure 3 shows the cash deficits and surpluses that resulted in the 2017-18 fiscal Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun year (a year the state had a very healthy budget situation). Cash Deficits Worsen When Revenues Do Not Meet shows, disbursements are mostly even. (In this Expectations. The state’s cash plan for the example, the month of September had notably upcoming fiscal year is based on the total amount more disbursements than other months because of revenue the budget act expects the state will it was the month the state made a $2.3 billion collect. If actual revenues receipts turn out to be transfer to the rainy day fund.) lower than anticipated, the state’s cash position will State Receives Most Revenues in Later Half be worse than estimated—with larger cash deficits of Fiscal Year. The personal income tax (PIT) on a daily and monthly basis. is the General Fund’s largest revenue source. As such, the Figure 2 timing of PIT collections has State Receives Most a significant impact on the Revenues in Later Half of Fiscal Year state’s monthly cash position. Figure 2 shows revenue receipts 2017-18 (In Billions) by month in 2017-18. As the $25 figure shows, PIT collections All Other Personal Income Tax are concentrated in four key 20 months: December, January, April, and June. These months 15 correspond with filing deadlines for tax filers who receive large 10 amounts of nonwage income. PIT collections in other months are 5 largely driven by withholding—the amount employers withhold from employees’ monthly paychecks. Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun State Faces Cash Surpluses and Deficits Throughout the Fiscal Year. The state’s receipts 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Figure 3 State Faces Cash Deficits in First Half of a Normal Fiscal Year and Cash Surpluses in Second Half 2017-18 (In Billions) $25 Cash Surplus Cash Deficit 20 Receipts of Revenues 15 10 5 Disbursement of Expenditures Jul Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun How the State Controller Manages the other funds that are classified as borrowable State’s Cash Position under law, in many cases with interest. When revenues exceed the General Fund’s cash The state’s daily cash situation is monitored and needs (or if the other fund requires the money managed by the State Controller’s Office (SCO), led for its operations), these funds are repaid. The by the State Controller, who has the constitutional combined balances of internally borrowable responsibility to pay the state’s bills. funds varies from month to month. As of Routinely Used Cash Management June 30, 2019, the state had $57.6 billion in Techniques. The Controller has broad internal borrowable resources to use for cash constitutional and statutory powers to manage flow management. state cash flows and can use a variety of • Borrowing From External Sources. techniques to address cash flow deficits. As Sometimes internal borrowable resources are Figure 4 (see next page) shows, these cash insufficient for the General Fund to address management techniques range from routine to its cash deficits. In these cases, the state extraordinary. Routinely used techniques include: borrows externally from municipal bond investors. There are two types of external • Borrowing From Internal Sources. To borrowing instruments. First, revenue manage daily cash deficits, SCO first borrows anticipation notes (or RANs), are usually from internal sources—that is, from state issued shortly after the budget is passed and funds other than the General Fund. Some of mature before the following June. Second, this borrowing is interest free—for example, revenue anticipation warrants (or RAWs, but borrowing from the Budget Stabilization technically called registered reimbursement Account (BSA), the state’s main budget warrants) can mature after the end of the reserve. SCO also can borrow from other fiscal year. Unlike RANs, RAWs allow the state internal sources, such as special funds and to borrow across fiscal years. www.lao.ca.gov 5 analysis full gutter AN LAO REPORT Extraordinary Cash Management Techniques. IOU forces a recipient of state funds (such as At certain times, the state faces very serious a vendor or local government) to provide the cash problems and internal and external sources state with an involuntary loan. of borrowing are insufficient to address cash deficits. When this occurs, SCO also has some How the Legislature Has extraordinary measures to use to manage the Addressed Cash Deficits state’s cash flows. These include: While the executive branch—particularly the • Delaying Payments Administratively. State Controller—has responsibility for managing the law—as well as contracts and disclosures state’s cash position, at various points in state made to the state’s bond and note investors— history the Legislature has needed to take action to establishes that certain state payments should address the state’s cash issues. In particular, the take priority. (Priority payments include, Legislature has: for example, payments to school districts, principal and interest payments on bonds, and • Delayed Payments Statutorily. While the employees’ wages and benefits.) Accordingly, executive branch has some authority to delay when the state’s cash resources are payments administratively (as described insufficient to meet all budgeted obligations, earlier), some payments can only be delayed SCO must make priority payments before with the enactment of statute. For example, making non-priority payments. In these cases, in the past, the Legislature has delayed the Controller can delay non-priority payments payments to school districts, transfers to by simply not paying certain bills