Tag Archives: Santa Monica budget

Aligning Santa Monica’s assets to its mission

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By Frank Gruber and Juan Matute

We wrote in our last piece that although the City of Santa Monica is experiencing an unprecedented financial crisis during which revenues are predicted to miss targets by $200 million over the next two years, the City has substantial assets to use to cushion the impact of the crisis. In this post, we want to dive deeper into those assets and what might be done with them, but we also want to start with some words of caution.

For one thing, the data set forth in the latest Comprehensive Annual Financial Report (CAFR), which we cited in our post, are as of June 30, 2019. While the CAFR shows that the City had over $700 million in cash and investments, of which the report identified $171 million as unrestricted, one friend pointed out to us that these numbers did not reflect the $42 million settlement of the Eric Uller abuse litigation; presumably the ultimate source of that payment was the City’s accumulated assets. But this only highlights the need for the City Council to be aware of just what the City’s resources are before the council makes decisions about the budget.

In our post we said that the City needed to prudently tap its assets to “determine how much [could] be tapped over three or four years” to maintain necessary services. We want to say that we don’t know if the crisis will be over in four years. As Frank wrote a few weeks ago, we could easily be at a major historical inflection point, the end of the post-War era of worldwide economic expansion. Neither one of us is an economist (not that economists are particularly good at predicting), but it is plain that 2020 is just as likely to be another 1930 as it is to be another 2008. If not more likely.

Even if we are facing another Depression, it makes sense to use the City’s assets to cushion the impact over a finite term (say, three to five years), because that would give the council and staff enough time to restructure the City’s finances to accommodate a changed world. Further, to the extent the City can dispose of non-financial assets, those assets are likely to lose value over time if the economy tanks.

A changed world, with dramatically less travel, with less disposable income available for entertainment, with less demand for office space, would be brutal for Santa Monica. A full one-third of the City’s revenues come from hotel taxes, business taxes, and sales taxes; these are to a great extent generated by non-residents. The City’s assets will not save Santa Monica from having to reconsider its levels of expenditures and what it spends money on. The assets should, however, allow Santa Monica to make thoughtful, not-panic-induced choices.

Many of those choices, however, must be made in the next few weeks, at least those that affect the next fiscal year. The City Charter requires the City Manager to submit a draft budget to the City Council at least 35 days before the start of the fiscal year beginning July 1st (May 27). According to the staff report for the May 26 City Council meeting (two days from now), the proposed budget will be submitted as an information item at the meeting. The City Council will have hearings in June and it must approve a balanced budget by June 30. After the initial budget is passed future adjustments would require a supermajority of five votes. It is critical that the council, before voting on the budget, be aware of the assets that are available to soften the impact of the impending deficits.

So what are those assets?

As we discussed in our first piece, the City’s net worth on paper is $1.6 billion. Its assets include $437 million in federal securities, $178 million in corporate bonds, and $25 million in municipal bonds. A portion of these relatively liquid assets is needed to cover current liabilities, which totaled $108 million at the end of fiscal year 2019. But before approving the 2021 budget, the City Council needs to know to what extent these liquid assets can be drawn upon to fund current expenditures.

Looking ahead longer term, into a potential Depression, the City must evaluate what fixed assets it can dispose of to soften the transition to a budget structured for a new reality. In certain circumstances, the two goals can be joined. Restructuring government is not only a matter of cutting jobs; it should also involve a discussion about the purpose and goals of local government.

When it comes to the City’s real estate, the CAFR substantially understates the City’s position. As we discussed in the previous post, accounting rules require deduction of depreciation, which has no connection to market value. Even more significant, accounting rules require the City to list landholdings at what the City paid for the land. For instance, all the land at Santa Monica Airport is valued at eight dollars (yes, about two cappuccinos) in the CAFR. (Not that selling any of the Airport would help the City’s budget, since per the FAA the proceeds would have to be deposited in the Airport fund.)

How accounting standards can differ from reality: the land at SMO valued at $8.

While much of the City’s real property is dedicated to municipal purposes, and can’t be sold, the City needs to consider what services and “enterprises” are, or should be, part of the City’s mission.

For instance, in the 1950s “Republican-Socialists” who ran Santa Monica believed it was the City’s mission to subsidize local businesses by building a Civic Auditorium. Unfortunately, once built the Civic became a large drain on City revenues. The fiscal bleeding only stopped a few years ago when the City closed the Civic to the public on the grounds that it was seismically unsafe. At that time the City formed a task force (one of us, Frank, was on it) to figure out how to save the Civic as part of a multi-use development. But any realistic hope of such a fate for the Civic evaporated when the City Council approved a walled-in soccer field and a water runoff retention facility in the Civic’s parking lot.

