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How escrow and smoothing can help manage the NBA’s salary cap problem

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Very good article about the cap.

https://theathletic.com/1820387/2020/05/18/how-escrow-and-smoothing-can-help-manage-the-nbas-salary-cap-problem/

Basketball!

The gathering optimism in the league that basketball will be back, in some form or another, by midsummer has everybody feeling good this week.

However, before that happens, there are multiple thorny issues to work out between the league owners and the players’ association, and little in the way of a roadmap for dealing with them. Sports imitates life in this respect: We are truly in terra incognita.

Major parts of the league’s collective bargaining agreement (CBA) will have to be renegotiated and rewritten, and thankfully both sides seem to realize this and appear to be operating in good faith toward a fair resolution.

That said, A LOT needs doing. For instance, player contracts that expire on June 30 will need to be adjusted to a later date (say, Oct. 1), guarantees for 2021-22 that kick in during June and July will need their dates modified, pay cycles for 2021-22 will likely need altering, and rulings will need to be made on some 2019-20 contract incentives that were written under the assumption of an 82-game season.

The negotiating won’t just be between the league and players, either. On the team side, nearly all staff and coaching contracts expire on June 30 or sometime in July; if teams have to renegotiate all of these individually, even just to extend them a few months, that could quickly get rocky.

Above all, however, one thorny issue stands out: What should they do about the 2020-21 salary cap?

While this isn’t necessarily an impediment to an immediate return to play, teams and players will both want answers quickly. Some teams will make decisions in whatever remains of the regular season that have implications for next year; knowing the cap number seems like a fairly important piece of information in that regard. And surely, the league will need this information well before the draft, whenever that happens.

In talking to several league cap experts in recent days, I found that the complexity of this issue immediately became apparent.

Let’s start at the top: The cap is such a complicated issue because of the potential for a tremendous drop in league revenue in 2020-21. Commissioner Adam Silver reportedly indicated 40 percent of the league’s revenues come directly or indirectly from fans attending games. If we have no fans in seats for all of 2020-21, or even a scattered smattering of socially-distanced, mask-wearing fans, revenue would swoon in response.

Since the cap is directly tied to the projected league revenue for the coming season, that portends a huge drop in the cap. That’s the first part, but consider also the longer term. What if this is a one-year problem, we get a vaccine in 2021, and we’re back to full arenas for the 2021-22 season? In that case, the salary cap would sharply snap back upward in response.

Here’s the catch: Nobody wants this. Whether it’s the drop or the spike, the unintended consequences of each would be massive.

On the team side, a massive drop in the cap number would also drop the luxury tax number (which is a set multiple of the cap number), which in turn would force several teams into huge unexpected luxury tax payments at a time when they are already likely to lose money. One exec who ran the numbers told me 25 teams could end up in the luxury tax without some fairly extreme roster adjustments. Undesirable consequences would include fire-sale trades and liberal use of the stretch provision on quality players just to avoid the tax payout.

From the players’ side, a huge drop would screw three sets of players in particular. The most obvious is the 2020 free-agent class, who would enter a market with virtually no money. All but the best would likely end up on one-year, budget deals. A shockingly large number would be forced to accept the minimum.

They actually might fare better than two other classes of players, however: Those who agreed to max contract extensions a year ago, and first-round draft picks who sign rookie deals in 2020. Pascal Siakam’s projected $116 million deal with the Raptors, for instance, could be slashed to more like $80 million. Ouch. As for 2020 first-round picks, their salary for their first four seasons and the qualifying offer for the fifth are all contingent on the salary cap for 2020-21.

Additionally, a potential cap spike in 2021-22 or 2022-23 offers a similar quandary in reverse. We all saw what happened in the no-smoothing summer of 2016 – an orgy of horrible contracts – and it would only get worse in a potentially much sharper spike in the summer of 2021.

Finally, there’s a huge element of uncertainly in all of this, in a system that relied heavily on its predictability. The players want to get paid their fair share – something that is written into the CBA, which entitles players to 49-51 percent of basketball-related income (BRI) by letter, and nearly always 51 percent in reality. That just got a lot harder to map out.

For instance, the league might project a huge revenue drop if there aren’t fans in 2020-21, but what if we have a vaccine six months from now and the league restarts in December with full arenas? The players could potentially be signing away a huge chunk of money if they agreed to a cap dip right now.

The owners face a similar risk on the opposite side of the coin. They can’t agree to pay the players based on next year’s original, pre-coronavirus cap projection – a now-laughable rise to $116 million per team – and then be left high and dry with no fan revenue. Nor can they sign off on a rosy projection for 2021-22, because we just don’t know how long we’ll be dealing with COVID-19 or what innovations might help us manage it.

In talking this over with cap experts around the league, I came to realize one solution stands out above the rest. In fact, it’s a mechanism that’s already in play to deal with disparities between the “projected” BRI and the actual BRI at the end of the year.

It’s called escrow. It’s usually a word you only hear about when you buy a house. Well, prepare to hear about it a lot more, because it’s the key to creating a workable salary cap.

Right now the players contribute 10 percent of their salary into an escrow account, which assures the owners against a shortfall in BRI that could lead to the players getting more than 51 percent of it. At the end of the season, enough escrow funds are distributed so that the players end up with their 51 percent, and the rest goes to the owners. (The actual machinations are more complicated than this, but I’ve distilled them for brevity).