when they local governments, and payments to Medi-Cal are presented to the office. providers. • Issuing Registered Warrants (or IOUs). In • Made Some Funds Available for Internal addition to delaying payments, the Controller Borrowing. Not all state funds are available has the power to issue registered warrants for cash flow borrowing. Sometimes these (also known as IOUs). IOUs allow SCO to restrictions are constitutional, but in other delay making payments until they can be cases they have been statutory. Over the last redeemed from available General Fund decade or so, the Legislature has enacted resources. At that point, the recipient can statutory changes to make billions of dollars redeem the IOU with interest. In essence, an Figure 4 Cash Management Options Internal Borrowing Internal Borrowing Administratively Registered from BSA/SFEU with interest special funds SAIF Delayed Payments Warrants/IOUs Routine Extraordinary Internal Borrowing External Borrowing External Borrowing Statutorily from noninterest special funds (RANs) (RAWs) Delayed Payments BSA = Budget Stabilization Account; SFEU = Special Fund for Economic Uncertainties; RANs = revenue anticipation notes; SAIF = State Agency Investment Fund; and RAWs = revenue anticipation warrants. 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT from other funds available for cash flow cities, counties, and other local entities in the borrowing. separate Local Agency Investment Fund (LAIF). • Created the State Agency Investment The PMIA is governed by the Pooled Money Fund. In 2011, the Legislature passed SB 79 Investment Board, which includes the Treasurer, the (Committee on Budget and Fiscal Review, Controller, and the Director of Finance. The board Chapter 142 of 2011), which created the has a fiduciary duty to safeguard the interests of State Agency Investment Fund (SAIF), a its investors—the state and local governments with mechanism that allowed the University of funds invested in the LAIF. California (UC) and California State University PMIA Investment Earnings Are Relatively Low, (CSU) to lend money to the state for cash flow but Vary Over Time. By law, PMIA monies can only purposes. The SAIF accepted deposits from be invested in certain categories of investments, the universities and then repaid those funds, including: (1) U.S. Government securities; with interest, at a later date. Altogether, UC (2) securities of federally sponsored agencies; and CSU deposited $2.2 billion into the SAIF (3) domestic corporate bonds; (4) interest-bearing in 2011 and 2012, giving the state additional time deposits in California banks, savings and loan cash resources. associations and credit unions; and (5) prime-rated • Authorized Automatic Expenditure commercial paper. The Treasurer typically Reductions to Facilitate Sales of RAWs. In invests funds in the PMIA in safe instruments some cases, the state might not have been with short-term maturity schedules, meaning able to execute a sale of short term cash the average effective yield of those investments instruments in the bond market successfully is relatively low—currently around 2.4 percent. without a mechanism to give investors more However, these average yields have varied confidence in the state’s ability to repay substantially over time. In the early 1980s, they the debt on time. Consequently, at various were generally above 10 percent, averaged around points, the Legislature has enacted “trigger 6 percent for much of the 1990s, and fell after the legislation” to facilitate the issuance of dot-com bust and ensuing recession in the early RAWs. For example, in 1994 the Legislature 2000s. After a brief period above 4 percent in the helped state officials sell a series of RAWs mid-2000s, the rate fell nearly to zero after 2008 to investors by passing a law that required and remained very low for a number of years. In the reductions in most categories of expenditures last few years the rate has been slowly increasing if cash flow projections showed that timely again. payment of RAWs was threatened. PMIA Earnings Distributed to General Fund and Other Funds. The entire PMIA pool How the State Treasurer earns investment returns and then those returns generally are distributed to funds based on their Invests the State’s Cash average daily balances (the General Fund is a key State’s Unused Cash Is Invested in the Pooled exception). For example, for the quarter ending Money Investment Account (PMIA). The prior June 30, 2019, the Fish and Game Preservation sections described how the Controller pays the Fund represented 0.8 percent of the average state’s bills when the General Fund faces a cash daily balance of the PMIA and therefore accrued deficit. However, during other months of the year, 0.8 percent of its investment earnings for that the General Fund has cash surpluses. These cash quarter (in this example, $526,000). After this surpluses do not sit idle: they are invested by the calculation is conducted for all funds that accrue State Treasurer’s Office in the PMIA. In addition to PMIA earnings on this basis, the remaining holding General Fund cash, the PMIA holds the quarterly earnings are all distributed to the General cash of other state funds in the Surplus Money Fund. In 2017-18, the General Fund earned Investment Fund and the cash of some participating $250 million in PMIA investment revenues. www.lao.ca.gov 7 analysis full gutter AN LAO REPORT HISTORY OF STATE’S CASH POSITION The state’s cash position is currently very cross fiscal years. Again, the court found that the healthy, but this has not always been true. This Legislature was within its legal authority to do so. section describes how the state’s cash position has State Issued Its First