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Most states were doing pretty well before the 2008 recession hit, but that ended in 2009. Most states had to make extremely difficult cuts or raise taxes, which was politically unacceptable. Of course invested pension systems received a lot of attention as their value dropped and long term sufficiency deteriorated, which was fodder for many changes in pensions, albeit not how they were invested. The good news is a lot of them came back in the ensuing 5 years, but 2015 may be different. A number of states have reported low earnings in 2015 and whether this may be the start of another recession. The U.S. economy has averaged a recession every six years since WWII and it has been almost seven years since the last contraction. With China devaluing their currency, this may upset the economic engine. At present there are analysts on Wall Street who suggest that some stocks may be overvalued, just like in 1999. If so, that does not bode well states like Illinois, Kansas, New Jersey, Louisiana, Alaska and Pennsylvania that are dealing with significant imbalances between their expenses and incomes. Alaska has most of its revenue tied to oil, so when oil prices go down (good for most of us), it is a huge problem for Alaska that gives $2200 to every citizen in the state. An economic downturn portends poorly for the no tax, pro-business experiment in Kansas that has been unsuccessful in attracting the large influx of new businesses, or even expansion of current ones. California and next door Missouri, often chided by Kansas lawmakers as how not to do business, outperform Kansas.

Ultimately the issue that lawmakers must face at the state and as a result the local level is that tax rates may not be high enough to generate the funds needed to operate government and protect the states against economic down turns. There is a “sweet spot” where funds are enough, to deal with short and long term needs, but starving government come back to haunt these same policy makers when the economy dips.   It would be a difficult day for a state to declare bankruptcy because lawmakers refuse to raise taxes and fees.


“If the assumption of all economists, government officials and investors is that the population must increase exponentially, what does that suggest for our future?” was a question asked a few days back.  Did you ponder this at all?  I suggest we should and here is why.  An exponential growth rate assumes a certain percent increase every year.  That means the increase in population is greater the farther out you go.  That doesn’t really make sense except perhaps at one point in Las Vegas (but not anymore).  The economy cannot really expand at a rate greater than the expansion of the population because there is no one to buy the goods or increase the demand, which is why increasing the US population is going to be viewed favorably by all politicians regardless what they say today.  House values do not increase faster than population increase unless they are in a bubble, nor does the stock market really (inflation adjusted).  Your water sales will not increase faster than your system’s population increase for any extended period of time either, so an assumption of ever increasing water sales is likely to be an overestimation sooner as opposed to later.  And then what – you have to raise rates, and keep raising rates to keep up because your demands are too low?

And what if your growth stagnates, or goes backwards as many did in 2009/2010?  That was a severe problem for most entities, causing layoffs and higher prices, pay cuts and deferral of needed improvements, mostly because no one had reserves because people thought the good times would roll on forever.  Layoffs, price hikes, pay cuts and deferral of needed improvements do help society (of course if you had lots of reserves, you weathered the recession without a problem, but too many did not).  Keep in mind the repair, replacement, and maintenance needs, along with ongoing deterioration, do not diminish with time or lack of new customers.  We have relied on new people to add money to solve old as well as new problems for many years.  What is the contingency if growth stops?

So a growth scenario makes us feel better and more confident when we borrow funds.  But if growth does not stop, where is the water to come from?  What are the resources that will be used faster?  Where does the power come from to treat the water or cool the houses?  And the cooling water to cool those power plants?  Even renewable resources are limited – most metals and oil have likely passed their peaks as far as production and water does not always fall consistently.  We have overstressed aquifers and over allocated surface waters, especially in the west.  So while growth makes us feel good financially, we need answers to the growth scenario despite the fact that we may have more funding.  Many resources are not limitless, but an exponential growth pattern ignores this.  Locally growth maybe less of an issue, but society wise?  Maybe a societal problem, or maybe we get into extreme completion with each other.  Some how that doesn’t look like a solution either


