Legislative Analyst's Office, January 16, 1998

Rethinking the
Cal-Vet Loan Program
Part II

LAO Concerns About Reform Plan

We have concerns about some elements of the Cal-Vet reform plan—particularly its impact on the state's equity and the expansion of benefits to peacetime veterans—but believe it is reasonable overall in the short term.

Reform Plans Have Merit

We have reviewed in detail the DVA's business reengineering and financial restructuring plans and have concluded that, on the whole, they represent a significant improvement in the operation of the program that is likely to be of great benefit to veterans and state taxpayers in the short term.

We believe, first of all, that it makes sense for the DVA to take advantage of what appears to be a low point in interest rates to lower its bond interest payments. A corresponding reduction in the interest rates paid by Cal-Vet borrowers also appears justifiable, given that veterans are now paying rates that are higher than can be obtained from private lenders.

Preliminary calculations indicated that the DVA's plan to stretch out Cal-Vet debt payments another 13 years would require the state to make $400 million in additional principal and interest payments to retire that debt. However, our analysis indicates that the state would effectively postpone the payment of dollars in the short term and increase the payment of dollars in the long term that, due to inflation, will be less valuable. Once these effects of inflation are taken into account (we assume an average inflation rate of 3.5 percent per year over the long term), the state could realize a net savings of $50 million.

Most of the changes now being made in Cal-Vet operations and programs appear to be warranted. The DVA has so far avoided the imposition of higher insurance premiums on Cal-Vet borrowers for fire and hazard and disaster indemnity coverages, electing instead to rein in program costs by tightening coverages of insured losses. These coverages have been more generous than any to be found in the private insurance market. The focus on getting district offices to more aggressively resell repossessed Cal-Vet properties already appears to have paid off; the number of properties held by the state has begun to decline.

LAO Concerns

Based upon our analysis of the Cal-Vet program, we are concerned with several aspects of the reform package being implemented by the DVA.

Impact on State Equity. One major cause for concern is the failure of the DVA and the California Veterans Board to fully assess and consider how the restructuring of Cal-Vet finances would affect the state's equity in the program.

At the time that the board approved a resolution of support for the restructuring plan, neither the DVA nor the board had obtained any analysis comparing how the state's equity would be affected if it proceeded with the plan versus a decision for the status quo. Given the significant amount of state funds at stake, we find this lack of analysis and consideration of the interests of the state's equity to be worrisome.

In fact, the implementation of the restructuring program will significantly reduce the state's equity in the short term. We have estimated that the state's equity in the program in 2001 could be as much as $80 million to $90 million lower than would otherwise have been the case, depending upon how much the Cal-Vet interest rate is lowered later this year. The long-term impact is unknown. At the time this report was prepared, the DVA had not responded to our requests for a long-range comparison of state equity under the DVA restructuring plan versus a decision not to proceed with restructuring of the debt and a lowering of the Cal-Vet interest rate. The DVA has advised us that it intends to conduct such an analysis after it has largely completed its financial restructuring of the Cal-Vet program.

No Analysis of Veterans' Needs. Our second major concern is that the DVA appears to be focused upon finding ways to perpetuate the Cal-Vet program without any analysis of whether its loan program is really needed.

In recent years, in an effort to prevent its loan pool from shrinking further, the DVA has sponsored and won passage of several state legislative measures to expand the pool of veterans eligible for Cal-Vet loans. This has included legislation over the last three years to bump up the amount of money that can be borrowed to buy a home from $90,000 to $250,000; to liberalize the rules to make it easier for a veteran to get a second Cal-Vet loan; and to expand the periods defined in state law as wartime service qualifying a veteran for Cal-Vet. (The DVA is also pursuing federal legislation that would allow use of general obligation bonds for Cal-Vet loans without regard to when and how a veteran served in the military, but four legislative attempts to do so have failed.)

Each time it sought these changes, the DVA predicted that they would boost participation in the program. Instead, the number of active contracts has continued to diminish. This decline in Cal-Vet loans in part reflects the fact that there are other private-sector and governmental loan programs that are meeting the needs of veterans.

Instead of trying to "compete" with other taxpayer-supported programs, we believe the DVA should consider whether the needs of California veterans are being met adequately by those competitors. For example, the VA loan program provides a generous loan package for both wartime and peacetime veterans, making the expenditure of state resources to compete with it unnecessary.