RANs in the Early 1970s. evolved over the last several decades. Facing cash deficits again in the early 1970s, the Legislature enacted a statute that temporarily Great Depression to 1980s authorized the Treasurer, in consultation with the Cash Management First Becomes Major Controller, to issue “notes of the State of California Issue During the Great Depression. In 1933, representing . . . registered demands” (Chapter 223 the Legislature faced its first cash problem when Statutes of 1971). Although the statute used it anticipated that the General Fund might be different terminology, these notes were equivalent exhausted before the end of the 1933-35 budget to today’s RANs. The intent of the measure was biennium. Legislation was enacted to provide that “to provide the state with additional means of SCO could issue registered warrants when the temporary borrowing to meet cash flow needs state was presented with valid claims unable to be and avoid more costly registered warrants.” The paid “for want of funds.” The registered warrants— constitutionality of this new cash management or IOUs—could bear interest of 5 percent per year. technique was again challenged on the grounds The State Treasurer challenged the constitutionality that it violated the Constitution’s debt limitations. of the practice. The California Supreme Court Relying on the precedent set in the 1930s cases on upheld the registered warrant law as a valid registered warrants, the Supreme Court found the use of the Legislature’s authority to appropriate use of these notes was allowable. About a month state monies and found it did not run afoul of the later, the state issued about $500 million in notes Constitution’s debt limitation clauses (see nearby under the temporary statute. box). A subsequent related case in 1936 challenged State Began Consistently Issuing RANs in the state’s authority to pay registered warrants in Early 1980s. Over a decade later, in the early the following biennium—that is, to have the liability 1980s, the Legislature passed a law giving the Treasurer, in consultation with the Controller, Cash Management and California’s Constitutional Limits on Debt California’s first constitution—as it was adopted in 1849 before California gained statehood in 1850—contained a constitutional limit on debt. Specifically, Article VIII prohibited the Legislature from creating any debt or liability that exceeds $300,000 without majority approval by the voters. In the state’s Constitutional Convention of 1879, a version of this text was reintroduced as Section 1 of Article XVI. Although this section of the constitution has been amended at various points in the state’s history, the same general requirement remains today. Some of the state’s cash management techniques have been challenged in court on the basis that they run afoul of this constitutional provision. However, the California Supreme Court has repeatedly found that the state’s cash management tools—such as registered warrants and revenue anticipation notes—are not constitutionally prohibited. For example, when the Treasurer challenged the constitutionality of the registered warrant law in the early 1930s, the California Supreme Court upheld it as a valid use of the Legislature’s authority to appropriate state monies. The court wrote: “it is well settled in this state that revenues may be appropriated in anticipation of their receipt just as effectually as when such revenues are physically in the treasury.” 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT permanent authority to issue RANs. As Figure 5 the Great Depression, the Controller issued IOUs shows, after this point, the state began consistently during a budget impasse. In 1994, the Legislature using RANs to address cash flow deficits—after helped state officials sell a series of RAWs to 1983, California issued RANs every year until investors by agreeing in law to automatically 1995. The state also issued its first RAW in 1982, reduce most categories of expenditures if cash flow although these instruments were not used again projections showed that timely payment of RAWs until the state faced a cash crunch a decade later. was threatened. The early 1990s were marked by a series of sales of RANs and RAWs—at the time, Cash Crunches in the largest such sales in the state’s history (see Early 1990s and 2000s Figure 5). Second Cash Crunch in Early 2000s. After a In the early 1990s and early 2000s, following period of relative calm in the mid- and late-1990s, recessions in each period, the state faced two California faced another series of years with acute “cash crunches.” During these periods, the budget problems following the dot-com bust and Controller and Legislature both needed to take ensuing recession. Although the dot-com bust some extraordinary actions to manage the state’s was relatively mild in economic terms, it hit the cash situation. California budget—which is particularly reliant on First Cash Crunch in the Early 1990s. After the Bay Area’s technology sector—especially hard. a recession in the early 1990s, the state faced Again, budgetary problems put pressure on the persistent budget deficits for a number of years. state’s cash position as revenue receipts came These budget deficits put pressure on the state’s in lower than expected. In these years, the state cash position. In 1992, for the first time since Figure 5 Historic Issuance of RANs and RAWs (In Billions) $20 RANa 18 RAW 16 14 12 10 8 6 4 2 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 a Includes interim RANs. RANs = revenue anticipation notes and RAWs = revenue anticipation warrants. Note: Excludes $150 million in notes issued in 1971. www.lao.ca.gov 9 analysis full gutter AN LAO