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GOVERNMENT: Creative Borrowing Catches Up with California Cities

Financing schemes that sidestepped voter approval have put local governments deeper in hock.



From the Los Angeles Times

By William Heisel

December 31, 2008

One in a series of occasional stories

Oxnard was in a bind, facing a $150-million bill to fix cracking and crumbling streets and no way to pay for the work without cutting other services.

The city had tried, and failed, to get voters to approve a bond measure for street repair. And it had borrowed money against almost all of its public property, including a soccer stadium, three fire stations and its library -- even the Police Department's evidence-storage building.

With virtually nothing left to hock, the city came up with an ingenious way to take on more debt: It borrowed against future revenue by "selling" its streets to a city-controlled financing authority.

"We had way too much construction work to do and way too little money," said Ken Ortega, Oxnard's public works director. "We really pulled every creative financing string we could to come up with the money."

Desperate for cash in a sputtering economy, local governments throughout California are digging themselves deeper into debt, and many are doing so through exotic financing schemes designed to sidestep the need for voter approval.

California cities, counties and other agencies borrowed $54 billion last year, nearly twice as much as in 2000, and governments are straining under the load.

Statewide, 24 cities and public agencies missed scheduled debt payments this year or were forced to tap reserves or credit lines to stay current, records show. That's up from nine in 2006, according to the bond industry's self-regulatory agency.

The city of Vallejo, burdened with huge debt obligations, in May became the largest city in California history to file for bankruptcy protection. Chula Vista, Orange County and Palmdale are among the other cities and counties staring at red ink.

Much of this borrowing binge was made possible by complex financial schemes such as the one Oxnard used. These nontraditional debt vehicles cost more over the long run because they are considered riskier than general-obligation bonds, which governments stand fully behind. Investors therefore demand higher interest rates.

"There are many cities and counties engaging in complex financial deals that they don't really understand," said Michael Greenberger, former head of the trading division of the Commodity Futures Trading Commission. "And now it's starting to catch up with them."

Government officials say such measures were necessitated by Proposition 13, the 1978 initiative that limited property taxes and required a two-thirds vote for future property tax hikes. Local governments can raise various fees or cut costs to reduce their need for borrowing, but many are reluctant to do so, fearing a voter backlash.

"Instead of saying we don't have enough income to do what we need to do, we've resorted to debt," said Jean Ross, executive director of the California Budget Initiative, a nonpartisan group that studies the state's budget priorities. "It's time for elected officials to have an honest conversation with voters about what their tax dollars can buy."

Sleight of hand

Oxnard's sale of its streets in December 2007 was a variation on a borrowing technique known as a lease-back.

In a typical example in the private sector, a business sells a property to raise money, then leases it back from the buyer. In the public sector, lease-backs are more a financial sleight of hand. A city council that needs to raise money might sell its city hall to a council-controlled finance authority. The council would then rent, or lease back, the building from the finance authority.

The authority, meanwhile, would issue bonds using the city hall as collateral. It would pay back the bondholders with the "rent" it collects from the city.

The sale of the building is a legal abstraction, a shuffling of paper whose purpose is to keep the debt off the city's books. That way, officials can circumvent the state Constitution's requirement of voter approval for government borrowing.

"The reason they enter into these leases is so that they don't have to get the debt voter-approved," said John Kim, an advisor with Los Angeles investment bank De La Rosa & Co. who has set up lease-back deals for a number of California cities. "They're so popular that a lot of cities then run out of assets to lease."

Oxnard is one of Kim's clients. In 2007, the city wanted to issue bonds to finance part of its $150-million street repaving project, using its share of state gas tax revenue to repay the debt. But the state Constitution says local governments can't issue debt against that revenue.

That's where Kim came in. His plan: The Oxnard City Council would sell the streets to the Oxnard Finance Authority, which consists of the council and mayor. The Finance Authority would issue bonds to raise money for the improvements and repay the bondholders by selling the streets back to the city.

Where would the city get the money to buy the streets? From its gas tax revenue.

"If you had to get a vote on everything, it would take a lot of time and there would be no guarantee that the voters would approve the debt," Oxnard financial services manager Michael More said. "Otherwise we would have to use a pay-as-you-go approach to every project, and we could never come up with enough money."

Recognizing the novelty of the approach, and facing some local opposition, Oxnard ran the strategy past state Atty. Gen. Jerry Brown.

Brown gave the green light, and De La Rosa & Co. -- which collected $300,000 in fees from Oxnard -- had a winning formula. The investment bank has since helped the cities of Santa Ana, Coachella and Indio come up with similar street deals, none of which went to a public vote.

"They're circumventing the intent of the law," said Larry Stein, an Oxnard accountant and longtime city activist. "They're indebting the taxpayers using future revenue streams that may or may not pan out in the long run. But the taxpayers have no say."

Of more than 10,000 bonds and other debt vehicles issued between 1998 and 2007, fewer than 700 went to a public vote, according to the state treasurer's office.

Legal trouble

It isn't just voters who are often left in the dark. The investors who lend to local governments are not always given a clear picture of the borrower's finances.

In April, the Securities and Exchange Commission accused the city of San Diego of misleading investors about its finances when selling more than $260 million in bonds. The SEC has asked a federal judge to fine the city, without specifying an amount. San Diego officials have denied the charges and are fighting the case in federal court.

"The fictions that are put together to fund the construction of public buildings and to cover these budget gaps are astounding," said Mattie Scott, a Monterey attorney who was hired by the Richmond School District to help it untangle its legal problems before it filed for bankruptcy protection in 1991.

Many cities pass their bond funds through technically separate public financing authorities, housing authorities, utility authorities or special taxing districts. The use of such entities makes it difficult for the public to assess a city's debt load.

Whether it's such a pass-through deal or a lease-back, bond buyers demand a higher rate of return for complicated deals.

The California Legislative Analyst's Office has estimated that the state government's use of lease-back deals costs as much as $370 million more for every $1 billion in debt than the use of general-obligation bonds. The report was issued in 1995, and finance experts say the added cost is probably greater now because the deals have become more complicated.

Chula Vista is an example of what happens when a city gets hooked on debt.

Between 2000 and 2007, the city in San Diego County took on $648 million in new and refinanced debt to build a city hall, a police headquarters and other projects, including a segregated dog park to keep the terriers from nipping at the Dobermans.

None of this debt was issued with voter approval. The City Council presumed that rising revenue would allow it to pay the debt. Then came the economic downturn, and Chula Vista now is cutting furiously to meet its obligations.

It has shrunk the budget by $30 million, or 17%, since mid-2006. Lost were library hours, senior programs, 200 jobs. Even the popular Fourth of July festivities were crossed off the calendar. More cutbacks may be on the way. The city is looking at a $20-million shortfall in the current fiscal year.

"We were growing so rapidly that the need to build these facilities happened quicker than people had anticipated," said Maria Kachadoorian, the city's finance director. "But now the growth has stopped, and we don't have the money coming in to cover a lot of our costs."

william.heisel@latimes.com



http://www.latimes.com/business/la-fi-citydebt31-2008dec31,0,4128886,full.story

Last Updated: Jan 01, 09

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