Wednesday, December 08, 2010

Reserves to the Rescue?

According to this piece from the SUNY New Paltz student newspaper -- hat-tip to the NFM Twitter feed on this one -- the faculty union at SUNY New Paltz is urging the administration there to spend down its reserves to prevent spending cuts.

I’ll admit laughing out loud at one passage, citing chapter Vice President Peter Brown:

Brown said the school could keep “every single program and employee here” if they used millions of dollars in reserve funds stored in over 400 accounts.
Though he said he does not know how much funding is available and if that money could legally be used, Brown said the time to use “rainy day” funds for emergencies is now. (emp. added)

That’s cute. I don’t know how much there is, of if we can legally use it, but I’m just sure it’s enough for every single employee and program here! I don’t know what I’m talking about, but I just know I’m right!

It’s a student paper, so he may have been misquoted. Even still, there are some pretty serious reasons that just patching deficits with reserves is dangerous.

I’ve written before on public college reserves, and how they differ from ‘endowments’ as usually understood. The short version is that endowments are supposed to produce income which can be used for various reasons, but reserves are supposed to be liquid and available either for capital projects (buildings) or short-term budget gaps. Reserves aren’t about generating income, even though it’s nice when they do; they’re there for emergencies and opportunities.

Of course, that refers only to general college reserves. It’s also common for various programs to have reserves of their own, earmarked for specific purposes. The college foundation might have reserves dedicated for certain scholarship awards. Some grant-funded programs will have reserves for specific functions and only for those functions. (In the context of multiyear grants, for example, it’s common to have ‘carryover’ of excess funds from one fiscal year to the next. That’s frequently allowed, but that doesn’t give license to transfer the extra grant money to the general college budget.) In cases like those, money comes with strings attached, and violating the terms of the money involves forfeiting the money. You can’t just move it around.

Still, most colleges have some ‘general’ reserves over which they have at least some level of control. Should they use reserves as alternatives to budget cuts?

Sometimes. Times when that would make sense would include:

- A short, sharp shock to the budget that isn’t likely to reoccur anytime soon. Recovery from a natural disaster or fire would fit this bill.

- When the reserves have grown so large that the state legislature is starting to see them as an excuse to cut your appropriation. If you’re in a “use it or lose it” situation, then use it.

- When the survival of the college is at stake.

- When you’re covering a short-term cost that will lead to long-term savings: severance/buyout packages, say, or installing energy-efficient lighting. You’ll take a hit upfront, but save money over time; reserves give you the flexibility to do that.

Times when it absolutely would not make sense would include:

- When the budget shortfall looks chronic or structural, rather than fleeting. If you burn cash to feed a structural deficit, you are on the path to insolvency. Institutions that do this for very long usually die.

- When you’re using reserves to postpone the inevitable. You’re actually paying for your own gradual loss of agency in determining your fate. This is madness.

The downsides to spending reserves on operating expenses are several. For one, once the reserves are gone, they’re gone. If you haven’t cut costs yet, now you really have to, and all at once.

Second is what I call the percentage trap. To keep the math easy, put this year’s appropriation at 100. You take a 20 percent cut, so you’re down to 80; you make up the 20 from reserves. Next year you “get it back” with a 20 percent increase. But because math has a sense of humor, a 20 percent increase from 80 only gets you to 96. Even after you’ve been “made whole,” you’re still in the hole. Now you’re paying 4 out of reserves indefinitely just to get back to even.

Of course, the percentage trap is much worse than that in real life. In real life, you never get “made whole,” even at that level. And the rate of health insurance increases is another kind of percentage trap that makes any budget squeal like a pig. But that just amplifies the point: if you use reserves to paper over a shortfall, and you don’t address the root causes of the shortfall, you’re just setting yourself up for disaster.

Finally, there’s the annoying truth that reserves are typically kept as securities, rather than as cash. If your shortfalls coincide with market declines, you force yourself to ‘sell low’ after having ‘bought high.’ Financially, this is suicide.

Most public colleges below the elite level have markedly small reserves -- a month or two of operating expenses, usually. If you used that to cover a structural deficit, you’d burn through it in a year or two. Yes, there are exceptions among the elites, and I have no argument with anyone who says that Harvard’s endowment has taken on a life of its own. But Harvard’s endowment is simply irrelevant to most community and state colleges. At this level, fantasies of self-funded bailouts are just fantasies.

I don’t know the particulars of the New Paltz case, so I won’t address it specifically. I’ll just suggest that the relevant criterion shouldn’t be whether budget cuts suck -- yes, they do -- or whether you care about “quality.” There are perfectly valid “quality” arguments on both sides. The relevant question is whether the shortfall is fleeting or structural. If it’s fleeting, then spend away. If it’s structural, then make the changes that need to be made.