For those of you who are NBA fans, you are currently being treated to some of the most exciting and entertaining playoffs in recent history. Most games are competitive and, at the time this post was written, there were only two series sweeps. However, this may be a curtain call for the NBA as it is known today. At the end of this season, the current Collective Bargaining Agreement (CBA) will expire, and it doesn’t look like the two sides, players and owners, are anywhere close to being on the same page. This post looks at the economics of the NBA and outlines how some of the ways it is undergoing problems similar to those of the U.S. economy prior to the recession.
What brought the NBA to this point?
In order to better understand how the NBA got to the point of what looks to be a certain lockout at the end of the 2010-11 season, we will first examine the current CBA. Today, there is a soft salary cap in place to try and limit what teams can spend on player salaries. This, in theory, would allow smaller market teams to compete for better players by “capping” the amount spent on player contracts. However, as with most rules, there are loopholes. The reason this is considered a “soft” salary cap is that there are a ridiculous number of exceptions that allow teams to spend more than the cap. For an explanation of these exceptions please follow this link.
If teams spend over the cap amount by too much, they have to pay a penalty called the luxury tax. Unlike the popular board game Monopoly, this is quite a bit more than $75.00. The amount a team can spend over the cap is calculated based on a pre-determined tax level. For the 2010-11 season, teams could spend up to $12.26 million over the cap of $58.04 million ($70.3 million) before the luxury tax kicked was enforced. The penalty that violators owed to the league was one dollar for each dollar spent over $70.3 million. The Lakers, for example, are spending $91.6 million in salaries. This means they would be paying the NBA $21.3 million in taxes. Considering they were just swept in the second round of the playoffs, we’re not sure that was money well spent.
At the time this entry was written, 24 teams were over the salary cap. There are 30 teams in the NBA. Let’s pause and think about that. 80% of the teams in the NBA are over the salary cap, so it’s no wonder there are 17 teams claiming they are losing money. Apparently, the salary cap is sort of like a speed limit. Technically you shouldn’t exceed it, but if the flow of traffic is going 15 mph over, you should too in order to keep up. Unfortunately, the NBA is headed for a 30-team pile-up.
When is signing an NBA player like buying a house?
How did the owners get themselves into this situation? The same way the U.S. got itself into the mortgage crisis. It involves the over-valuation of property/talent, and people unqualified to own a home/team making decisions.
Let’s use the unfortunate example of Drew Gooden to illustrate the point.* On July 1, Drew Gooden signed a 5 year/$32 million contract with the Milwaukee Bucks. This means he will earn an average of nearly $7 million a year for the next five years. Looking at his average stats from the two years prior to the contract signing, he would be earning $18,350 per point he scored. If this same amount were applied to a player of Kobe Bryant’s caliber, Kobe should be making about $38.2 million a year; he actually made $24.8 million.
Maybe the Bucks didn’t sign Drew for his scoring, so let’s look at his rebounding. Again, using his average stats from the two years prior to the contract signing, he would be earning $25,830 per rebound. Applying this amount to a premier rebounder like Dwight Howard, Dwight should be making about $28.1 million a year; he made $16.5 million. It’s over-valuation of talent either way.
*Note to NBA fans: There were several horrible contracts we could have used as examples (anything Isaiah Thomas did, really) but we figured we’d pick one from our home team.
The point is, players like Drew Gooden, who are decent but certainly not great, have been getting over-valued. This drove up other player contracts to the point where some owners could not afford to pay the players what they promised, and are losing money.
Sound familiar? Over-valuing property was central to the recent mortgage crisis in the U.S. According to the S&P/Case-Shiller home-price index, between 1997 and 2006 American house prices rose 124%. If someone pays $300,000 for a four-bedroom, one-bath house in Compton, CA (Drew Gooden), then it stands to reason that the price of that same house in San Francisco, CA (Kobe Bryant) will inflate. (Compounding the problem was that there were a lot of people given credit to purchase a home who were not equipped to understand that the mortgage payments they would eventually have to make would far exceed what they could afford.) Like the housing bubble before it, the NBA bubble is about to burst.
Bailout – NBA Style
Why would owners agree to pay players such inflated salaries? As discussed above, part of the issue is poor talent evaluation and incompetent management. Another issue was betting on the continued success and popularity of the NBA. The graph below shows average attendance numbers for the NBA from 2001 to 2011. From 2001 to 2007, attendance was on a steady increase signifying growing popularity in the NBA. In order to capitalize on the popularity of the league, owners over-paid to get the best talent they could. The problem is, popularity (based on attendance) peaked in 2007.
By 2008, revenue earned by most teams was not matching what owners anticipated, and this put some owners in a bind when they couldn’t cover player contracts without losing money. Now, with the CBA expiring, they are asking for tighter rules to protect themselves from…well, themselves. Again, sound familiar? (We’re looking at you AIG). The owners are asking for a “hard” salary cap that would not allow any exceptions…in theory. That means there would be no luxury tax. Owners could only pay salaries up to what the salary cap allows. Owners are also asking that contract lengths be shortened and that there be a decrease in the amount of annual salary raises from 8–10 percent down to 5–7 percent. Owners can’t figure out how to spend within their means, so they are asking the NBA to create rules to figure it out for them. Not quite a bailout, but still.
Labor of Love
It is looking like the owners are going to stand firm on their demands, because of the massive financial hole they have dug themselves into, and that puts the players in a bad situation. The deal the owners are going to put on the table will dramatically reduce overall player salaries, and the players, who were probably over-paid to begin with, will have to bear the cost of years of financial mismanagement by their employers.
Wait, there is a labor union that was given very generous benefits and salaries, and now the business its members work for is hemorrhaging money to the point of shutting down? Where have we heard this before? NBA players should give the members of the United Auto Workers a call and ask how things worked out for them. We don’t see the government stepping in and bailing out the NBA, and taking part ownership like it did with GM. Although you never know - it is widely known that our president is a big basketball fan.