Voters Have Not Approved Use of Existing Bond Funds to Aid Peacetime Veterans. Last year, the DVA sponsored and won passage of Chapter 155 authorizing the granting of loans to peacetime veterans for the first time in the 77-year history of the program. Based on that legislative authority, the DVA initially announced plans in September 1997 to create up to a $100 million loan pool for peacetime veterans not otherwise eligible for loans from its general obligation or revenue bond funds.

In December 1997, we were advised by the DVA that it does not now intend to use the $100 million pool of "unrestricted" funds to make loans to peacetime veterans. The DVA states that it will instead only make loans to peacetime veterans using the proceeds of revenue bonds that were not subject to voter approval. We remain concerned, however, that the difficulty in finding loan applicants who meet these strict eligibility rules for loans financed with revenue bonds might prompt the DVA to revise its policies in the future to again use the $100 million pool for peacetime veterans.

In our view, granting loans to peacetime veterans is inconsistent with the Cal-Vet bond issues approved by California voters. The electorate was told at the time these measures went on the ballot that the bond issues would be used for the benefit of war veterans, not peacetime veterans. If the Legislature wishes to expand Cal-Vet benefits to peacetime veterans, it may wish to consider placing a new general obligation bond issue before the voters seeking their approval for such a program.

The DVA contends, based on the legal advice it has received from private counsel, that it already has all the legal authority it needs to use "unrestricted" funds for loans to peacetime veterans. However, we have been advised by the Office of Legislative Counsel that the proceeds of bond issues enacted by the voters prior to the effective date of the new Military and Veterans Code section cannot be used for loans to peacetime veterans. We have been advised that the proceeds of future bond acts could be used for such a peacetime loan program if the voters approved such a bond measure. Thus, the new code section appears to be legal, but is not effective for "unrestricted" funds until ratified by voters in a future bond act.

Veterans' Needs Are Changing

The Cal-Vet loan portfolio is likely to continue to dwindle because of federal legal restrictions on tax exempt state bonds and because the aging war veteran population is buying fewer homes and has less need for loan assistance. Veterans do have other growing needs that are likely to create pressure for more General Fund spending.

Restructuring Will Only Slow Program Decline. The DVA has publicly stated that its financial restructuring plan is intended to stabilize the Cal-Vet portfolio after years of decline in the number of active loans. Our analysis suggests that, while the DVA's latest efforts may in fact slow the decline in the program, the number of active contracts is likely to continue to drop.

We agree with the DVA that the number of new home loans generated is likely to increase. The number of new loans issued annually could double and may well exceed 2,000 as the department has suggested. However, based on our analysis of the situation, we expect that the number of loans taken off Cal-Vet's books each year for various reasons will continue to exceed the number of new loans that are issued.

We believe the decline in the Cal-Vet portfolio is likely to continue because of several factors:

What these factors generally indicate, in summary, is that the need for the Cal-Vet program is steadily declining along with the size of the Cal-Vet portfolio. The population of wartime veterans that Cal-Vet has traditionally served is exiting the home-buying market. The new group of peacetime veterans to whom Cal-Vet would like to begin making loans has other generous lending programs available, including several tailored specifically for veterans, to provide them with such assistance.

Other Veterans' Problems Are Growing. While their need for mortgage assistance is ebbing, California's population of veterans (estimated variously at 2.8 million to 3.2 million) has large and growing problems.

While precise numbers are not available, some estimates suggest that tens of thousands of younger veterans in California are homeless and lack job-training, mental health, substance abuse, housing, and outreach services. A 1994 report by the General Accounting Office (GAO) surveyed eight communities across the country, including San Francisco, and concluded that the U.S. Department of Veterans Affairs' "current programs constitute a small portion of what is likely needed to fully address the needs of the home veteran population."

Hundreds of thousands of aging veterans are likely to require living assistance at home, nursing home care, and hospital services, special treatment for Alzheimer's, dementia, and alcoholism, and other support services. In anticipation of such needs, the state is already building four new veterans' homes in Southern California to complement the Civil War-era home operated at Yountville in Northern California. Veterans' groups are also voicing concern about the lack of adequate and available cemeteries in which to bury and honor military veterans.