REPORT issued historically large RANs and RAWs—with Cash Crisis in 2008-09 total short-term borrowing of $20 billion issued in Early in the Great Recession, the State Could 2002 alone. Not Anticipate the Depths of Its Cash Deficits. In State Used Overlapping RANs and RAWs to January 2008 the state had just entered the Great Address Persistent Cash Deficits in Early 2000s. Recession, but policymakers had little knowledge RANs and RAWs are short-term cash instruments— of how deep the recession would be, nor the extent even the longer-term RAWs usually mature about a of its impact on the state’s financial situation. year after issuance. However, with the state facing Figure 7 compares the state’s expected cumulative persistent cash deficits in the early 2000s, these cash deficits for each month of 2008-09 to its instruments took on a longer-term quality because actual cash deficit (measured in January 2010). new debt was issued to replace maturing debt from previous Figure 6 sales. Figure 6 shows how this State Used Overlapping RANs and worked—with each sale of a RAWs to Address Persistent Cash Deficits new RAN replacing a maturing RAW and vice versa. This means (In Billions) that continuously from October 2001 to June 2004 the state had $7.5 $1.5 $3.0$3.0 $11.0 $11.0 billions of dollars in outstanding cash deficit financing. $5.7 $5.7 $9.0 $3.5 $12.5 $3.0 $3.0 Cycle Ends With Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Authorization of Economic 2001 2002 2003 2004 Recovery Bonds (ERBs). The cycle of overlapping RANs and RAN or RAW Issued RAW RAWs ended in 2004 when voters RAN or RAW Repaid RAN authorized $15 billion in long-term RANs = revenue anticipation note and RAWs = revenue anticipation warrant. bonds, known as ERBs, to pay off the state’s accumulated budget Figure 7 deficits. (The same measure also prohibits the state from using California Quickly Accumulated a Large Cumulative Cash Deficit in 2008-09 this tool again in the future.) In the 2004-05 fiscal year, the (In Billions) state issued roughly $11 billion July Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun in ERBs—leaving the remainder for future issuance. ERBs were a Expected cumulative cash deficit (January 2008) The state anticipated ending the 2008-09 fiscal year in a nearly tool to address a budget deficit, -$5 cash neutral position . . . not a cash deficit. Nonetheless, issuing ERBs allowed the state -10 to address budgetary deficits in the short term and, by giving the -15 state additional cash, meant the -20 Actual cumulative cash deficit state no longer needed to issue . . . but later developed a sizeable cumulative the same quantity of cash flow cash deficit. -25 borrowing. 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT As the figure shows, in January 2008, well before 1996-97 to 2018-19 (a month when the state often the fiscal year had started, the administration reaches its annual cash balance lows). The figure expected the state would end the fiscal year with a displays month-end cash, so the state reached cumulative cash deficit close to zero—meaning the even lower levels in some of these years within state would disburse roughly what it had received the month. As the figure shows, the state’s cash in revenues. However, what actually happened cushion dropped substantially between 2007-08 was quite different. Revenues in this year came in and 2008-09, and in December 2008 nearly fell far below expectations, meaning the cash deficit below the minimum level. went below $20 billion and the year ended with a Throughout the Crisis, the Controller Took cumulative cash deficit of $10 billion. Many Extraordinary Actions. The state did not California Faced a Frozen Credit Market in ultimately request aid from the federal government September of 2008. Near the end of 2008, the for cash deficit financing. Instead, throughout the state understood the extent of its cash needs, but Great Recession, the Controller and Legislature found itself unable to address those needs with took a number of extraordinary actions to address external borrowing. The Legislature passed the the state’s cash flow shortfalls. This included 2008-09 Budget Act on September 15, 2008—the delaying billions of dollars in payments and the same day Lehman Brothers filed for bankruptcy. Controller issuing billions of dollars in IOUs. At this In the following weeks, California approached the time, in the midst of the state’s budgetary crisis, the bond market for cash flow borrowing and found the Governor also made an unprecedented proposal to U.S. credit market had frozen, partly in response use a cash flow borrowing instrument to finance the to the financial market uncertainty accentuated by state’s budget deficit. This proposal, although never Lehman Brothers’ collapse. On October 3, 2008, adopted, is described in more detail in the box on Governor Schwarzenegger wrote to the Secretary page 12. of the U.S. Treasury alerting him to the possibility Cash Crisis Was Unique Because of that California might ask the federal government for External Constraints. Before 2008, the state short-term financing—an unprecedented move for had faced significant cash deficits as a result of the state. weak revenues. The state also had issued large, The State Depleted Its Internal Borrowable Resources Figure 8 by the End of 2008. As a result State's Cash Cushion of falling state revenues and the Neared Minimum Levels in Late 2008 state’s inability to access sufficient (In Billions) external borrowing, around the end of 2008, the state neared $40 its minimum “cash cushion.” 