Once upon a time, people worked until they died.  But the longer people lived, the more infirmities impacted older people, and the concept of stopping work came into play.  So these folks labored all their lives, put some money away in a safe place, like a bank, where someone else would watch over an manage their money until they needed it.  Then one day, they found out that the banks have gambled and lost on real estate, and their money was gone.  There was no government to bail anyone out.  So the people had to try to go back to work, became beggars and destitute or died.  The government thought this was unfair to those older folks who had worked so hard, but through absolutely no fault of their own, had lost everything.  So the government decided that it would “tax” people a portion of their income, and put it into a retirement system.  People could retire at 65, and of course they were only expected to live another r3 or 4 years.  There were 16 people laying in for every person taking out.  And the government told the banks that they could not gamble with people’s hard earned savings, passed legislation and created an insurance pool to backstop losses by criminal or unethical activity.  All was good and the people were happy.

As time went on some things changed.  For one, people lived more than 3 or 4 years.  The population retirees increased, and the ratio dropped to 1:10 and then to 1:6 ration of retirees:workers, but the “tax” did not go up, but investments were made that increased the pool.  It was called good management.  The government also encouraged people to save money by deferring taxes, which they did, and the banks used it to make money.  All good as long as the investors gambled well.  They gambled so well, they were able to talk the government into undoing the anti-gambling rules from the past, so their pool to invest was twice as much.  And the markets grew and the portfolios grew and the people were happy.

And then it came to pass that the banks again gambled on real estates, and created complicated investment tools to hide the risk, but the risk was exposed and half the money was gone overnight.  And the retired were wondering about jobs again.  But there were no jobs.  And the employed now had fewer jobs.  So less people paid into the system.  And the people were sad.  And mad because they thought they were being protected from the gambling of the past.  They did not understand.

And the government could supply no answers because they had changed the rules and they knew the people would be unhappy, so the government felt there was no choice, so they borrowed money, and bailed out the banks.  And some people were happy.  And some people were concerned about all that debt.  And some people wondered why it was that history could repeat itself and put society at risk.  And some people asked why people who did bad things were not punished.

And none of these questions has been answered.  Good thing that these fairy tales don’t depict anything real right?


Some recent reading led me to the following items that seem to crop up when municipalities have fiscal problems that are not otherwise created by the economy or federal or state government decisions:

Assuming high returns of retained earnings (Orange County, CA)

  • Pension systems that are underfunded (Portland OR, and others)
  • Lack of appropriate financial advisors (many)
  • Assuming growth will be exponential
  • Failure to address deterioration of infrastructure (many)
  • Getting involved in complicated credit swaps and revenues tools involving borrowing (Detroit).
  • Declining use by customers that are economically stressed (many)

Food for thought… or caution.


Since 2010, the Federal Reserve Bank indicates that the wealthiest 10 percent of American have seen their income rise by 2%.  The Bottom 20% have seen their income DECLINE by 4 percent and the average for all families DECLINED 5%.  That tells me that the majority in the middle income brackets, decreased at a rate greater than the bottom 20%.  In other words more of us are moving down in economic standing, not up.  To make matters worse, the Federal Reserve Bank indicates that the top 3% actually had their incomes increase by 27.7% since 2010, meaning that the upper middle class people are falling back with the rest of us.  Quite the opposite of what our parents had hope for us.

Wages have not rebounded as many people had to take pay cuts or find new a career at lesser pay, which places all kinds of issues at risk – retirement age, retirement goals, college for the kids, investments, home ownership, etc.  All play a role in the economy of the country.  People spend less on eating out, new clothes and other things – generally more frugal, which means less demand for goods and services, and therefore less employment.  A vicious cycle that doesn’t help the economy.  We have already started to see real estate cool off as wages have not rebounded and people figure it is time to defer or get out.  Places like Miami and Las Vegas may remain warmer than say Cleveland or Detroit, but the Miami market has cooled in the past year.

