June 14, 2008

Letting the Unions Win the Lottery

Justin Katz

I have to admit that NEA head Bob Walsh's proposal to give the public sector pension system "equity" from the state lottery instead of this year's cash contribution confused me. Most prominently, I don't see how a government that habitually spends hundreds of millions of dollars over its revenue can be presumed to need a one-year fix, even if the economy were to right itself within the three to four years that Walsh predicts. Second most prominently, Bob doesn't explain why the pensioners would want an asset yielding cash returns this year at a fraction of the cash that they were expecting.

Anchor Rising readers have the advantage that one of Walsh's numbers should look familiar: The 8.25% that he puts forward as his "conservative expected return" is precisely the figure that inspired so much discussion 'round here. The key to his whole scheme, in other words, is to determine the percentage of the lottery that would be given to the pension system in lieu of this year's $243 million payment by calculating backwards from the "expected" return that the pension system requires in order to be solvent.

If the state were to put $243 million into the account, that money would have to generate a $20 million return (in a slow economy) for the pension scheme to work, so Walsh is requesting $20 million from next year's lottery revenue and calling that 8.25% of the pensions "equity." One could pick just about any number, suggesting, for example, that the projected $365 million in total lottery revenue really represents only a 3% of a total value (we're assuming) of $12 billion, making the pension's $243 million just 2% equity, with a projected return of $4 million, instead of $20 million.

But we could run this formula all evening. The salient question is, accepting Walsh's proposal, what happens next year. The state could resume cash payments, or it could give the pension system another chunk of lottery equity. Me, I'd wager that Walsh would, at that time, recalculate the value of the lottery such that his union members still receive their 8.25% return (plus, of course, the percentage already covered by this year's revenue). The one certainty is that the revenue coming into the state would diminish each year this method is used.

Another certainty is that those who control the pension system would be able to divest themselves of this lottery equity, should things turn around such that other investments would yield better returns. Again, I'd wager that the unions would turn to the state to buy back the equity at more than its value.

It's a clever ploy, buried beneath the confusion of Walsh's "sound financial principles," and treating it all as if it were found money. The money is not "hidden" in the system, though. It's our money, and it's under the control of our representatives, both of which make it as a shiny thing to Walsh's searching eye.

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Perhaps the many folks who have written about my proposal would have been better served to have actually read it and then taken the time to do some research before commenting.

As to the valuation of the lottery, an 8.25% return values the lottery as an entity at just over 12 times next years expected earnings. The S & P 500 is in the 15 x range, and gambling stocks, or gaming stocks, as they are now called, are in the 19 to 20 X range. My valuation was deliberately conservative, and intentionally matched the expected return of our state pension system since that was the entity best suited to receive a portion of the asset while keeping it an in-house transaction. A piece of the equity could be sold just as easily, but the fees would not be insignificant and future gains in in the underlying value of the asset would not benefit the state in any way.

To claim that the proposal had anything else to do with the pension system is false - the full flexibility inherent in a cash contribution from the state is always preferable for the pension system. At the level I suggested, however, the risk was reasonable at the valuation level I suggested, with upside potential in both future revenue growth (threats of bankruptcy notwithstanding) and a higher market valuation if the lottery were ever actually sold.

If we sold the lottery in its entirety, the valuation would likely be in excess of the unfunded pension liability, and using the proceeds of such a sale to fully fund the pension would give the state a net positive cash flow as the combined management contribution would drop more that the expected cash flow from the lottery, and gambling would never again be part of our budget calculations. Alas, I am against this scenario as I do not want oversight of state gambling in outside hands, a likely outcome of such a transaction. This idea, however, if pursued, would be all about solving the unfunded pension liability question.

My proposal simply answered the question of how to both fund programs that I believe are important in the state budget without raising taxes in the down cycle we are currently experiencing in the economy. If the economy in Rhode Island does not recover in the next two to three years as projected, we would be back in the same boat as today. If it does, and they had adopted my proposal, we will be better prepared to take full advantage of it.

While I am Feynman-like in not actually caring what most of the folks who post here think, especially those without the courage to reveal who they are so their biases and backgrounds can be factored when their comments are evaluated, other readers at least deserve to understand the background of this proposal, which may be heard from again.