35 This minimum cash cushion is 30 the dollar amount of internal borrowable resources that are left 25 unused—or the daily amount that 20 are not being used to meet the state’s disbursements. In these 15 Cash Cushion (December of Each Fiscal Year) years, SCO had set a minimum 10 cash cushion of $2.5 billion for the 5 end of each month (although cash Minimum Cash Cushion levels within the month fluctuated below that level). Figure 8 shows 1996-97 1999-00 2002-03 2005-06 2008-09 2011-12 2014-15 2017-18 the state’s cash cushion in December of each fiscal year from www.lao.ca.gov 11 analysis full gutter AN LAO REPORT short-term bonds previously. The cash crisis in State’s Internal Borrowable Resources Are at 2008-09 was unique not because the state needed a Historic High . . . A key reason that the state has to borrow significant amounts from external sources not needed to issue a RAN for years is that internal but because the state found itself unable to do so. borrowable resources have reached a historic high, For a number of days in October of 2009 the state both in dollar terms and as a share of disbursements. confronted a very real possibility that it would not At the end of 2019-20, SCO estimates the state will be able to issue a RAN large enough to meet its have $54 billion in internal borrowable resources cash obligations. As a state government, California available, representing about one-third of that year’s has the power to levy taxes and cannot declare total disbursements. As the top part of Figure 9 bankruptcy. These factors make the state a reliable shows, this level of internal borrowable resources as borrower. Nonetheless, the state cannot access a a share of disbursements is higher than at any other credit market that is either unwilling or unable to point in the last several decades. lend to it. Figure 9 Today: A Dramatic Reserves and Special Fund Balances Are Largely Improvement in Responsible for State's Positive Cash Position California’s Cash Source of Available Resources (In Billions) Situation $50 Internal Borrowables as a Share of Annual Disbursements 40% The state’s cash situation 30 today is dramatically different. As 40 BSA 20 Figure 5 on page 9 showed, after 10 30 decades of issuing RANs nearly 1996-97 2006-07 2016-17 every year, the state has not 20 issued a RAN since 2014. Instead, the state has exclusively used 10 Special and Other Funds internal borrowable resources to SFEU manage its cash situation. 1996-97 1999-00 2002-03 2005-06 2008-09 2011-12 2014-15 2017-18 SFEU = Special Fund for Economic Uncertainties and BSA = Budget Stabilization Account. Note: Reflects available internal borrowables as measured in December of each fiscal year. A Proposed Cash Solution to a Budget Problem Facing budget deficits in the tens of billions of dollars, in May of 2009, Governor Schwarzenegger’s administration proposed using $5.5 billion in revenue anticipation warrant (RAW) proceeds to address a budget deficit. Although RAWs are an infrequently used, but well established, cash management technique, they had never before been used as a budget solution. Had the proposal been adopted, the state would have had to repay the $5.5 billion of RAWs with interest by the end of 2010-11. In effect, this would have shifted this part of the budget problem one year into the future. Such a move also would have represented a significant departure from the state’s historic fiscal and cash management practices. At the time, our office called the proposal a “terrible precedent” and “poor fiscal policy.” After meeting with legislative leaders and federal officials, the Governor withdrew the proposal. In a statement, he indicated the administration would develop “additional options to cut state spending so that we can eliminate the need to seek borrowing in the form of a RAW.” 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT . . . Primarily Due to Increased Reserves now available for cash flow borrowing. For and Other Fund Balances. The largest single example, in 2012 the Legislature created the contributor to these sizable balances are the Greenhouse Gas Reduction Fund (GGRF), state’s budgetary reserves, most notably the BSA. which receives revenues from the state’s Since 2014, largely as a result of strong revenue cap-and-trade program. On a cash basis, the growth and legislative choices, the state has been fund now stands at $7.7 billion (as of June 30, making sizable annual deposits into the BSA. By 2019)—representing over 13 percent of the the end of 2019-20, the fund is expected to reach state’s internal borrowable resources. (The $16.5 billion and currently represents 28 percent Department of Finance’s [DOF’s] most recent of the state’s total internal borrowable resources. estimate of the budgetary balance of GGRF The second reason the state’s internal borrowable is much lower—$1.3 billion for the end of resources have increased is that balances in special 2018-19. The box below describes why funds’ funds and other funds—such as nongovernmental balances differ on a budgetary versus cash cost funds—also have increased. These increasing basis.) balances are shown in dark blue in Figure 9. • Balances in Some Existing Funds Have Other Fund Balances Have Increased for a Grown. Finally, balances in some existing Few Reasons. There are a few reasons that the funds have increased over time. For example, cash balances in special funds and other funds the Unemployment Compensation Disability have increased substantially, particularly over the Fund collects revenues from a state payroll tax last decade. They are: and finances short-term disability insurance and paid family leave. On a budgetary basis, • Legislature Has Made Some Existing this fund has grown from several hundreds of Funds Borrowable. As was discussed earlier, millions of dollars in the early 2000s to over the Legislature