However, the state faces significant fiscal constraints that could hamper efforts to address these problems. Given current forecasts for the growth in state revenues, significant expansion of any state program generally will create pressure to either make cuts in other existing programs or increase state revenue sources.

Major Expansion of Federal Aid Not Likely. Although all military veterans became so as employees of the federal government, a major expansion of federal support for veterans' programs does not appear likely. A reduction of federal assistance for such programs in the future appears to be more probable.

For example, the veterans' home at Yountville depends on the federal government for about 53 percent of the funding needed to support its operation. The federal balanced-budget agreement approved by Congress and the President last year may eventually result in significant cuts in Medicare, Medi-Cal, and U.S. Department of Veterans Affairs' expenditures—the very three programs upon which the home is most heavily reliant. The shortfall experienced by the state could be millions of dollars annually, depending on how the balanced-budget accords in Washington are implemented.

An erosion of federal support for Yountville and the other veterans' homes now under development would likely leave the DVA with essentially only three difficult choices: (1) increasing fees for veterans who reside at the homes; (2) cutting the cost of operating the homes, potentially affecting services to residents; or (3) backfilling lost federal money with the state General Fund.

There are other indications that federal assistance to California veterans is likely to be limited in the future. For example, a 1994 GAO report on homeless veterans cast doubt as to whether any additional aid for that group was likely to be forthcoming from the federal government. "In an era of tight budget constraints, enhancing the services for the homeless could require curtailing services to other veterans," the GAO concluded.

LAO Recommendations

The Situation Has Changed

Time for a New Direction. Much has changed since the Cal-Vet program was established 77 years ago:

Given this changing environment, we believe it is time to rethink the basic direction that was set for the Cal-Vet program in 1921 and establish a fundamentally new state approach to veterans' assistance that reflects the realities of the 1990s. In the short term, we believe the state should follow through on the ongoing reengineering process and ensure that the Cal-Vet program runs more effectively. In the long run, we believe the provision of new loan assistance through the Cal-Vet program should be phased out and the state's significant remaining equity in the program be redirected in a way that will benefit both state taxpayers and veterans.

Our specific recommendations to carry out this approach are described below and are summarized in Figure 14.

Improve Cal-Vet Checks-and-Balances

We recommend that both internal and external oversight of the Cal-Vet program be strengthened to ensure that the program is properly managed and that an appropriate balance is struck between providing tangible benefits to deserving California veterans and protection of the interests of state taxpayers.

Strengthening Oversight. To accomplish this end, we propose that the Legislature modify the statute that created the California Veterans Board to ensure that the panel has the expertise needed to supervise a program with $3 billion in outstanding debt and 39,000 active loans. The seven-member board should be expanded to nine, with both the State Treasurer and the Director of Finance, or their appointed representatives, given ex officio positions on the panel. In addition, three of the other board positions should be reserved for veterans with experience in accounting, the mortgage lending industry, and financial investments. These requirements could be phased in over time to ensure that no current board member loses his or her present position and would ensure that the board has the financial expertise and balanced perspective to ensure proper operation of the program. Establishing this expertise on the board could be especially important if the Legislature wishes to consider any proposals to transfer authority over issuance of debt and investment of funds from the State Treasurer to the DVA.

To strengthen legislative oversight of the program, we further recommend that state law be changed to make the California Veterans Board a separate item in the state budget subject to annual line-item appropriation by the Legislature. The source of funding for the board would continue to be the 1943 Act Fund, and not the General Fund. Because of the entrepreneurial nature of its loan-making activity, we do not propose that other Cal-Vet program operations be placed in the budget beyond those administrative positions already appropriated through the budget act. This is because, in our view, such a step would make it difficult for the DVA to respond and adjust to rapid changes in the mortgage market and the economy.

The new and separate budget for the California Veterans Board should include a newly created staff position, who would be hired by and be held accountable to the board and who would be independent of the administrators of the DVA. This staff position would be charged with providing independent analysis and advice to the board on the major policy issues and decisions on its agenda.