That works when you’re dealing with maybe 5 percent uncertainly in your revenue projection, but what do you do when the uncertainty is 40 percent?

Obviously, one option is to sharply increase the escrow amount. The beauty of doing this is that it allows the cap number to hold relatively steady (we’ll get to that in a minute), which means that we don’t get all the unintended consequences of sharp yo-yos in the cap number. If teams withheld 30 percent escrow instead of the current 10 percent, for instance, that triples the allowable band of uncertainty in the revenue projection.

Consider a case where the league sets the cap number exactly the same in 2020-21 as it was in 2019-20 – $109 million per team (a proposal, incidentally, that multiple execs mentioned as a fair solution). Then it makes up any difference between that and the final BRI by taking the money out of escrow. The advantage to this is that every player bears the financial brunt equally and there are no unintended consequences that impact 2020 free agents rookies, or players who signed a max contract extension this past autumn.

Using the $109 million cap number in 2020-21, a 30 percent escrow withholding would cover owners down to a cap number of about $76 million, which is pretty close to a worst-case scenario from the league side. The players, on the other hand, would get to keep all the money if things turn out better than expected.

They could conceivably withhold even more than 30 percent. However, players are likely to push back harder the higher the escrow amount gets. Swallowing the entire potential BRI variance under escrow means taking out a huge chunk of their paycheck until after the season, if ever. For whatever reason, nearly every person I talked to mentioned 30 percent as a likely target.

Escrow does a lot of the heavy lifting, but it can’t quite do it all. That’s where the second piece of this – cap smoothing – comes in. I was initially skeptical of what smoothing could accomplish, because of one huge lingering question – smoothing to what? When a sharp cap rise was easily projectible, as in 2016, smoothing made a ton of sense. But now? Nobody knows what the landscape will look like in three or four years. In addition to the short-term issue of fans in seats, we have a huge economic crater to consider.

Still, we know more or less what is possible, and can make some inferences about what might be likely. Combined with a larger escrow withholding, it can allow for planning stability for both players and franchises. The league and players would likely need to revisit any smoothed cap estimates several times over the coming years, but this is still better than wild yo-yos.

For instance, suppose the league’s number-crunchers’ best estimate of an unsmoothed, un-escrowed cap number in a post-coronavirus environment looks something like this:

CAP YEAR

CAP AMOUNT

2019-20 (current):

$109M

2020-21:

$85M

2021-22:

$110M

2022-23:

$120M

2023-24:

$130M

I should mention that the CBA has a mutual opt-out in 2022-23, so let’s assume for a moment that the league and players set that aside (I’m a trained economist; assuming problems away is a lifestyle). Plot out the numbers for the remaining four years of the agreement, and the average of the four seasons would be $115 million.

A “smoothed” cap would still have changes in slope (otherwise you could get an equally ugly unsmoothed year in 2024-25), but an agreement on smoothing could obliterate the yo-yo in 2021-22 as follows:

CAP YEAR

CAP AMOUNT

2019-20 (current):

$109M

2020-21:

$109M

2021-22:

$112M

2022-23:

$116M

2023-24:

$123M

Again, I need to emphasize I’m working with made-up numbers here, but they aren’t that far off from the league’s pre-virus estimates for 2021-22 and 2022-23 (which I adjusted downward to account for the virus’s severe economic impacts). An agreement on smoothing would be important for planning purposes, as both players and teams could enter into contracts with some certainty in an otherwise uncertain environment. Shortfalls and overages could be made up for in future seasons – there are already accommodations for this built into the cap rules – but again, a large escrow withholding would likely limit the overall carnage.

I should note that a few execs I talked to mentioned other proposals, such as fiddling with the tax levels or penalties, or adding an amnesty provision. I don’t really see these as necessary or important. Most are unnecessary with an escrow-smoothing combo in place and lipstick on pigs without one.

One hopes the league and players’ association can both see the logic because the pathway to a solution is here. Escrow is more crucial than smoothing, but each is an underwhelming solution without the other. Between the two, however, they form a pretty solid roadmap for the league and players to navigate an uncertain future.

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Now or never.  Sooner rather than later.  Still getting "Last Days of WCW" vibes.

The league needs: reopening in Florida, fans in the stands sometime next season, AND expansion (at least two teams -- Seattle and Las Vegas -- and maybe even 2 more.  A 34 team league actually makes for a great 82 game schedule, if my math was right).

Anything less than that, I am not gonna hold my breath.

Pro sports musical chairs is gonna come down to the NFL, MLB, NBA, and NHL.  Who gets voted off the island?

If the season resumes soon, who is gonna win the Narrative Olympics?  Will LeBron continue his slow motion chase down of MJ's GOAT status?  Will Greek Freak take the torch from LeBron??? Who is the Next Next Guy -- Luka? Ja Morant? Zion?  Will Zion Williamson be WORTH THE WEIGHT once he gets back?

Can't wait for JV's Revenge of the Big Man Big Board.

I think "our narrative" is as good as any other teams.

The Grizzlies are the Brave New Team of the Future. 

The last days of disco are truly upon us. 

Get your popcorn.

 

 

ALT GRIND

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