And to reiterate, this proposal was mine, not that of any of the groups which which I am associated, and a careful reading of the original document should make that fairly obvious.

Posted by: Bob Walsh at June 14, 2008 11:35 PM

If you really wanted to make a partial sale scheme like this work (and, of course, I'm in full agreement that we shouldn't be trying), you could simply hold an IPO for a small amount of the lottery, so that the state would have quick access to a market-based valuation if it ever wanted to trade additional stock away. This could actually have a number of benefits beyond the initial cash infusion. First, the reporting requirements and shareholder scrutiny might make this worth doing on its own by making the lottery a better-run company. Second, it would prevent certain unscrupulous public officials from simply giving parts of the state's holdings to their friends at a discount, as we would at all times have a verifiable value. Third, this would also boost the value to potential minority shareholders, negating the bulk of my RIF criticism (which, in essence, was that beyond being a bad idea for the state it would be a bad deal for the pension system at the proposed price).

Oh, and Bob, I never thought I'd actually see someone ask for more information so that they could engage in logical fallacies; usually such people are quite comfortable knowing less of which they speak. Anyway, the background and biases of the speaker have no relation to the value of their comments. For instance, basing their opinions on your background, one might have been forgiven for assuming that this would have been a good deal for the pension system, or, at a minimum, a good deal for the state, given that you are a Rhode Islander. To propose a bad deal for both, though? I never would have guessed.

Posted by: Mario at June 15, 2008 12:41 AM


I'm sure you understand that your Projo op-ed will be read more broadly than your proposal document, so if I am unable to comment on your proposal based on your explanation in the newspaper, imagine the confusion among the general public.

I've no doubt that your valuation was "deliberately conservative"; the way you've constructed your calculations yields a better return for the pension the more "conservative" you are. If the value is 20 times projected earnings, the pension's $243 million would translate to 3.3% equity, with a projected return of about $12 million — again, less than your required $20 million.

As for the length of our downturn: I don't see on what grounds you believe your solution gives us even two-to-three years of leeway. The truth is that we'll "be back in the same boat as today" next year (or, more likely, in the fall when we "discover" that the current projections and savings are so much smoke and mirrors). You didn't answer my question: what then?

Posted by: Justin Katz at June 15, 2008 8:29 AM

Bob Walsh,

You say: "If the economy in Rhode Island does not recover in the next two to three years as projected, we would be back in the same boat as today".

You are dead WRONG.

In fact, if the economy doesn't recover, we'll be in far worse shape as a result of your plan / "idea" because we will have continued unsustainable SPENDING on programs that we can NOT afford, putting us further into debt.

To use your "boat" analogy, we'll be in a boat that will have taken on three more years of water, that will be on the verge of capsizing. But alas, the boat you are most concerned with, the SS Pension Fund, will have remained afloat.

With all due respect, your plan does nothing more than rearrange the deck chairs on the Titantic. Worse, it cuts loose a few life boats.

Let's not get tangled up in the various assumptions and fancy "sound financial principals", which may fool some fools. The assumptions are simply details to be used in sizing the transaction.

Let's first strip away the BS and focus on the basic concept of the transaction in a manner that people can understand. Then, if we agree with the concept (which we won't), we can move to discussing / debating the details that impact the size.

In simple terms, your proposal is nothing more than a "refinancing" of obligations,wrapped in fancy terms.

Unfortunately, in an effort to obtain broad support using the Union techniques of appealing to other constituents who have their hands out (as recently reported and described in the Projo), you have added a diabolical twist by continuing Spending at the Unsustainable levels that have brought us $400m+ deficits, despite some of the highest taxes in the nation.

Bob, correct me if I am wrong, but what you are proposing is as follows:

Current facts:

1) The State has, over time, built a cost structure / budget based on, in part, projected Lottery Revenues (i.e. the future Lottery Revenues are already spoken for). In fact, the State has built a cost structure that exceeds all "revenues", as evidenced by the ballooning budget deficits.

