After the Silicon Valley Bank (SVB) and Signature Bank failures, lawmakers in Texas should take these events as warning signs and proceed with caution when planning the 2024-25 budget. Unfortunately, instead of doing this, the House Committee Substitute for House Bill 1 (CSHB1) will boost spending even more and tap resources from the Rainy Day Fund.

It is getting cloudy out there, but due to changes in CSHB1, the Texas Rainy Day Fund will no longer reach its maximum capacity in the next biennium. The Economic Stabilization Fund (ESF), or Rainy Day Fund, was created to cover any potential shortfall from the General Revenue Fund (GR). That is, if tax collections and other sources of revenue unexpectedly fall due to adverse economic conditions, then funds from the ESF will be used to maintain state spending. Under current law, a maximum of 10% of the GR can be held on the ESF.

On the first version of HB1, the ESF was projected to reach its cap in 2025 with $27.1 billion. However, this changed with the supplemental appropriation passed by the House Committee Substitute to Senate Bill 30. It appropriated $5.2 billion of unencumbered balance from the GR that would have otherwise been transferred to the ESF to fund additional compensation for public sector retirees. That leaves the projected balance for the ESF at $21.9 billion for the next biennium. On top of that, the proposed House Bill 9 (HB9) would appropriate an additional $5 billion for broadband infrastructure.

Lessons from the Great Recession:

Will $21.9 billion be enough to face an adverse scenario in the near future? It will depend on the magnitude of the revenue shortfall. According to a previous analysis, the worst-case scenario for sudden drops in state revenue came about during the Great Recession, with a consecutive decline in tax collections of 8.5% in 2009 and 6.5% in 2010. If history repeats itself, that would be approximately an $11 billion loss that the Rainy Day Fund can cover for now.

But keep in mind that the ESF is designed to maintain previous spending levels, not to fund additional spending growth. CSHB1 will boost spending by 14% compared to the General Appropriations Act of the last biennium—a significant departure from the initial HB1. This represents an increase of $38 billion for a total of $303 billion in All Funds. As a result, the ESF would only be able to fund some of the additional spending in an adverse economic scenario.

Sadly, this is what happened during the Great Recession. The 2011 legislative session, apart from tapping resources from the ESF and getting federal help from the American Recovery and Reinvestment Act, took additional measures to raise more revenue and reduce new spending on education and health care to make up for the gap left by the drop in tax collections.

But policymakers should try to do the exact opposite during a recession. For instance, eliminating school districts’ property taxes can help growth and employment, thus accelerating economic recovery.

Winter is coming?

According to a Bloomberg survey, there is a 65% chance that the U.S. will enter a recession. Moreover, before the SVB and Signature Bank failures, the Federal Deposit Insurance Corporation (FDIC) reported $620.4 billion of unrealized losses in the financial sector. The Deposit Insurance Fund (DIF) reserve ratio is 1.3%, below the long-term goal of 2%. This means that only $1.3 for every $100 secured deposit is covered by the DIF. In case of a systemic failure, that reserve can be quickly depleted.

To make matters worse, the Federal Reserve continues to tighten fiscal policy by raising interest rates, now at 5%, making long-term bonds lose more value, whereas fiscal policy is running out of ammunition as debt-to-GDP is nearly double that of the pre-Great Recession era. Under these conditions, any federal rescue would be arguably more limited in the case of a new economic crisis.

At the state level, caution is also advised. Industries that are highly sensitive to interest rate swings, like real estate, banking, and insurance, have gained more weight in the Texas economy since the Great Recession. Furthermore, Texas’ overheated housing market and interest rate hikes are putting more pressure on mortgage payments. Finally, don’t forget that ESF was implemented because oil and gas prices usually decline during a recession.

Granted, nobody has a crystal ball to predict what exactly is going to happen in the future. But if things go south, Texas would be better positioned to weather out any negative shock with a fully funded Rainy Day fund. The Legislature should stay the course and let the ESF reach its cap in 2025.