Cities throughout California are having severe budget problems due to rising pension and health care benefits for city retirees, lower sales and property taxes and the loss of their Redevelopment Agencies (RDAs). RDAs were meant to remove blight while improving city tax revenues. Some cities used RDA monies to buy non-revenue producing properties from themselves in order to get one-time cash infusions while others overspent on pet projects. Many cities used RDA monies to cover annual operating expenses – an unintended and risky use of the funds.

To help you understand how cities used RDA funds to cover annual operating expenses, I will use an analogy:

Let’s start in 2009 when you owned a home valued at $250,000. You wanted to do a renovation of the backyard and the out of pocket cost was $10,000. As you didn’t have the cash to do the remodel (and were a little tight on your household income), you borrowed the money as the renovation was going to increase the value of your home. As the backyard remodel took a percentage of your time, you went to the bank and told them that you needed $15,000 for the remodel as it was going to cost $10,000 for the work and another $5,000 to cover the time that you spent overseeing things. You justified the $5,000 of time to the bank by showing the number of hours that you spent thinking about the remodel, reviewing designs, discussing it with your neighbors and ‘billing’ the remodel for you time at the hourly rate that you would earn at your nine-to-five job. The bank said okay and lent you the $15,000.

In 2010, you still have a household cashflow problem. In fact, things are a little tighter than 2009. What to do?

Bathroom remodel!

Renovating the bathroom will cost at least $15,000 and will demand another $7,500 of your “time”. You go to the bank and tell them how you now need a loan for $25,000. Hold on: $15,000 plus $7,500 is only $22,500. Where did the other $2,500 come from? The answer is that you spent $2,500 of “time” monitoring the backyard remodel done in 2009. Now you have $10,000 of cash to cover the annual costs of operating your home.

How are you going to repay the $15,000 in debt that you took on to cover your living costs in 2009 and 2010 as well as the other $25,000 in debt? Not to worry, you expect to make more money in 2011 and your increased salary will begin to take care of your cashflow problem. Your plans go awry when your nine-to-five job is struggling and you have to take a 20% cut in salary.

Not to worry. In 2011, you bridge the cashflow gap by converting your house to solar power. That has a $50,000 price tag and will demand $25,000 of your “time”. This will get you through the year as you are also getting money from the bank to maintain the 2009 backyard remodel and 2010 kitchen remodel as well.

In 2012, the bank that was financing your remodels goes out of business (not much of a surprise given their crazy lending practices). Given that you have inadequate cashflow to service existing debt, you can’t find another bank to cover the annual household costs that you were attributing to the remodels. What to do?

First, you exhaust your cash accounts and then you raid your retirement funds. You try and cut your expenses and defer other spending but that isn’t enough. The only remaining solution is to declare bankruptcy and reorganize your debts.

This is exactly what is happening throughout California. When the RDAs went away, many cities lost the mechanism through which they were balancing their annual budgets.

In 2011, one Coachella Valley city did this more aggressively than any other city in the state by attributing more than 50% or $5,000,000 of their operating expenses to RDA projects – Indian Wells. Not exactly the best way to balance the budget.

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