My concern increased with the report that the State of Kansas had, on June 30, around $2 Billion on hand in all funds because the report did not contain enough explanation of those special revenue funds.

Some people related stories of citizens who, based on a cursory reading of the news article, stated that they thought the state had a financial challenge but it appeared we don't, we are just hiding the money.

I think this presents an opportunity for two points to be discussed. First, what are our actual cash balances? Second, does sound financial management require us to respect the dedicated purposes for which special revenue funds have been created?

As the Director of Investments for the Pooled Money Investment Board reported to you, of the $2 Billion in cash on hand on June 30, about $1.08 billion actually belonged to the cities, counties, schools and other local governments that invest in the municipal investment pool. Therefore it is not the state's money and is not available for us to use.

Local governments are relatively dependent on property taxes and therefore have property tax revenue that comes primarily in December and May. Therefore they naturally have cash balances that are much larger at certain times of the year. The local governments must first offer the idle funds investments to local banks. If the banks do not have enough demand for the cash the locals can then invest in the Municipal Investment Pool. (Larger municipalities have the authority to invest on their own without using the MIP.)

After deducting the cash owned by Kansas municipalities well under $1 billion is available. Of that amount about $340 million resided in the unemployment trust fund. In the past the Kansas Chamber has been quite vocal that unemployment taxes should be collected only for unemployment benefits. At one point the Graves administration proposed using some interest earnings on the Trust Fund to finance certain work force training and software upgrades. That proposal was denied as most legislators as well as industry leaders held the belief that unemployment tax revenues should not venture outside of the Unemployment Trust Fund. The Unemployment Trust Fund is not held in the State Treasury. It is invested in "Special Issue Bonds" with the federal government. The State does not actually have that money, even though it shows up in A&R balances as "unencumbered funds."

Other funds among our code 7000 funds, which are also known as trust funds, are in a similar situation. For example, $ 19.1 million resides in the Star Bonds Fund for which we have a fiduciary responsibility to pay bond holders.

Motor fuel dealers who pay into the underground storage tank trust fund typically believe they are taxed for the program in order to provide remediation insurance. The insurance has kept many gas station owners from being put out of business by providing the funding necessary to clean up fuel tank leaks. A similar program exists for fertilizer and chemical dealers and tire dealers. I doubt these business leaders would like their funds diverted for general operating expenses such as higher education.

Over the last few years several banks have switched from being primarily regulated by the Comptroller of the Currency to the State Bank Commissioner. The most common reason I have heard for this is that the state regulatory fees are lower. In this case, competition results in lower costs for an industry. However, if we discontinue state regulation we force our state chartered banks back to a higher cost regulatory environment. The alternative of sweeping fees from the state bank commission and thereby forcing an increase in fees charged to state banks is also not a "cost-free" alternative.

In other words, considering the fees that create these revenues to be frivolous is, in most cases, in error. In addition, considering special revenue funds to be available for operating expenses does not present a tax-free source of revenue as it can raise costs for many industries.

Tough times have already forced us to dip into special revenue funds through "fee sweeps." Now, we have a report that leads many of our voters to believe that we have no serious problem as we can once again access these idle funds. Therefore now is the time to consider what is the best management practice for special revenue funds.

Looking for authoritative articles on this subject I emailed a professor at a Kansas Regents university and told him that there is interest in using more special revenue funds for general operating expenses. I then asked if he had guidance from writers on the subject. He responded first by saying that not much is written directly on this as it is considered such a "no-brainer" as being poor management.

I did pull out my old textbook Management Policies in Local Government Finance, published by the International City Management Association. The principles laid out here are the same principles followed by most loan officers in the private sector.

The ICMA lays out three categories of practices that, if used for too long, may jeopardize a government's financial health. The category most relevant to us is "practices that sustain an operating deficit." Three key types of practices are noted under this category:

1. Using reserves (fund balances) from prior years.
2. Using short term borrowing.
3. Using internal borrowing.

Clearly, to use special revenue funds without replacing them in some way is a way of using reserves from prior years. Second, as we have refinanced some of our debt and pushed back principal payments we have exercised a type of short term borrowing. Third, my view of discussions held by the Pooled Money Investment Board is that board members are unanimous in the belief that we should not go any higher than the current level of internal borrowing in which we have certificates of indebtedness for $700 million to the State General Fund.

I should also mention that another category of business practice that can jeopardize financial health is failure to life cycle cost capital investments. I mention this as I believe it is critical to continue to require state agencies, especially the Regents institutions, to fully fund maintenance costs of new buildings prior to construction. Otherwise, as we have learned from the deferred maintenance issue, these costs occur without being accounted, to the detriment of future legislators and taxpayers.

As we began business on July 1, 2008 the state treasurer's balance net of MIP and unemployment on hand in all funds rested at $3,012,056,112. On June 30, 2009 that amount stood at $2,316,851,141. We project that cash balances may decline by as much as 50% from current levels over the course of FY10, due to negative cash flows.

Our cash balances are now so low given our commitments that the Office of State Treasurer, the staff at the Pooled Money Investment Board, and the Budget Director are communicating frequently to share data and plan jointly in order to maximize our investments and minimize problems caused by the cash flow shortages that we know will occur.

Summary

It is my opinion that to further dip into special revenue funds is a violation of the trust the State of Kansas has established with the industries affected by those funds. Second, it is my opinion, and I have not heard any disagreement expressed by other members of the Pooled Money Investment Board, that policies which further decrease the state's cash balances will pose substantial risk for our financial health.

I remember clearly hearing former Governor Hayden say that after the recession that caused cutbacks in FY 1987 we should regain a position in which no certificates of indebtedness are required. I think that remains good advice for us today.

Thank you Mr. Chairman for the opportunity to be here today.

Additional Note: Approximately $29M is housed in a Fiscal Agency Bond Fund which is used to make bond payments.