Real losses in purchasing power goes back to the 1980s form the lower half of earners in the US.  And we argue about the minimum wage – which is the very bottom of the pile.  The failed concept of the Great Society was to try to get enough money in everyone’s pocket that the total purchasing power of the population would increase.  Did not work out that way, but the concept of increasing purchasing power of all has appeal.  Inflation goes up.  Purchasing power goes down.  The economy will stagnate if wages for the bottom 90% do not increase.  That makes official less likely to raise water and sewer rates to pay for those needed infrastructure upgrades.  Which will put more assets at risk of failure and stress operations budgets further.


Earlier this year the Journal for AWWA had several articles about water use and infrastructure needs.  One of the major concerns that has arisen in older communities, especially in the Rust Belt and the West is that demands per person have decreased.  There are a number of reasons for this –the 1992 Energy Policy Act changes to plumbing codes that implemented low flush fixtures, the realization in the west that water supplies are finite and conservation is cheaper than new supplies, a decline in population, deindustrialization, and climate induced needs.  But all add up to the result that total water use has not really changed over the past 30 years and in many locales, water sales may have decreased.  Water utilities rely on water sales for revenues so any decrease in sales must be met with an increase in cost.  Price elasticity suggests the increase will be met with another decrease in sales, etc.  It is a difficult circle to deal with.  So less water, whether through deliberate water conservation or other means, creates a water revenue dilemma for utilities.  A concern about conserving to much and eliminating slack in the system also results.

Less water means less money for infrastructure.  Communities do not see a need for new infrastructure because there are fewer new people to serve.  Replacing old infrastructure has always been a more difficult sell because “I already have service, why should I be paying for more service” is a common cry, unless you are in my neighborhood where the water pipes keep breaking and we are begging the City to install new lines (they are on my street J)  Educating customers about the water (and sewer) system are needed to help resident understand the impacts, and risk they face as infrastructure ages.  They also want to understand that the solutions are “permanent” meaning that in 5 or 10 years we won’t be back to do more work.  Elected officials and projected elected officials (the tough one) should be engaged in this discussion because they should all be on the same page in selling the ideas to the public.  And the needs are big.  We are looking at $1 trillion just for water line replacement by 2050 and that is probably a low number(2010 dollars).  The biggest needs are in the south where infrastructure will start hitting its expected life.  The south want west will also be looking for about $700 billion in growth needs as well.  All this will cause a need for higher rates, especially with ¼ less low interest SRF funds avaialalbe this year from Congress.


In my last blog I outlined the 10 states with the greatest losses since 2006.  Florida was not among them, yet given our legislature’s on-going discussion and hand-wringing with the state run Citizen’s insurance, you would  think we have a major ongoing crisis with insurance here.  Maybe we do, but I will provide some facts.  Citizens,averaged between 1 and 1.5 million policies over the last 8 years.  according the the South Florida SunSentinel, the average person pays $2500 per year for windstorm coverage.  Somehow I think I want that bill because my insurance is about $6000 through my private insurer and when I had Citizens it was $5700/yr.  But I digress.

Let’s assume there is 1.2 million policies over that time paying the #2500/yr. That totals.$3 billion a year in premiums.  That means Citizens should have reserves of $24 billion because they have not paid-out since 2006.  They have $11 billion according to the SunSentinel sources.  So wher eis the rest of the money?  We can assume there are operating expenses.  They pay their executives very well for a government organization.  I am sure they pay the agents as well.  I asked a couple friends in the industry and they indicate that for private companies, about half your premium goes the the agent who writes the policy.  That’s only Citizens.

Let’s assume there are conservatively another 8 million policies in Florida and since many of those are inland, let’s day they average $1500/yr.  If you have it for less, check out your policy!.  That means there is another $12 billion collected each year for a total of $15 billion per year.

Now let’s look at storms.  According to Malmstadt, et al 2010, the ten largest storms 1900–2007, corrected for 2005 dollars are as follows:.