has passed laws to make $3 billion in 2019. On a cash basis, the fund a number of funds borrowable that in the had $3.5 billion on June 30, 2019—which past were not. For example, the February represents 6 percent of total borrowable 2009 budget package for the 2009-10 budget resources. In this example and others, made about $3 billion in special funds balances in existing funds have grown as borrowable for cash flow purposes. revenues to those funds also have grown. • State Has Created Some New Funds. The state has created some new funds that have substantial balances and are Funds’ Balances Differ on a Cash and Budgetary Basis Just as the General Fund’s cash position and budgetary situations are different, so are the cash and budgetary situations of other funds. For example, as described in this section, while the Greenhouse Gas Reduction Fund (GGRF) has a cash balance of $7.7 billion as of June 2019, the Department of Finance estimates it had an uncommitted balance of $1.3 billion for the end of 2018-19 and our office’s estimates of that balance are even lower at about $500 million. This discrepancy between a fund’s budgetary balance and its cash balance occurs when funds have been expended, but not yet disbursed. For example, in the case of GGRF, a portion of funds are continuously appropriated for high-speed rail—which are disbursed as construction continues. Once monies are disbursed, they are no longer available for cash flow borrowing. www.lao.ca.gov 13 analysis full gutter AN LAO REPORT RECENT BORROWING FROM STATE’S CASH POOL Reflecting the state’s positive cash situation, accrue these benefits are to repay the loan to the the balance of the state’s cash pool—the PMIA— PMIA with interest. has increased in recent years. The average Repaying the Loan. Under the CalPERS daily balance of the PMIA was $97.7 billion for borrowing plan, the General Fund eventually will the second quarter of 2019, although it was repay about 50 percent of the loan and other funds $74.1 billion excluding local governments’ funds. will repay the remaining 50 percent. The General The balance of the PMIA has also grown remarkably Fund’s share of the loan will be repaid from the in recent years. In fact, from 2015-16 to the end of state’s annual Proposition 2 (2014) debt payment 2018-19 the PMIA grew by about $30 billion. requirements. (These requirements vary from year With this increased liquidity, the state has had to year according to a formula, but are generally the capacity not only to cover its internal cash $1 billion or more depending on expected state flow needs, but also to use the state’s portion of revenue performance.) Other funds are to repay the cash pool to make loans. Twice in the last few their shares using their own available resources. As years, the Legislature has authorized the executive a result, in the case of the General Fund’s share of branch to borrow from the state’s cash resources the loan, the state has a well-defined plan for the and allocate the funds to specified uses. In this stream of repayments. section, we describe these two recent legislative Effect of SB 84 on State’s Cash Balances. actions and how they have affected the state’s cash Senate Bill 84 initially affected the state’s cash position. position by lowering internal borrowable resources by $6 billion relative to what they would have been Senate Bill 84 otherwise. As this loan is repaid with interest, As part of the 2017-18 budget package, internal borrowable resources will increase again. Chapter 50 of 2017 (SB 84, Committee on Budget By the end of 2019-20, the state will have repaid and Fiscal Review) approved the Governor’s May Revision proposal Figure 10 to borrow $6 billion from a portion How the CalPERS Borrowing Plan Works of the PMIA to make a one-time supplemental payment to the California Public Employees’ Retirement System (CalPERS). PMIAa Figure 10 shows how this borrowing plan is meant to work. Under the plan, the Controller has transferred $6 billion from the Principal and Supplemental Payment Interest Repayments PMIA to CalPERS, which CalPERS has invested to help pay down its unfunded liability, earning an expected return of 7 percent per General Fund year. Over the next few decades, Other State Funds CalPERS Federal Funds Benefit (Lower Rates) funds that pay pension costs accrue benefits through lower employer contributions costs relative to what they would be otherwise. Finally, funds that a The loan was made from a subset of the Pooled Money Investment Account (PMIA). 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT nearly $2 billion of this loan (including interest, Repaying the Loans. In the new law, the the state likely will make around $7 billion in Legislature has stated its intent to repay the loan total repayments). The outstanding amount of from the state’s cash resources as quickly as SB 84 borrowing is not particularly large in the possible. To accomplish this, the law authorizes the context of the state’s overall internal borrowable state to issue bonds to repay the loan with interest. resources. That said, the duration of this loan could The debt service on those bonds will be repaid be relatively long. Statute requires the loan to be with revenue from a surcharge on ratepayers’ bills. repaid by 2030, meaning it could result in lower This surcharge will replace an existing one that is cash balances for over a decade. currently funding the debt service on a different set of Department of Water Resources (DWR) bonds, Assembly Bill 1054 which are expected to be fully repaid near the end Chapter 79 of 2019 (AB 1054, Holden) created of 2020. Once those existing DWR bonds are fully a fund to help cover the costs of investor-owned repaid, the