Meanwhile, the staff report for Tuesday night’s City Council meeting calls for another $228,000 to be spent to maintain the Civic. Is owning a Civic Auditorium integral to the City’s mission in 2020? We don’t think so. We’d rather see $228,000 used for more productive purposes.

At $200 per square foot, a conservative valuation in Santa Monica, the four acres containing the Civic would be worth $35 million. Perhaps it is time to sell the property?

The City also owns many parking structures and parking lots. Municipal parking structures are assets of declining value in an era of shared ride apps and scooters and a future of automated vehicles. Given that City policy now is to discourage driving to fight Climate Change, would the City today choose to enter the parking business? The City should look into selling one or more parking structures downtown, including those at Santa Monica Place. The owners of the mall might be willing to pay a premium given that in the long run redevelopment potential for these sites is among the greatest in the city as they are in the Transit Adjacent Zone.

The City should also consider whether it should be in the development business. We’re thinking in particular of the fiasco at 4th and Arizona. It’s proven impossible for the City to make decisions when it is both the landowner and the regulator. It is time to sell that property. It would be valuable. A city-owned, 25-space surface parking lot in downtown Santa Monica sold for $6.2 million in 2018. Based on that, the much larger property at 4th and Arizona could be worth at least $100 million at its current zoning, and more if permitted to develop in accordance with the large site parameters set in the Downtown Community Plan.

The City also owns properties that it leases to commercial tenants who pay ground rent, sometimes at below market rents. Some of the city’s properties aren’t even in the City of Santa Monica. The City should determine whether the market values of these properties are greater than the present value of the future rents: it may be advantageous to sell. The City would receive a one-time infusion of cash by selling any of these holdings, either to investors or to the long-term land lease holders, which include the Windward School in Mar Vista, the Viceroy Hotel, and Kite Pharmaceuticals. Other properties the City owns are not developed, such as a parking lot near the City’s water treatment plant in West L.A. that is conservatively worth $15 million.

Even if the market for commercial real estate drops 20% from its recent peak, the City should be able to generate at least $80 million by selling just a portion of these properties, which generate about $4 million a year in land lease payments. We don’t know if a one-time infusion of cash in exchange for a perpetual reduction in lease revenues is prudent, but now is the time to explore such trade-offs.

Santa Monica can hope that future revenues exceed current projections. It can hope that a higher power (the federal government) grants it a proportional share of a proposed federal stimulus ($142 million). But if it needs cash, the City has substantial assets from which to draw. Santa Monica’s motto is “a fortunate people in a fortunate place”. We are indeed fortunate that the City has accumulated substantial wealth.

Thanks for reading.

A Local New Deal for Santa Monica

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By Frank Gruber & Juan Matute

The City of Santa Monica is experiencing a financial crisis unprecedented in living memory. If left as is, planned expenditures are likely to exceed revenues by $200 million over the next two years. To close the gap between now and the end of the fiscal year (June 30), the City has already committed to spending its operating reserves and the City Council has approved hundreds of layoffs. 

But Santa Monica is not broke. It has cash, securities, and other assets worth billions of dollars. The City has the second-best ratio of assets to debt of its peer cities in Los Angeles County (justifying its triple-A bond rating). Many of these assets are, of course, essential for the City’s purposes—think City Hall, or parks, or the City Yards—and can neither be disposed of nor borrowed against. The City has, however, about three quarters of a billion dollars in relatively liquid assets, mostly government bonds. (The details on the City’s assets are set forth in the City’s Comprehensive Annual Financial Report (CAFR) for the year ending June 30, 2019, which was delivered to the City Council last December 16 and which is available on the City’s website. For ready reference, the summary of all accounts, the “Statement of Net Position,” is reproduced below.)

The City amassed its liquid assets over the past two decades of (nearly continuous) prosperity, by nearly always spending less each year than it took in as revenues. These assets are above and beyond the City’s explicitly denominated operating reserves (which are tiny in comparison). The City is wealthy.