Rank   Storm                         Year        Loss($bn)

1 Great Miami                        1926       129.0

2 Andrew                               1992        52.3

3 Storm                                  1944       35.6

4 Lake Okeechobee               1928       31.8

5 Donna                                1960       28.9

6 Wilma                                  2005       20.6

7 Charlie                                2004        16.3

8 Ivan                                     2004        15.5

9 Storm # 2                            1949        13.5

10 Storm # 4                          1947       11.6

So for all bu the top 9 storms in a 107 year history,the annual receipts exceed the losses for a storm.   The total over the period is $450 billion (adjusted to 2005 dollars)  That means an average of $4 billion per year.  So what is the issue?  Sure a big storm could wipe out the trust fund, but that is what Lloyd;’son London, re-insurers and the ability to borrow funds is all about.

I suggest that the fuzz is really about is this.  Most people do not understand the concept of an insurance pool.  That includes many public officials.  The idea of insurance is to pool resources is to collect huge sums of money so that if something bad occurs, there is the ability to compensate people for their losses.  Insurance is a good thing but individually we hope it is never us that needs to be compensated because that means something bad happened.  But we expect our premiums to pay into that pool, build large pools of money, and have money when you need it. The more people that pay in, the more the  risk is split and lower the likelihood that any individual suffers a loss.  Hence the lower risk should lower premiums.  And people who live in high risk area should pay more than those who don’t.  Flood plains, dry forests, coastal areas, high wind areas, tornado alley, etc are all high risk.  Florida is one, but clearly there are many others,

So Citizens has a pile of money. Most private insurance companies should also, although their money is invested and they expect most of that will not be paid out.  I suspect the concern is a fear that the pile of cash will create a public furor, but that shows a lack of communication and education.  Cash is good.  Lots of it is better.  It’s like running surpluses in government or in your personal savings account. The idea is to have money when you need it.  Running at a point where you never have surpluses guarantees you will have deficits that require cuts in services,and possibly losses of jobs when the economy tanks again.   For insurance, those losses occur when big event hit.  Fortunately those are infrequent, but they have and will happen.  We need the cash pools on hand to protect our citizens just in case.    In the meantime we need some leadership and education of the public.


We all know that our infrastructure is deteriorating.  Deferred maintenance increases the risk of system failure. The need for capital reinvestment within the utility industry has historically been very low. As a result, in its “2013 Report Card for America’s Infrastructure,” the American Society of Civil Engineers assigned a grade of “D” to America’s drinking water systems, citing billions of dollars of annual funding shortfalls to replace aging facilities near the end of their useful lives and to comply with existing future federal water regulations (ASCE, 2013).  AWWA estimates that investments of at least $1 trillion are needed over the next 25 years.

While a pay-as-you-go capital funding seems like the best way to go, that is difficult to accomplish with the large outlays needed to upgrade the infrastructure system and the controls on rates often exercised by local officials.  As a result, borrowing is required and the condition of infrastructure and the lack of reserves are a part of how the utility is viewed by those who lend monies.   Utility managers need to understand how the lending agencies evaluate risk. 

Lenders use many tests.  Among them are: whether the utility’s annual depreciation expense is used of accumulated as reinvestment in the system, whether adequate reserves are present, whether  annual capital spending that is below the amount of annual depreciation and the amount of revenues in excess of projected debt (debt service coverage).  The target debt service coverage may depend upon the requirements of the underwriter, the rating agencies and the investors.  Debt service coverage could be as low as 15% or as high as 50%.  In 2012, the median all-in annual debt service coverage excluding connection fees for utilities rated “AAA” by Fitch Ratings was 220%, while the median for AA-rated and A-rated utilities was 180% and 140%, respectively. (Fitch, 2012).  

A working capital target of 90 days of rate revenue is a minimum, but since 2008, more is likely to be required depending on the size of the system and the history of revenues.  Where the revenues were stable despite 2008, less may be required.  For those utilities that suffered major decreases, reserves should be far larger – perhaps a year or more.  Other criteria that could be used to evaluate the projects when borrowing money include public health and safety, regulatory compliance, system reliability, the risk and consequences of asset failure, redundancy, community/customer benefit  and sustainability. At the same time, the expectation is that  the utility systems that retain all monies in the system to be utilized to improve the system and pay for debt service, except those used  for the purchase of indirect services from the General Fund that are justified with indirect cost studies. 