2) The state's Pension Fund has a massive $5B+ deficit, which is approximately the second largest Pension deficit in the nation. The deficit is attributed to sevaral factors, but chief among them are the overly generous benefits that are doled out to pensioners in the form of the early age at which a pensioner can begin collecting and the extremely high payout ratios provided in light of the ZERO risk assumed by the pensioners.

3) The Current state budget assumes a significant Obligation, and related contribution, to the Pension Fund in Fiscal 09 ($243m). The budget also assumes Lottery Revenues and other "revenues", as well as Spending that produce a balanced budget.

Walsh Proposal / Alternative (put in laymen's terms, as opposed to Wall Street terms):

1a) State goes to the local bank and borrows $223m and promises to repay the loan, plus 8.25% interest (total principal & interest of $243m). The bank happily makes the loan based on the State's ability to repay the loans from Lottery Revenues (similar to a bank providing a home mortgage based on the buyer's income).

2a) The State's general fund receives $223m of loan proceeds (i.e. "found money" in some folk's eyes).

3a) The State then transfers $223 over to the Pension Fund to cover it's "obligation" to the Pension Fund. The Pensioners throw a party and pat Bob Walsh on the back, as they just received a significant contribution and removed all risk that they would not receive the funds from the State as planned. The Pension Fund is no longer an Obligee of the Taxpayers who might wake up and say "wait a minute, why am I working like a dog so people can retire in their 40s & 50s."

4a) As a result of Step #3, the State no longer has an Obligation to the Pension Fund. BUT, it now has an Obligation to the Bank. That is, we simply REFINANCED the State's obligation to the Pension Fund with an Obligation to the Bank.

5a) Now here is the diabolical / dangerous part of the Walsh "idea": We suspend reality, close our eyes and pretend we don't have an obligation due to the Bank. Instead, we delude ourselves into believing that we have relieved ourselves of a $223m obligation (before interest) to the Pension Fund and that we have "found" money to spend. So, instead of reducing Spending to be in line with our Revenues, we continue to spend that $223m "found" money as if the Lottery Revenue wasn't already earmarked to pay off the Bank debt.

Bob, face it, the Lottery Revenue stream is ALREADY spoken for. You are "selling" it twice.

You refuse to deal with reality. You want to keep kicking the can down the road. You want one more golden egg from the goose that you have already plucked, cleaned, cooked and digested.

We can no longer afford gimmicks. We need to start operating the old fashioned way. That is, we need to start living within our means and stop mortgaging our children's future.

Your approach is in keeping with everything you are about. You acknowledged your "idea" is all about the Pension. And a Pension is in it's essence nothing more than something that provides benefits today based on promises / obligations coming due tomorrow?

Try as you might, Bob. But all you are doing is dressing up a pig in fancy clothes, using terms such as "equity" and "sound financial principals". Telling us the "economy will turn around".

It is all akin to the fools that pulled "equity" out of their homes and continued their unsustainable spending on such things as flat TVs and SUVs because we had Wall Street bankers telling them their home values would alway increase (i.e. the economy will rebound) and that what they were doing was based on "sound financial principals".

It turns out "equity" was just another word for DEBT. But "equity" sounded sexy and was just confusing enough for the average fool to buy into the nutty transaction that was put before them ...the transaction that told them they could have their cake and eat it.

Bob, take a look at the Foreclosure notices if you want to see how those "equity" transactions turned out. That is what is in store for the RI Future if we buy into your "sale of equity" scheme.

Stop spending today in the hopes of a windfall tomorrow. Start living within your means. Stop destroying the state with your smoke & mirrors nonsense. Isn't the present reality enough to wake you up?

Posted by: George Elbow at June 15, 2008 11:10 AM

Well said, Mr. Elbow.

Mr. Walsh's proposal is reminiscent of what Congressional Democrats started in the early 1990's (under Senator Mitchell, as I recall), that is, the "rich should pay their fair share" mantra.

In so doing, and I'm sure deliberately on their part, they and their sycophants in the "mainstream media" shifted the whole debate from the Reagan era's "how much should be be spending on government?" to "who's gonna pay for government?"

The whole question of the size and scope of government disappeared, displaced by a debate over tax rates (which the Democrats knew would always be lost by whoever they characterized as "rich" for ultimately that is a minority).