new bonds—to backfill the state’s cash utilities’ liabilities for wildfire claims when those resources—can be issued. utilities are legally liable. The law requires the Effect of AB 1054 on State’s Cash Balances. utilities to meet certain conditions to participate, Similar to SB 84, AB 1054 affects the state’s cash including contributing at least half of the fund position by lowering internal borrowable resources balance with shareholder contributions. Should the relative to what they would have been otherwise. utilities meet those conditions, the law will allow The total amount authorized is large, although them to access funds that they can use to pay out the initial loan of $2 billion is relatively small in the wildfire liability claims. (The two currently eligible context of the state’s overall internal borrowable investor-owned utilities have stated they intend to resources. The overall effect of AB 1054 on the participate. Pacific Gas and Electric [PG&E] is not state’s cash balances is yet to be seen—it will eligible to participate until it has exited bankruptcy depend on decisions by the administration about protection.) The law scheduled an initial loan of how much to transfer to the fund, when to make $2 billion from the state’s portion of the PMIA those transfers, and when to issue the new bonds to establish the fund and, potentially, pay initial to repay the loan. (These decisions will depend claims. The law also gives the Director of Finance in part on whether PG&E participates or not.) the authority to make an additional loan of up to Depending on these decisions, the effect on the $8.5 billion to provide more initial capitalization for state’s cash balances could be relatively significant the fund. or not. WHAT WILL HAPPEN IN THE NEXT RECESSION? Revenue Receipts Will Be Lower Than (see next page) shows, the projections of revenue Anticipated. When the Legislature passes a receipts for 2008-09 were too low by nearly budget for an upcoming fiscal year, it does not $15 billion, with receipts from April alone off by know if a recession will occur or, sometimes, if $5 billion. In the next recession, estimates of one already has started. When a recession occurs, revenue receipts will again be too high and cash revenues come in lower than both budget and cash deficits—and the state’s borrowing needs—will projections anticipated, resulting in lower receipts. increase. This is precisely what occurred, for example, in Balances of Internal Borrowable Resources the 2008-09 budget. When DOF prepared the Will Decline. In the next recession, the balance cash projections for 2008-09 in January 2008, of internal borrowable resources likely will decline policymakers might have understood budgetary relative to their current levels. There are two primary problems were emerging, but did not know how reasons for this: deep the revenue drops would be. As Figure 11 www.lao.ca.gov 15 analysis full gutter AN LAO REPORT • Budget Reserve Balances Figure 11 Will Decline. When revenues Projection of Revenue Receipts do not meet expectations, Were Too Low by Nearly $15 Billion in 2008-09 a budget problem usually (In Billions) emerges. For the first time in the state’s recent history, $18 the Legislature will have a Actual 2008-09 16 significant reserve available (in Projected 2008-09 (January 2008) the BSA) to address a budget 14 April revenue receipts alone came in $5 billion problem in the next recession. 12 below projections. While these resources are 10 currently available for cash 8 management, once they are appropriated and eventually 6 disbursed, they will no longer 4 be available for this purpose. 2 • Other Internal Borrowable Sources Will Decline. In Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun addition to declines in the BSA, in the next recession, the balances of other borrowable sources also State Could Need External Borrowing. In a likely will decline. There are two reasons for future recession, when cash deficits become larger this. First, the Legislature might address a and internal borrowable resources decline, the future budget problem by borrowing from state might require external borrowing to address special funds. Budgetary borrowing from a cash flow deficits. Although there are advantages special fund that also is available for cash to primarily relying on internal borrowable sources flow borrowing does not initially change the for cash management, issuing short-term debt to total amount available for borrowing, but it meet cash management needs is not inherently does eventually once the funds are disbursed. problematic. Such borrowing is historically a routine Second, the cash balances in some special part of the state’s cash flow management and it funds could decline for other reasons, for carries relatively low interest rate costs. example, because of their own revenue declines or expenditure increases. KEY TAKEAWAYS The State’s Cash Position of a number of factors, including: strong revenue growth, the state building a sizable budget reserve, Is Now Very Strong and the growing balances of other funds. In fact, After a long history of cash problems over the state’s cash situation is so positive that the several decades, the state’s cash position is now Legislature has been able to commit a small part very good. After decades of issuing RANs nearly of this liquidity pool to make loans to fund other every year, the state has not issued a RAN since priorities—including reducing the state’s long-term 2014. Instead, the state exclusively has used its pension debt and creating a fund to address sizable internal borrowable resources to manage its utilities’ liabilities arising from wildfire claims. cash situation. This positive