 

Despite the above, rate are an issue.  Fitch Ratings has indicated that it considers rates for combined water and wastewater service that are higher than 2% of the median household income – or 1% for an individual water or wastewater utility – to be financially burdensome (Fitch, 2012).  The Environmental Protection Agency (EPA) considers that rates for an individual water or wastewater utility that are greater than 2% of median household income may have a high financial impact on customers. (EPA, 1997). Utilities with a stronger financial profile might have residential charges for combined water and wastewater service that are less than or equal to 1.2% of median household income, or less than or equal to 0.6% for an individual water or wastewater utility. All revenues generated through system operations generally must remain within the system and can only be used for lawful purposes of the system.

Canadian utilities employ more formal polices to establish fiscal policies to provide reserves to insure stability in the event of unforeseen circumstances. Reserve targets focus on ensuring liquidity in the event there is an interruption in funding, increased capital costs due to new regulatory requirements or a short term funding emergency – all the issues evaluated by the bankers.  Reserve targets are policy decisions. Benchmarking is an evolving practice within Canadian public sector utilities particularly as it relates to financial planning and capital financing. The benchmarking exercise provides valuable information to help assess fiscal performance, the needs of customers, and provide the tools to help support optimum performance. 


We have talked about reserves, the need for them, reasons why they are neglected and how to establish appropriate numbers (an area where more research is needed).  Reserves are an issue when the economy tanks.  We all recall the problem in 2008, but this is where utilities need to look beyond just their system to see what might be coming.  2008 was a problem that we should have seen coming, or at least planned for, but did not.  But it means that we need to look at the national and local economic picture and understand a little about events beyond our reach that can affect us.  Utilities and governments generally do not do this well. 

In 2005-2007, it was very clear we had a property bubble going on.  There was discussion on the news, financial channels, Wall Street Journal and even columns by economist like Paul Krugman.  A few of us may have taken advantage of the bubble through prudent real estate sales, but many did not.  Likewise, few utilities or governments planned for its inevitable fall.  After the crunch hit, those who owed the least amount of money, had savings and had stable incomes fared better than those who did not.  Same for governments.  Unfortunately most Americans and most governments fell into the “did not” category. 

So let’s look at a couple issues.  First, we knew there was a bubble and should know that all bubbles pop.  We had the tech stock bubble in the late 1990s.  People on Wall Street knew that the investments had turned to real estate and bankers where busy loaning money out with no interest for two years, no money down, adjustable rate mortgages and the like.  If you owned a computer you were inundated with Countryside and various other folks trying to loan you money.  Or buy your house and pay you an annuity if you were older. 

The reason that these “opportunities” were so prevalent was to help speculators who expected to own the property for short periods of time, or help those who might not have the means to buy time to get the means to support the payments.  All the subsequent financial instruments discussed in books like “Too Big to Fail” come from tools used by bankers to disperse the risk associated with speculators and the risky.  It made money for bankers and investment houses (remember they are private businesses beholden to their private stockholders). 

Like all bubbles, we get caught up in the money being made by speculators (and yes if you invest in the stock market you are speculating).  We try to grab onto the rising instruments to get ahead, but we forget that especially with real estate, the growth overall rate across the nation could only grow at the rate of population growth.  It is basic supply and demand. 

For governments, revenues rise, especially during real estate bubbles.  Some bubbles last for years, which creates a distorted view of the future.  In south Florida, there was a lot of buzz concerning water supply projections and arguments between regulatory staff and utilities over water supplies that were projected 20 years in the future, based on demand projections from 2000-2005.  When the dust settled in 22011, most of those issued disappeared because virtually all projections were substantially revised downward.  And most revenue growth projections were likewise revised downward and capacity needs delayed.  Planning 20 years out is historically inaccurate because the global economy can impact local growth.

Of course these new projections are incorrect as well.  Because the test period was 2005-2010 or 2000- 2010, the growth is stunted.  So they are likely underestimating demand and revenues.  Uncertainty with time means that the accuracy of projection decreases with time.  As a result, simply relying on past projection methods increases risk that of significant deviations.