Establishing the premise of the debate (such as avoiding the real underlying issues) can be the first victory for one side.

What Mr. Walsh is attempting here is the same thing - attempting to shift the debate away from the underlying and fundamental issue, i.e., the size and scope of the existing pension system - and having the debate limited to who / how do we pay for the status quo pension system.

Posted by: Tom W at June 15, 2008 11:31 AM


Just to clarify Walsh's plan: I don't believe it involves a third-party lender. Rather, what he's proposing is that, instead of giving the pension system a cash contribution that it can invest elsewhere, the state gives the pension system a percentage ownership of the lottery in an amount equal to the contribution.

The pension system, in other words, would become the holder of the "equity." It isn't the state leveraging its own equity in the lottery to finance its payment to the pension system.

Posted by: Justin Katz at June 15, 2008 12:30 PM


Thanks. However, I understand perfectly what Bob Walsh is proposing. He is essentially securitizing the future cash flows of the Lottery. The problem is that those future cash flows are already spoken for.

My comments & description of his plan in terms of "borrowing" is an attempt to better explain what is happening in reality. I guess I failed :).

People understand going to the bank to borrow money (e.g. take out a mortgage) based on the expectation that their paychecks will support the repayment of that mortgage.

Just because they walk away with a big fat check in their hand does NOT mean they have "found money" so that they can reapply their paycheck to other spending. They still have an obligation to repay the Bank loan.

Said differently, if I already have a mortgage based on my ability to repay, which is based on the future cash flows from my paycheck, it is disingeneous to say I can go out and borrow another chunk of change based on those same cash flows that are already spoken for (or in Walsh's terms, "sell" the equity in my already spoken for paychecks / cash flows).

Heck, why don't we take Bob's idea to the extreme and securitize ALL of the State's future cash flows? Let's call all of our future tax revenues an "unrealized ASSET" and sell some or all of the equity in that asset today and then SPEND all those "sale" proceeds in the current year?

Woops, we'll have a problem as we won't have any "revenues" next year (cuz we sold them) to pay for next year's spending. The revenues coming in next year will have to be turned over to the folks that purchased them this year (i.e. we borrowed this year against next year's revenues, which is exactly what Bob is proposing in simplified terms).

Step back and break the transaction down into its pieces:

1) Pension fund is owed $243m

2) State will raise revenues via taxes and lottery proceeds

3) State will take in lottery proceeds with the Left hand and hand those same proceeds over to the Pension fund with its Right hand, relieving itself of the Obligation (debt) noted in #1 above. The funds handed over to the Pension fund are NOT available to spend on other programs.

Bob Walsh's plan modifies the above slightly:

1) Pension fund is owed $243m

2) State will raise revenues via taxes and lottery proceeds

3) State will take in Lottery proceeds with the Left hand. With the Right hand, it will issue an "equity" security, to the Pension Fund, which is really an IOU (debt) that says we will use future Lottery Revenue to satisfy the IOU that we just provided to you. The State STILL has an Obligation (debt) that must be satisfied with the Lottery Revenues. But slippery Bob would have us continue Spending based on those same Lottery Revenues that must go to satisfy the "equity" security. The day of reckoning is just further down the road.

Posted by: George Elbow at June 15, 2008 1:09 PM

Mr. Elbow does not understand my proposal at all, nor does he seem interested in understanding it, but since he is a fictional character with no obvious seat at the table for any of these discussions, it does not matter. On the other hand, he may have a hidden agenda, and for all we know, his real job could be to assist Twin River in negotiating a better deal for itself to the detriment of the state, and this idea could be seen as a roadblock to that objective.

I am satisfied that those in a position to make a decision have the preliminary information they need, and if the proposal is pursued to completion, the details will be scrutinized and reported. Further discussion here does not seem to be particularly meaningful or productive, because at this point, you either get it or you don't (or you have another agenda.)

Tune in during the November revenue estimates for more on this issue . . .

Posted by: Bob Walsh at June 15, 2008 3:20 PM

I hear in your comment the presumptions of the past, Mr. Walsh. Yes, by all means, bide your time until the inevitable recalibration in November.