Because the Legislature's oversight of the Cal-Vet program would remain limited, we believe that state law should also be modified to strengthen the decision-making role of the board to ensure accountability in program decision making. An important first step in that direction was taken with the enactment of Chapter 1145, Statutes of 1996 (SB 1470, Johannessen), which required that the Secretary of the DVA "fully brief" the board before making any policy change in veterans' programs. We believe the board's role should be additionally enhanced by requiring that off-budget staffing and administrative expenditures of the Cal-Vet program be reviewed and approved each year by the board and justified by the DVA on a workload basis. (Expenditures reviewed and approved by the Legislature would not be subject to board approval a second time.) Finally, the DVA's business plan, which outlines how the program will be financed, operated, and marketed in the coming fiscal year, should be subject to advance review and approval by the board. The new staff analyst position we propose would assist the board with independent review and advice in these matters.

In order to preserve program flexibility, the DVA would retain its broad, existing authority to make new loans to veterans, invest program funds, issue debt, and make other key operational decisions without the specific preapproval of the board. The board would continue to function as an appeals board for persons denied Cal-Vet benefits by the DVA.

Improved Reporting Requirements. The current legislative reporting requirements for the Cal-Vet program, in our view, need to be strengthened.

State law requires the board to report by August 1 of each year on "the activities, accomplishments, and expenditures of the board" during the prior calendar year. We recommend that the board's report be changed to require that it cover the activities of the prior fiscal year, not the prior calendar year. The deadline for reporting could be changed to September 1 to ensure that the board has sufficient time to prepare its report.

Existing law also requires that the Secretary of Veterans Affairs annually commission an independent financial audit of the Cal-Vet fund. By law, the completed audit is to be provided to the legislative policy committees and the board. We recommend that state law be changed to specify that the auditor is to be commissioned by and held accountable to an audit committee of the California Veterans Board, not the Secretary of the DVA.

In addition, the DVA should be mandated to provide a comprehensive annual report to the Legislature regarding the operation of the Cal-Vet program. That report should detail information about loan issuance and repayments, debt levels, loan interest rates, the return on the investment of program cash, trends in delinquencies and foreclosures, the solvency and reserves achieved in insurance programs, and other measures of program activity to be defined in state legislation. The report should be submitted to legislative committees with jurisdiction over fiscal affairs, veterans' issues, and housing policy.

Given the extensive reengineering process that is ongoing at the DVA, we do not believe there is a need at this time for another broad performance review of the Cal-Vet program. However, we recommend that, once the DVA has had a chance to substantially complete its reform efforts, the Bureau of State Audits (BSA) should be commissioned to conduct a more narrowly targeted financial audit and program compliance review of the program.

The BSA audit would check the accuracy of Cal-Vet financial reports, verify that eligibility rules for the program are being enforced, determine whether staffing levels are consistent with program workload, review cash- and debt-management practices of the program, and determine whether the state equity in the program is being properly preserved. Because such audits are time-consuming both for auditors and the agency being audited, we propose that the BSA review be delayed until DVA reform efforts, such as the installation of a sophisticated new computer information system, have been completed. Thus, we recommend the BSA review of the Cal-Vet program be completed by September 1999, if the BSA agrees that timetable is feasible.

We believe the steps outlined above will establish the appropriate checks-and-balances needed to ensure better operation of the Cal-Vet program without unduly intruding on the authority of the executive branch or the ability of the program to adjust to changing economic conditions. Our recommendations for improving oversight of the Cal-Vet program are summarized in Figure 15.

Program Restructuring Needed

We recommend that the Cal-Vet program be restructured so that future Cal-Vet loans could be issued at an interest rate different, if necessary, from the rate established for previous Cal-Vet borrowers. Other short-term program improvements to complete the reengineering process begun by the Department of Veterans Affairs should also be encouraged.

Abandon Single-Interest Rate. As we discussed earlier in this report, virtually all Cal-Vet loans—with the exception of about 800 loans issued before 1974—bear the identical interest rate. If the DVA determines that the interest rate for newly issued single-family home loans should be adjusted, it must by law also adjust the interest rate for all outstanding post-1974 loans at the same time. The single-interest rate requirement makes it very difficult to manage the program in periods of economic change.

Consider the difficult situation in which interest rates are rising and it becomes more expensive for the program to borrow funds through bond issues. In such an event, the program can leave unchanged the rate it charges to its borrowers, and issue loans to new borrowers at rates that will result in financial losses to the program year after year. In the alternative, the interest rate can be raised for all borrowers—an unpopular step likely to create financial difficulties for many veterans.

