Wednesday, April 16, 2014

On Water, Trust, and the Texas Legislature


"Now the rest of the acts of Hezekiah—all his might, and how he made a pool and a tunnel and brought water into the city—are they not written in the book of the chronicles of the kings of Judah?"
2 Kings 20:20

This morning, we attended the Texas Public Policy Foundation's economics conference.  The event covered a number of topics, including an intriguing proposal to re-vamp the sales tax.  The topic that stands out, however, was water.

Federal Reserve Dallas president Richard Fisher gave the luncheon keynote.  He detailed Texas' stellar economic performance against the backdrop of Obama's national malaise.  Fischer identified water as Texas' biggest long-term economic challenge.

Demand for water is increasing while supply is going down.  The Texas Water Development Board estimates Texas will need to invest $231 Billion (with a B) over the next 50 years to meet demand (*).  As Fischer dryly noted: "You can't count on the Rainy Day Fund" for an investment of that magnitude.

Fischer urged the legislators in attendance to consider seriously the use of 100 year notes to finance Water infrastructure development.  He detailed how "some of our shrewdest operators" in the most recent credit cycle borrowed over a 100 year term.  When interest rates rise, wealth is redistributed from lenders to borrowers.  With interest rates near record lows, an opportunity exists to create a physical asset and pay for it with less valuable money later.  As Fisher predicted: "interest rates will rise in the next 100 years."

Going back to last year, when Governor Perry made a similar argument with us in a semi-private conversation, we've always found this argument the most persuasive.  There's a certain logic in saying that, since (due to decisions made outside Texas) the money is going to be worthless in a few years, we may as well convert it into something with intrinsic value.  The problem, unfortunately, is trust.

In 2013, the 83rd Texas Legislature had a gigantic surplus.  They blew through it, increased spending by 26%, and still had to raid the rainy day fund.  If you can't prioritize within a biannual budget, what makes us think you can successfully manage interest rate risk over the life of a 100 year note?!?

Using long-term debt to finance genuine water infrastructure development makes a certain type of financial sense.  Due to decisions made outside Texas, the money WILL be worthless in a few years.  Unfortunately, until Texas policymakers prove themselves trustworthy over smaller sums and shorter time frames, this sort of massive long term commitment remains a non-starter.

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* For the record, we don't accept the $231 Billion figure, but we readily admit it will be a big number.

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