There is dispute raging at City Hall – has the City of Houston balanced its budget or not?
According to Mayor Annise Parker, the City has balanced its budget, every year, in compliance with the requirements of the city charter. Technically, that is correct – the city charter and state law require that the city’s budget be balanced according to the CASH method of accounting. This is akin to balancing your checkbook at home. As long as you have enough money coming in to cover the cash requirements of your spending, all the rest may not matter.
For those of us in the private sector accustomed to scrutinizing balance sheets, where the money comes from does matter! Let me illustrate with a simple example – imagine a couple at home, having a worried conversation about their family’s finances:
Spouse #1: “Did you balance the checkbook?”
Spouse #2: “Yes, I did.”
Spouse #1: “Please tell me how you did it. I know you have been earning a lot of money lately, but our household expenses have been growing too, and may be bigger than our income.”
Spouse #2: “ I did several things: I emptied our savings account, I sold our car, I decided not to pay grandma’s nursing home bill, and I put the mortgage payment on our credit card.”
Spouse #1: “That’s amazing! What are you going to do next month?”
There are three key takeaways here. First, context – in this case, the source of cash –matters. Second, the City’s financial behavior over the past decade is analogous to that of our hypothetical family. Third, CASH accounting alone is inadequate for understanding an entity’s true financial condition.
Let’s put the City’s financial behavior in context. In the last article, I wrote that the City had not balanced its budget (under the accrual basis of accounting) since 2002. In other words, expenditures have exceeded revenues in the City each year since 2002, with the cumulative shortfall now exceeding $2.6 billion. This means that every year, the City covered the shortfall (by borrowing, drawing down reserves, and/or selling assets). Of course, once assets are sold or reserves are drawn, they cannot be used again. If the shortfall is covered through borrowing, the amount owed rises. After a decade or so, it’s not hard to reach nearly $3 billion – with far fewer assets to liquidate and far less capacity to continue borrowing.
The City of Houston has funded these deficits mostly by borrowing (along with some accounting sleight-of-hand, not to mention the sale of city properties and assets at distressed prices.) By the end of fiscal year 2013, the City had borrowed some $2.9 billion (mostly from the employees’ pension funds), including issuing $600 million in pension bonds to cover the cumulative shortfall.
The consequences of this situation are dire. The City’s infrastructure and capacity to deliver services are deteriorating (hit a pothole lately or waited on a permit?), despite the spending and borrowing spree over the last decade or so. There are far fewer assets and reserves to draw upon. And the City is reaching a point at which it cannot borrow enough to cover its shortfalls. Indeed, the City’s Long Term Financial Management Task Force, appointed by Mayor Parker, predicted in February 2012 that “General Fund cash balances will be exhausted in FY2014.” The day of reckoning is near.
As Spouse #1 asked, “What will we do next month?”
A version of this article appeared in the Houston Business Journal on December 31, 2014.