We recommend that state law be changed to allow the program to issue new loans at rates commensurate with the cost to the state of borrowing the bond funds used to fund those new loans. Veterans may have to pay a higher rate than prior Cal-Vet borrowers, but they would still receive a real benefit from the state. Even those higher interest rates could be lower than they might obtain in the private sector.

One additional benefit of this approach is that the Cal-Vet program could essentially "lock in" the new, lower loan rates it hopes to achieve through its ongoing restructuring of program finances. Most of the 39,000 present Cal-Vet borrowers would be assured that the rate reduction that they are scheduled to receive this April will never be reversed.

Report on Reengineering Progress. We recommend that, at the time of its budget hearings, the DVA also update the Legislature regarding its progress in implementing the operational improvements specified in its Cal-Vet reengineering program. In particular, the DVA should indicate:

Limit Use of Revolving Fund to War Veterans. We also recommend that the $100 million pool of "unrestricted" funds that the DVA is now setting aside for veterans of recent wars (primarily the Persian Gulf, Panama, and Grenada military incursions) be limited to that purpose and not be used for loans to peacetime veterans. As we noted earlier in this report, Legislative Counsel has advised that the proceeds of bond issues enacted by the voters for the benefit of war veterans cannot be used to make loans to peacetime veterans. Lacking such voter approval, we believe that loans from the $100 million revolving fund should go only to war veterans of these more recent conflicts who until now have had only a limited opportunity to obtain Cal-Vet benefits. The exact criteria for eligibility should be determined, as current law provides, by the California Veterans Board.

We believe these recommendations would ensure that the Cal-Vet program operates more efficiently, fairly, and with fewer financial problems. Our recommendations for improving the current operations of the Cal-Vet program are summarized in Figure 16.

Time for an Exit Strategy

We recommend the enactment of state legislation directing the orderly phase-out of issuance of new Cal-Vet loans by the year 2007. The legislation would also ensure the proper stewardship of the Cal-Vet loan and bond portfolios until their expiration.

Program Slowdown Inevitable. While it is important to follow through with the reforms of the Cal-Vet program discussed in this report, we believe it is important for the Legislature to evaluate whether new lending activity ultimately can and should continue over the long term. Three reasons argue for the phase-out of the program. First, as we noted earlier in this report, federal tax restrictions will have the effect of prohibiting the use of tax-deductible general obligation bonds for loans to war veterans after January 1, 2007. By 2002, large numbers of Vietnam War veterans, the vast majority of whom were discharged before 1972, will no longer be eligible for loans financed with such tax-deductible bonds. Second, even if legal restrictions on the program were to be eliminated—a step requiring congressional action that appears unlikely given last year's federal balanced-budget agreement—the aging of the veteran population will sharply reduce their demand for loan assistance anyway. Finally, both the private-sector housing market and various governmental programs appear to be meeting the home loan needs of veterans.

For these reasons, we believe the state needs an "exit strategy" for the Cal-Vet program. In our view, it is time to enact state legislation establishing a clear timetable and process for phasing out all new Cal-Vet loan activity as of January 1, 2007. At that point, the state will have no choice under federal tax law but to terminate the issuance of loans using the proceeds of general obligation bond funds, which has been the source of 90 percent of program finances. We recommend that issuance of new loans using other sources of funds and revenue bonds also be phased out at the same time.

We are not recommending that all program functions be terminated in 2007. Loan-servicing, debt management, and cash management operations must continue in some form until all outstanding loans and bonds have been retired sometime before the year 2032. New loan activity, however, would cease.

No outstanding Cal-Vet loan to any veteran would be affected; a Cal-Vet borrower would continue making monthly loan payments long after 2007 unless the borrower chose to retire his or her debt ahead of schedule.

Needs of Peacetime Veterans Would Be Met. The phase-out of new loan activity in 2007 that we have proposed also means the state would not carry on in the long term with a new home loan program for peacetime veterans. This is because we believe the needs of creditworthy peacetime veterans for substantial housing assistance will continue to be met through both the private-sector housing market and various governmental programs.

