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L.A. must preserve its reserve fund

Budget problems aside, this isn't the time to dip into the city's 'rainy day' money.

February 02, 2010

Los Angeles is facing an immediate budget gap of $199 million that must be closed by June 30, the end of the fiscal year. It also has a reserve fund of $189 million. Shouldn't the city tap that fund so that it has to find only $10 million in cuts, rather than go through the wrenching process of layoffs and department consolidations to cover the full amount?

No, it shouldn't. The city should leave the reserve fund intact and, if anything, should boost it to $220 million to meet its policy target of 5% of the budget. Depleting the reserve fund to cover the shortfall would be worse than fiscally imprudent. It could be fiscal suicide.

Some city leaders apparently think of the reserve fund as a "rainy day" stash, to be used when times get rough. They figure that there is little point to having a rainy day fund if they can't use it when there's a fiscal drizzle, or especially, as in the current case, a deluge.

The first problem with that thinking is that Los Angeles is not simply trying to make ends meet over the next five months in anticipation of some July 1 payday. No such payday is coming. The end of the fiscal year simply introduces next year's trouble -- a budget shortfall perhaps twice the size of the current one. That kind of problem cannot be faced without a prudent reserve, underfunded though it may be, carried over from the current year. The reserve is there to deal with the problems that can't yet be seen (an earthquake, perhaps, or a state budget raid), not the ones in plain view.

The second problem is that the reserve is not really a rainy day fund. It is supposed to be a store of money -- actually, two stores of money -- that does its work not when it is being spent but when it is left alone. It facilitates cash flow. When the city has bills to pay this month, but won't get the revenue to pay them until next month, it can use some of the cash now, knowing the money is about to be replenished. Or the city can go to the credit market and sell tax and revenue anticipation notes to lenders who will be only too happy to buy such notes at reasonable interest rates -- but only if they see an untapped reserve fund to back their investment. The smaller the fund, the higher the cost of borrowing against it.

It is fiscally responsible for city leaders to use money from the reserve fund only when they intend to replenish it with money they are certain to get at a certain future date. Otherwise, it's not a reserve fund -- it's mad money, spent on a binge to deaden the knowledge of the coming flood.

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