I do an exercise n class where I give students three sets of projections.  10 years apart, for 50 years.  I tell them nothing else.  The examples are The State of Nevada, Cleveland, and Collier County, FL.  All are in the past (Cleveland is 1910-1950) There is absolutely no easy method that can project the growth in either Collier County or the State of Nevada, or that Cleveland’s population will drop in half. We could do the same with Detroit and never project that decrease either.  But when you tell them where the population are and what year, the wheels start to turn.  They realize that economics is a major issue.  While Nevada and Collier grew from 1960-2000, the rate of change is likely to be very different in 2010 to 2020 due to the 2008 recession. 

Tracking economic activity is a utility responsibility.  We need to know what is really happening, and understand bubbles.  We need to recognize that when property values and housing number increase fast, it will be short term.  Plan for savings and reserves.  Figure out what your recovery period might be.  We need to understand our economic base.  For example try this out and see what your conclusion is.  Florida’s economy is based on three major industries: agriculture, tourism and housing.  What could possibly go wrong with that model?  Well if we have an economic problem nationally, 2 of 3 take major hits because people outside the state do not travel to Florida and retirements get put off.  The economy gets hit hard and recovery is slow.  We have experienced that exact phenomenon from 2009 to date.  And many of those jobs are low wage positions which means the people who struggle most get hit hardest.  Storm events can impact the state.  Bit hits to all three, and agriculture is also a low wage industry.  It is a precarious economic model that sets itself up for potential fluctuations.  We need to plan for this.  It is our responsibility, utility staff and decision-makers to plan and prepare for the next big event.  


I have been inundated by articles recently about the issues with integration of Gen X and Millennials workers into the workplace.  Not sure why, but this is a hot issue in trade journals and newspapers.  The recent articles seem to focus in on the potential conflict between older, and younger workers who seem to have different perspectives on how work gets done and protocols.  These folks would do well to read Dan Pink’s book Drive, which discusses the differences in motivation and how supervisors can carefully cultivate innovation and efficiently by recognizing the differences. 

 Since I teach at a university, I deal with Gen X and Millennials all the time.  There are huge differences in their use and comfort with technology versus older workers.  It is truly second nature for the younger workers, while the older generations had to learn these technologies.  Many, if they had access to computers, they wrote programs by using punch cards and wrote their own compute programs in FORTRAN.  The younger workers don’t know even know what a mainframe computer is let alone punch cards.  Technology accelerates exponentially with time, which is why people feel left behind. 

Funny how technology works though.  While the kids I teach today are far more savvy than their predecessors 5 years ago (and those five years before that), they have to keep up of get left behind.  That’s the older worker problem – the older guys cannot compete with the use of technology, but not to worry, in five years, same for these kids.  As a result the older crowd may resist helpful technology.  It surprises me how many engineering firms resist 3 dimensional design programs, despite my students knowing how to do it.  By the way, the contractors hire my students because the contractors see the value in profits (and change orders). Younger workers know how to integrate the technology into the workplace.

 While comfort with technology is the big difference you notice, it is not the driving issue as Dan Pink points out.  Most of them make a decent wage so they are looking for more than salary to motivate them.  Interestingly money is not the primarily motivation like it can be for older workers.  The younger folk avoiding the rigid looks for flexibility, especially as it relates to family and friends.  They are comfortable with working at home and at times throughout the day.  It’s not that they work less, it’s they work differently.  We should focus on productivity, versus conventions.  Maybe we’d spend time appreciating each other more!

 

 

Go back to Drive and you realize that the Gen X and Millennials want to pursue these new technologies and integrate them into their jobs.  They are motivated by responsibility, flexibility and independence, much because that’s what their baby boomer parents taught them.  They are comfortable with flexible schedules and working when needed.  Baby boomers need to help them use these concepts to innovate and create in the workplace.  We need to learn to use this to our advantage in the workplace, not fight it.

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