Future governmental assistance from other quarters does not appear to be in question. For example, federal VA and FHA assistance programs are now self-funded operations largely immune from federal budgetary constraints and thus are highly likely to continue to provide home loans to veterans. Moreover, many veterans will continue to qualify for assistance under the state's CHFA loan programs, which offer loans at interest rates well below what Cal-Vet has been charging.

Put Loan Servicing Out to Bid. As part of the Cal-Vet phase-out legislation, we recommend that the Legislature direct the Department of General Services (DGS) to conduct a procurement of loan services for the Cal-Vet portfolio by January 1, 2006. The DGS would be empowered to determine which specific loan-servicing functions would be procured and would issue and administer the request for proposals. If the DVA could demonstrate, through the bidding process, that it is the most cost-effective and highest-quality service provider, it would continue these services. If another governmental or private-sector entity submitted the best bid, however, it would take over those operations under state contract. In that event, the contract would be administered by the DVA. The cost comparisons should take into account the expense the DVA would have to incur to monitor a private-sector vendor, should one win the bidding.

We believe these recommendations would ensure that the Cal-Vet program is phased out in an orderly and cost-efficient manner, preserving the state's equity in the program while ensuring proper management of the outstanding loans and debt. Our recommendations for the orderly phase-out of new Cal-Vet loan activity are summarized in Figure 17.

Shift Resources to Needed Veterans' Programs

We recommend that surplus funds be shifted to programs that will benefit both California veterans and state taxpayers. This should be accomplished carefully by means that ensure that all obligations of the state to bondholders are met and that the program retains adequate reserves to meet the requirements of the program.

Tap Reserves to Meet Growing Needs. In the short term, the DVA has proposed to use its considerable cash surplus to lower the interest rate paid by most Cal-Vet borrowers and to create a new $100 million loan pool for veterans of more recent conflicts. Even with these financial commitments, a DVA consultant projects that as much as $600 million in state equity will remain at the termination of the program.

Given this projection, and the substantial and growing needs of California's aging veteran population, we believe it makes sense to begin using those resources in a prudent fashion to address those needs. Thus, we recommend that, if California voters concur, surplus funds should be channeled into other programs that will benefit both veterans and state taxpayers.

The first task is to determine the size and the timing of the availability of that surplus. Accordingly, we recommend the enactment of budget bill language directing the DVA to provide the Legislature with an analysis of the 1943 Act Fund, the main revolving fund for Cal-Vet operations.

This analysis, which will probably require the assistance of the DVA's cash-flow and debt-management consultants, should detail how much of the current cash and investment assets of the program are now needed for prudent reserves to ensure the repayment of the outstanding Cal-Vet debt and to provide all funding needed for loan and related insurance program operations. The analysis should also project how much reserve funding is needed year by year for the duration of the program, and the amount of surplus funds that could be available for appropriation for other purposes in each year. The analysis would be based upon the assumption that the issuance of new Cal-Vet loans would cease by the year 2007 in accordance with federal restrictions on general obligation bonds.

The DVA would also analyze its existing agreements with bondholders, bond insurers, and bond rating agencies, as well as any relevant sections of the federal tax code, to ensure that they would not be violated by a future redirection of surplus Cal-Vet funds.

We further recommend that state law require that the Veterans Finance Committee of 1943 conduct a review to verify that only truly surplus funds are transferred from the Cal-Vet fund, that all obligations to bondholders are met, and that any transfers would not violate federal tax code restrictions. Their analysis, along with any comments of the Veterans Finance Committee, should be completed and submitted to the Legislature by January 1, 1999.

How Surplus Funds Could Be Used. Once the DVA has determined if and when surplus Cal-Vet funds could be available for other programs, the next major task is to determine how they could best be used to benefit both veterans and state taxpayers. In our view, the funds should be used for the benefit of veterans because they were generated through loan repayments by veterans to the Cal-Vet program. But the funds also belong to all state taxpayers, and should also be used in ways that benefit the state generally and implement good public policy.

We can suggest several possibilities that would meet both of our criteria. For example:

Before appropriation of any surplus Cal-Vet funds could occur, we recommend that the California Veterans Board be directed to conduct public hearings to solicit testimony of veterans and the general public as to the best use of the funds that ultimately become available. The board, with the assistance of the DVA, should also be directed by law to recommend policies and priorities to the Legislature for the expenditure of the anticipated surplus.