One should ask: for what purposes does a City amass wealth? We can think of only two: for either (i), investing in capital improvements, something not relevant to this discussion, or (ii) the proverbial rainy day. With respect to the proverbial rainy day, what we are experiencing now, with Covid-19, is a Biblical deluge. There is no reason for the City not to tap these assets, prudently, to get the City through the coronavirus crisis.

Although the current crisis is extreme and dramatic, it’s not the first time the City has faced economic difficulties. When Douglas Aircraft left Santa Monica in the late ’60s, Santa Monica entered two decades of economic decline. Businesses, visitors, and residents were no longer attracted to Santa Monica as the public realm was increasingly blighted and unsafe. The City’s decline seemed to be epitomized when our famous Pier was badly damaged by storms in the winter of 1982-83. 

Yet the City picked itself up. Enlightened leadership and an engaged community not only invested to rebuild the Pier, but the City turned the dead zone of the old Third Street Mall into the bustling Third Street Promenade. The Northridge Earthquake clobbered downtown Santa Monica in 1994, but the City responded proactively and emerged stronger not only economically, but also socially, as our city supported sustainability, equity, education, housing, and social services at higher levels than did other California cities.

Now the public health and economic crises threaten our local economy. City Council has voted to reduce the size of local government by about 25 percent, a major disinvestment in services that will lead to a decline in what makes Santa Monica a good place to live, work and visit. In our opinion, although budget cutting is needed, the drastic cuts the council approved threaten to turn Santa Monica into a place that would not be in a position for an economic recovery when the pandemic ends—whenever that will be. 

The City needs a local bailout. The City cannot avoid the downward spiral of disinvestment without expenses exceeding the City’s lowered revenue projections over the next two (and we expect three or four) years. The City will ruin itself if it reduces expenditures to the dramatically diminished level of revenues. Not only because of the degradation of services, but also because of the knowledge and expertise that will be lost when experienced employees are let go.

Of course, municipalities, unlike the federal government, cannot run deficits. But they can sell or otherwise turn to account the assets they own. Santa Monica needs to analyze its portfolio of assets and determine how much can be tapped over three or four years to maintain as much in the way of necessary services as possible. 

No, this doesn’t mean we sell the Pier. The assets that the City could sell are government bonds it is holding or various real properties the City owns, some not even in Santa Monica, which serve no municipal purpose. This will require a close look at the City’s future obligations, both fixed and contingent. In our opinion the CAFR makes it clear that the City’s liquid assets far exceed its liabilities, especially considering the timing of when those liabilities are due.

To begin that analysis, we suggest that the City’s own analysis is far too conservative about what assets are available. Looking at the Statement of Net Position (copied below), you’ll see that while by the City’s accounting its net assets total $1.602 billion, of which $703 million is in the form of cash and investments (i.e., liquid, not operational assets), only $171.9 million is available, without restrictions, to be spent. (How the City reaches the $171.9 million is set forth on page xxii of the CAFR.) While $171.9 million is, itself, a lot of money, and spread out over three or four years could save many City services, it is an understatement of the City’s available funds. 

It’s an understatement because to get to that number the City not only deducts from its assets $850 million of depreciation on fixed assets (an accounting requirement that does not reflect the value of the property being depreciated), but also deducts long-term liabilities that are never meant to be paid dollar-for-dollar from the City’s accumulated assets, but rather paid over time.

The biggest number in that regard is the often discussed $447.8 million net liability for pensions. This is a big number, but the pension obligation is payable over time to CalPERS according to an actuarially determined schedule, not all at once. Indeed, the City has been reducing its long-term pension liability by pre-paying the debt voluntarily from the City’s annual surplus cash. In accordance with the City’s current plan to deal with the crisis, those payments are being suspended for two years, but there’s nothing that requires the City to hold hundreds of millions of dollars of assets hostage because of its future obligations to CalPERS.

In upcoming articles, we will discuss other possibilities involving how the City can monetize assets that are not used for municipal purposes and possibly borrow against assets and receive support from the Federal Reserve to do so.

The Pier’s bridge and famous sign were built in 1938 by the federal Works Project Administration, a program of the New Deal. In 2020 Santa Monica can tap into its long-term assets to access the revenues necessary to avoid the vicious cycle of disinvestment and smooth the fiscal curve. Santa Monica can fund its own New Deal to help Santa Monica during a deep recession.

Thanks for reading.

Here is the City’s Statement of Net Position, as of June 30, 2019:

Apocalypse Now?