situation is the result 16 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT The State Likely Will Have Time to Anticipate loan, given the high level of internal borrowable a Problem. A key advantage of having a high resources, a future proposal is possible. Neither amount of internal borrowable resources before of the existing loans has yet compromised the the next recession is that although those resources state’s internal liquidity. However a future loan, will decline, they are unlikely to decline very coupled with these existing ones, has the potential rapidly. In short, having this significant cushion to jeopardize the state’s cash position in the next buys the Legislature time and likely will allow the recession. To help the Legislature evaluate the risk state—including the Controller and Treasurer— of a future proposed loan, this section outlines to anticipate a cash problem in advance. Those some criteria that the Legislature might want to entities will then have time to take corrective consider. actions before a crisis occurs. Size of the Loan. The first consideration in evaluating the risk of a future loan is its size: The State’s Cash Position in particular, the size of the loan relative to the Will Not Always Be This Strong amount of internal borrowable resources likely to be available in the next recession. A loan of only In the next recession, the state’s cash position $1 billion represents a small portion of the state’s will decline. Revenue receipts will be lower than cash cushion and is unlikely to substantively affect anticipated, creating larger cash deficits, and the the state’s cash management needs. A loan of balances of internal borrowable resources will $10 billion would be more noticeable in the state’s decline as the state uses its rainy day fund to cover cash position, particularly when internal borrowable budget deficits. For example, using $10 billion from resources decline by billions of dollars. the BSA to cover a budget deficit would mean the state’s internal borrowable resources are lower Duration of the Loan. In the case of a large by $10 billion by the end of the fiscal year. These proposed loan, its duration becomes an important risks also are correlated—when one condition consideration. That is because these loans deteriorates (for example, revenues failing to become more significant problems if they are still meet expectations) other conditions also likely will outstanding when the next recession occurs. As deteriorate. such, the longer the duration of a cash pool loan, the more risky it is. This means there are two key A key lesson from the cash crisis of 2009 is that considerations for the Legislature in evaluating a the state’s cash situation is not only a matter of future loan: (1) its duration and (2) the timing of internal choices but also of external factors beyond the next recession. Of course, no one can know the state’s control. When internal resources are when the next recession will occur. Nonetheless, in insufficient, the state relies on the external bond evaluating a future loan, the Legislature must make market to finance its monthly cash deficits. That a judgment about the likelihood that a recession will market might, at times, be unable or unwilling to occur while the loan is still outstanding. lend to California. Although the series of events at the end of 2009 represented a true crisis, the Dependability of Repayments. Another key factors that led to it were relatively unique. The consideration for the Legislature in making future chances that the state will face a problem precisely cash loans is the degree of certainty with which the along those lines again in the future are low. loan will be repaid. Loans made with a dedicated Nonetheless, the state likely will face some kind of revenue or resource stream—such as SB 84—are cash challenge again in the future. more likely to be repaid promptly than loans repaid using all-purpose General Fund resources. A Framework to Fiscal Benefit. In evaluating any future cash Evaluate Future Cash Loans loan, we would finally encourage the Legislature to consider the loan’s potential fiscal benefit using The Legislature has authorized two loans from high-quality, rigorous quantitative analysis. Loans the state’s cash resources in the past few years. that result in substantial fiscal benefit to the state While we are not aware of any plans for a future are more advantageous than those that do not. www.lao.ca.gov 17 analysis full gutter AN LAO REPORT One key benefit of SB 84, for example, is that it state—the loan is likely to result in billions of dollars likely will have a substantial fiscal benefit to the in savings to the state over time. CONCLUSION After nearly two decades of persistent budgetary condition deteriorates (for example, revenues problems and a fluctuating cash position, California failing to meet expectations) other conditions also is now enjoying both healthy budget and cash are likely to deteriorate. Given this, the Legislature situations. As with the state’s budget situation, will want to consider any additional loans from this positive cash position is unlikely to last forever. the state’s cash resources carefully. In particular, When a recession occurs, it will mean lower assessing the size, duration, security, and benefit of revenue receipts, larger cash deficits, and declining the loan can help the Legislature determine whether balances of internal borrowable resources. the reduction in borrowable resources is merited. Moreover, these risks are correlated—when one LAO PUBLICATIONS This report was prepared by Ann Hollingshead and reviewed by Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 18 LEGISLATIVE ANALYST’S OFFICE