Seek Voter Approval of Funding Shift. Before any shift of surplus Cal-Vet funds to other purposes occurs, we recommend that California voters be asked to authorize such an action. We recommend that such approval be sought for limited purposes specified by the Legislature in a future statewide ballot measure. The DVA has indicated that another Cal-Vet general obligation bond issue may need to be placed on the statewide ballot in the year 2000 if the proceeds of previous bond issues are exhausted. In that event, it may be possible to include a funding-shift provision in the next bond issue submitted to voters.

Under our proposal, funding for any new program would be determined by the Legislature on the basis of the hearings conducted and subsequent recommendations of priorities received from the California Veterans Board. The new programs for veterans that would be designated as potential recipients of surplus funds would be specified in the ballot measure presented to voters.

The DVA concluded in a 1995 memorandum that surplus Cal-Vet funds could not be reallocated to other programs by statute alone. The memorandum by DVA's then-chief attorney referenced a 1974 Third District Court of Appeal ruling (Veterans of ForeignWars v. State of California). In that case, the court struck down the legislative redirection of $500,000 per year of the Cal-Vet operating fund to support of CVSOs' operations between 1965 and 1973. The court held that the redirection of the funds was not permissible because the redirection of funds through the state budget act amounted to an illegal, partial repeal of the various Cal-Vet bond acts approved by the voters.

The Legislative Counsel's office has advised us that, given the 1974 court precedent, voter approval would be needed before surplus Cal-Vet funds could be redirected to other purposes. Legislative Counsel has also advised us that use of surplus funds also faces potential legal hurdles stemming from federal tax code restrictions on the use of the proceeds of tax exempt bonds and the state's obligation to bondholders. Accordingly, we have recommended above that the Veterans Finance Committee of 1943 review any plan to redirect Cal-Vet funds to other purposes to verify that all of the state's legal obligations are met.

Circumstances have changed significantly since the court issued its ruling almost 24 years ago. At the time of the ruling, issued just as the Vietnam conflict was ending, the court noted that the ranks of veterans were growing and that the DVA was planning another bond issue to meet the anticipated heavy demand for a new wave of veterans being discharged from military service. These factors led the court to conclude that no surplus was actually available in the 1943 Act Fund to be redirected.

The situation is now different. Demand for Cal-Vet loans, and the size of the Cal-Vet loan portfolio, has been dropping since the early 1980s. Federal restrictions on use of general obligation bonds will have the practical effect of halting any issuance of new loans from this funding source as of 2007. Meanwhile, the veteran population is aging and faces significant needs that may go unmet unless that surplus becomes available for new programs. This near to the conclusion of the Cal-Vet program, we believe it is considerably easier to demonstrate to the events that a substantial surplus will accrue to the state in the future.

In any event, we believe it is prudent to require that any redirection of surplus funds for other purposes be ratified by the electorate. California voters financed Cal-Vet loans through their repeated approval of bond issues and, thus in our view, it is reasonable that they should have a say in regard to the use of funds generated by the program. We believe such a measure needs to be well-crafted to include strong protections for the loan program and bondholders.

The alternative, if the DVA's projections prove accurate, is to allow as much as $600 million in state equity in the Cal-Vet program to accumulate and be left unused over the next 34 years. If none of the state's equity can be accessed until all Cal-Vet bonds are retired as scheduled—a date the financial restructuring plan will delay until as late as the year 2032—few veterans alive today will receive any benefit from the surplus they helped generate through their participation in the Cal-Vet program.

We believe the above recommendations will ensure that the changing needs of California's veteran population are met without creating additional fiscal demands on state government. Our recommendations for shifting Cal-Vet program resources for these purposes are summarized in Figure 18.


In our view, our recommendations would ensure that the work the DVA has already begun to reform the Cal-Vet program is carried though to a successful conclusion. We also propose an exit strategy for the orderly phase-out of the program. Further, we propose to revamp the state's array of veterans' programs with the voters' permission to meet the changing needs of the veteran population using the anticipated surplus no longer needed for the program.

Figure 19 shows the timetable of activities we recommend be set in motion by state legislation.



This report was prepared by  and Craig Cornett, with the assistance of many others throughout the office. The Legislative Analyst's Office (LAO) is a nonpartisan office which provides fiscal and policy information and advice to the Legislature.
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