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AFTERSHOCKS - PHYCHIC AND OTHERWISE : The Public Investment That Built America

January 30, 1994|Felix G. Rohatyn | Felix G. Rohatyn, senior partner at Lazard Freres & Co., is the former chairman of the Municipal Assistance Corp

NEW YORK — The disaster created by the Northridge earthquake, together with continuing pressures to curb domestic federal spending, have forged a political opportunity to deal with both problems.

California, already financially strained be cause of its weak economy, must now spend billions of dollars to rebuild roads, bridges and other infrastructure damaged by the quake. There will be a sterile argument in Congress about whether disaster relief should be offset by spending cuts or treated as an "off-budget" item. What California, along with every other state in the Union, needs is federal assistance in the form of public investment.

Such public investment, if properly financed, should never be part of the federal budget. The fact that investment in a school building or a bridge is treated as if it were next week's welfare payment is economic nonsense. But like so much economic nonsense, it has strong political support. An attempt should now be made to step away from this trap by creating a free-standing, independently financed public corporation to assist state and local governments with their investments.

An aggressive, long-term federally assisted public-works construction program is an economic and social necessity. Investing $25 billion to $35 billion annually could generate from 800,000 to 1,000,000 jobs each year; could be part of a targeted defense-conversion plan and, if combined with Civilian Conservation Corps-type training camps, could provide training and employment for inner-city youth. It would also be psychologically uplifting at a time when fear of new layoffs in the private sector, as well as of cutbacks in state and local governments, is pervasive.

The challenge is to create a structure that could serve as the centerpiece for such a program. New York's Municipal Assistance Corp. could be a useful model.

MAC was created, in 1975, by the state of New York to provide financing for New York City, then in serious financial difficulties. Between 1975 and 1984, it raised nearly $10 billion. Through the sale of MAC bonds, backed by a portion of the city sales tax, New York City was able to significantly increase its investment in its physical facilities. Since 1985, MAC has been paying down its debt and will retire its bonds by 2008.

A similar approach, using a longer time frame, should be adopted at the federal level. We need not start with the largest possible program. Rather, the initial goal should be limited, though capable of expansion if the program works. To illustrate, let's consider a $200-billion, 10-year effort.

The federal government would create the "Public Investment Assistance Corp." with authorized capital of $20 billion and $200 billion of borrowing authority. The PIAC would provide incremental financing to state and local governments over a 10-year period on a matching-fund basis. Washington would contribute 80% of the funds, which would be generated by sales of PIAC bonds, guaranteed by the U.S. government. The remaining 20% would be provided by participating states on an equity basis reflecting their distribution share--for example, a state eligible for 4% of the funds would be responsible for 4% of the capital.

Revenues could perhaps be generated by raising the federal gasoline tax by 2 cents a year for five years--equaling about $2 billion annually. The revenue stream, which would build to $10 billion to $12 billion a year after five years, would support a 10-year, $200-billion borrowing and investment program and fully service and retire the outstanding bonds after 40 years. The federal guarantee would only come into play if Congress interrupted the revenue stream. The debt-service coverage should result in an investment-grade rating for the bonds--which would make them eligible for pension-fund investment.

Right now, the total amount of private and public pension funds is about $3 trillion. This is expected to double over the next 10 years. A $200-billion, 10-year, public-investment program could be entirely funded by the commitment of less than 10% of the increase in pension funds becoming available over the same period.

Naturally, the bonds would have to meet the most stringent fiduciary standards; they could also be sold to the general investing public. The only federal budgetary cost would be the value of the guarantee (no more than 1% to 2% of principal) and the PIAC cash flow and borrowing should be totally off-budget. A strong control mechanism, such as MAC's board of directors--consisting entirely of independent, private-sector directors--would insure funds were used prudently.

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