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The 19th century saw a great expansion of global connectivity and vast increases in productivity. The century didn’t begin in 1800, but at Waterloo in 1815; and it ended in 1914, in Sarajevo. What then followed were three catastrophic decades of destruction, a reckoning for contradictions embedded in 19th century progress. In 1945 a new period of expanded global connectivity and increased productivity began: the “post-War era.”

I hope I’m wrong, but I suspect that the post-War era ended in Wuhan late in 2019.

How does it feel, living during a historical moment? The Covid-19 pandemic looks to be the defining moment of the first half of the 21st century. Future historians will study us. How will we, the people of the world, deal with the contradictions embedded in post-War progress?

My son is getting a Ph.D. in ancient history, focusing on the last years of what’s called “Late Antiquity,” meaning when the Roman world fell apart. He has professor who makes the point that around the fifth century people in the western Mediterranean and western Europe grew up in a world that had not changed from a material perspective for a thousand years, but their grandchildren lived in a completely changed world. And not a better one.

Apocalypse is not inevitable. We are not helpless. But history teaches that when unprecedented environmental, economic or social stress coincides with a lack of world order and leadership, calamity happens. Bad luck can be a factor, too. What were the odds that the pandemic that scientists (and popular culture) predicted, would arrive when America had its first president in nearly a century who didn’t care about the rest of the world?

Many civilizations have fallen since Sumerians and Egyptians and other ancient literate peoples began recording history, but if it happens to us, we’ll be the first to have been aware it was happening and why. (This goes for global warming, too.) We have the knowledge, and the resources, to confront epidemiological and environmental crises, but we will we have the will and wisdom?

Will and wisdom. That brings us to the situation in Santa Monica. Our little city, because so much of its economy and wealth is based on globalization (tourism, entertainment, technology), has abruptly felt the impact of the pandemic. When tourism collapsed about two months ago, the city’s tax revenues, of which about 25 percent come from visitors, collapsed.

Social distancing customers outside Bob’s Market this week.

The first impact, once the scope of the disaster became evident, was that City Manager Rick Cole departed. I don’t know whether Cole voluntarily quit or was fired. His departure did remind me, however, that when he took the job five years ago, leaving a Deputy Mayor position in the City of L.A., Cole said he wanted to work in a city where there was enough money to pay for the kind of programs he thought a city government should deliver. Speaking of Santa Monica, he said at the time, “it has the resources to do some incredible things.”

Incredible things. Many Santa Monicans felt the same way. Tuesday evening, I listened to much of the nearly eight-hour City Council meeting, the one where the council voted to cut nearly 500 jobs (about 20 percent of the City’s total) (and including non-permanent positions). Many residents spoke. Most of them politely pleaded to the council not to cut the City programs that they believed were most important.

Like everyone else, I could rank City programs on a scale from essential to “what were they thinking, and why the hell are they paying so much for it?” I won’t go there. Let’s face it, we were all willing to drink from, or have the thirsts of our favorite programs quenched at, the public trough. Nor was it irrational to expect that the water for the trough would continue to flow from tourism. Hotels and restaurants, and stores where tourists shopped, were not, after all, like factories that could be moved to China or Mexico.

The City should have screened Contagion or Outbreak on the Pier every summer.

What I did not hear Tuesday night was anyone (although I’ll admit I didn’t hear everyone who spoke) giving any credit to the tourism industry or the people who work in it for generating the money that once filled that trough. Over the years I’ve heard many disgruntled residents appear at council and commission meetings to complain about tourists. Many of these residents would complain that UNITE HERE, the union that represents hotel workers, had too much influence over City policies. Some of those same residents appeared Tuesday night to plead on behalf of the programs they like.

How about a word of appreciation for those workers? They are now unemployed, and not likely to go back to work for a while. They never made much money, and few could afford to live in Santa Monica, yet it was their labor that underpinned extensive services that benefited the residents of Santa Monica and the city employees who provided the services.

And I know this will be hard for some, but how about a little sympathy for the owners of and investors in the hotels, too? Let’s recall now the many times some council members said that the economy of Santa Monica would always be booming and profitable for (always greedy) investors.

But I don’t want to be tough on residents. Santa Monica voters have rarely turned down a new tax or bond issue. There have been some scrooges (I used to call them right-wing nihilists), but, like Rick Cole, Santa Monica residents for the most part have appreciated a city with the resources to do incredible things, and they have been willing to tax themselves. What many perhaps didn’t realize until now was how much of those resources came not from them, but from somewhere else in the world.

Thanks for reading.