Wednesday, March 04, 2009

 

Reserves

The story in the Chronicle yesterday about California paying its community colleges in IOU's got me thinking about reserves, and the conflicting roles they play.

In good years, some cc's are able to salt away some money and put it into reserves. (It's also commonly called a “rainy day fund.”) The idea is that public funding is notoriously and viciously cyclical, so having a pile of stray money can minimize the damage you have to endure in down cycles. Given how much of our budget is fixed cost, there's a real logic to this.

But reserves are a tricky business.

If they get too high, they become very tempting targets for state governments and/or employee unions. It's hard for an employer to plead poverty at negotiation time if it's sitting on a big honkin' pile of money. And it's hard to make the case for sparing a college from cuts during recessionary crises when the other institutions with which they're basically competing for funds – prisons, K-12, etc. – don't have reserves.

Boards of Trustees also frequently have conflicted attitudes towards reserves. On one level, they love reserves, since they signify good financial management, and they buffer against abrupt cuts. But there's also a commonly-held view that reserves aren't to be used for 'operating' expenses, since that's interpreted as feeding a structural deficit. Depending on how strongly the Board feels about this, it's possible for a college to find itself spending reserves on construction even while it lays off employees. Even if it's generally understood as a rainy day fund, it can be nearly impossible to convince some Boards that it's raining.

(In their defense, using reserves for operating expenses can get you into a 'percentage' trap. If, say, three percent of this year's budget is covered by 'excess' reserves, then next year you either drain the reserves more, or ask for what looks like an astronomical percentage increase in your appropriation (an inflationary increase plus three percent). In very real ways, do it once, and you never stop paying for it. The percentage trap comes from an annoying fact of arithmetic: say your budget is 100. Take a ten percent cut, and you're down to 90. Receive a ten percent increase, and you're only back to 99. In the public mind, you've been made whole – ten percent down, ten percent up -- but you're actually behind where you were when you started.)

Then there's the sensitive, but very real, issue of how reserves are kept. Most people imagine a great big savings account, but that's often inaccurate. In most cases, they're invested in market securities. Put differently, over the last six months or so, the value of our reserves has been dropping like a rock. Just when they're most needed, they're least valuable. “Buy high and sell low” isn't a very good investment strategy, but buffeted by circumstance, that's what we've been doing.

I'm concerned that, when the dust settles, colleges will emerge from this crisis having learned the wrong lessons. When the value of your reserves drops by thirty or forty percent in a single year, it's easy to question the value of saving in the first place. This is doubly true when reserves become political cover for legislators cutting your operating aid. And when using your reserves results in very real percentage decreases to future appropriations as far as the eye can see, the argument for just-in-time budgeting becomes more persuasive by default.

I really hope that doesn't happen, though. Our degree programs are supposed to take two years, and often take more than that. When budgets are on annual cycles – that is to say, less than the normative amount of time to complete a degree program – flexibility is severely limited. Academia is not a just-in-time business. Yes, drawing down reserves in a bad year is a bad idea, but sometimes the alternatives are worse. I'd rather have some tense conversations with the President than leave a bunch of students high and dry in the middle of their degree programs. (To his credit, my President agrees.)

When enrollments are up and appropriations are down, reserves draw natural scrutiny. I just hope we're able to get it right this time.

Comments:
The answer to this depends on the ratio of reserves to operating expenses and how long an institution expects a downturn to last. If the reserves are 8-9% of the operating budget, that's a health reserve fund, but no one can expect you to run programs on that, or not more than a year. If the reserves are 25% of the operating budget, you can run a small program for a few decades off that. Similarly, if a downturn is 2 years, you can spend SOME of the reserves on long-term structure. If we're in for a half-decade of economic woes, that's a different story.

One very defensible use of reserve funds is for a program phase-out. That takes the issue out of the "getting us into a structuring hole" question and into the realm of "fulfilling commitments to students and employees."
 
Those born booted and spurred to ride humanity don't like it when you try to insulate yourself from their careful ministrations . . . Dean Dad, you are absolutely correct that there are stout (and rapidly increasing) disincentives for fiscal independence through thrift and savings.

The grasshopper and the ant as it were. There are more grasshoppers than ants. The grasshoppers have powerful allies in statehouses.

This also applies to organizations as you point out.

Reserves/endowments are not *your* money.

They are *the people's* money. How dare you greedily hoard capital while we are all starving in the streets without health care?

Also note many states heavily regulate endowments/reserves and how they can and can't be used. Several very large funds are now "quarantined" because their values have fallen below some fraction of the principle required to be maintained.

Yes, just when we need it the most . . .

The point is, don't set aside reserve. Maintaining a reserve actually borders on a fraudulent practice in today's climate.
 
The problem is that there is no right amount (whether as a level or as a proportion) of reserves. Enterprises subject to market tests are no guidance either: sometimes, the companies with a lot of cash become takeover targets, sometimes they do the taking over. About the best you can do is sigh and try.
 
As an aside, in California, public k-12 schools are required to have a reserve. This is typical 2% of your budget (I believe). That being said, the local district pushed to have more. It is still doing okay while many others out here are in a mess.
 
Use excess money to do maintenance ahead of schedule. When you hit the pothole catch up. That way there is no tempting target.
 
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