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IOUs pave the streets

More cities struggle to pay off financing schemes

December 31, 2008|William Heisel

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.

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