There are two paths from here: one the painful way out, one the painful way toward deeper calamity. In fora such as this it will be determined whether enough followers of the old way recognize the insanity of political habit to turn toward the exit, and I've little doubt that your disinterest in defending your idea to the commons will weigh in their considerations.

Either we get it, or we don't, as you say, and now all that remains to the manipulators is power and politics.

Posted by: Justin Katz at June 15, 2008 3:57 PM


Of course I get it. If I don't, have the courage of your convictions to correct me and educate the masses.

But, alas, you won't because we in fact we do get it.

As previously noted, strip away your rhetoric and your silly terms (e.g. "equity"), and the reality of your proposed transaction is nothing more than borrowing against already spoken for revenue.

I can't make it simple enough. Your proposed transaction (and the results) can be accomplished by simply having the State go to the local bank (or Wall Street investors if you want to impress people) and borrow funds with the promise to repay those funds with future Lottery Revenues, which have already been spoken for.

The proceeds from the borrowing (which would be new and additional funds flowing into the General Fund) would then be turned over to the Pension Fund to satisfy the $243m that the State was planning to pay into the Pension Fund.

So, rather than using Lottery Revenue (and taxes) to satisfy the $243m obligation owed to the Pension fund, which would have necessitated a reduction in Spending due to the use of those Lottery & tax receipts to fund the Pension, we instead use money borrowed from the bank. As a result, we have $243m of "found" money to Spend on programs that would have otherwise been eliminated.

The only difference between what I have described and what Walsh has proposed is that the Principal on the borrowing has not yet been physically borrowed. But in both cases, the Taxpayers are left with an IOU that is supported by previously spoken for Lottery Revenues.

Walsh slyly masks the true nature of his proposed transaction by talking about monetizing an "asset" and pulling "equity" from that asset, when in fact, the transaction, in substance, is nothing more than the Taxpayers BORROWING against future Lottery Revenues, which have already been spoken for.

Come on Bob, do you think we are all fools? And, as you continue to avoid answering direct questions, it is clear to all that you are not the least bit interested in debating an issue unless it is with the fools from RIFutureless that hang on and agree with every word that comes out of your mouth.

The oldest trick in the book is to side step a question and say "how dare you question my integrity ...I'm not going to dignify your question with a response", which is really code for "crap, they are on to my BS!"

Bob, no doubt the gang you hang with, 99% of whom are Pension Beneficiaries, love your "idea". That, my friend, does not make it a sound idea.

Also, with respect to your comments about Twin Rivers. I've never stepped into the place. But I do know that your second in command, Pat "I struggle with basic math" Crowley was a sneaky supporter of 24/3 gambling in Lincoln, despite the overwhelming majority of dissent from the town's folk. You guys love the gambling thing, as it helps pay for your flock's entitlements.

Posted by: George Elbow at June 15, 2008 9:06 PM

I don' understand why unions are a part of this discussion at all. Giving up part of a healthy revenue stream is just bad economics, no matter which side od the debate you're on, whether it's a union guy or the governor's office proposing this.

Posted by: rhody at June 15, 2008 11:13 PM

As to the allocation of official power, that's correct, Rhody. Unions and other special interests can make all manner of proposals. But our elected officials (the G.A., usually) just have to say, "sorry, it's not in the best interest of the state" and that's the end of it.

Posted by: Monique at June 16, 2008 7:34 AM

No one ducks back into his hole quicker than “Punxsutawney Bob” Walsh when no one agrees with him, which at AR is almost always because most here happen to be able to think for themselves. Of course as he is sliding back down into his den he always manages to throw out a few insults to those who have challenged him. At least he’s stopped trying to give everybody “time outs”. I wonder what his next gimmick might be as he tries to defend the indefensible.

Nice work Mr. Elbow.

Posted by: Frank at June 16, 2008 8:42 AM

If unions were that all-powerful, R.I. voters would've approved the Marriott casino in '06 by a mile. The fact that it was defeated, even with huge Democratic turnout, shows that unions are not nearly as powerful as their foes blow them up to be.

Posted by: rhody at June 16, 2008 2:03 PM
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