AMERICA´S MUNICIPAL DEBT RACKET / THE WALL STREET JOURNAL OP EDITORIAL ( VERY HIGHLY RECOMMENDED READING )

OPINION

JUNE 14, 2010.

America's Municipal Debt Racket

State and local borrowing as a percentage of U.S. GDP has risen to an all-time high of 22% in 2010.

By STEVEN MALANGA

New Jersey officials recently celebrated the selection of the new stadium in the Meadowlands sports complex as the site of the 2014 Super Bowl. Absent from the festivities was any sense of the burden the complex has become for taxpayers.

Nearly 40 years ago the Garden State borrowed $302 million to begin constructing the Meadowlands. The goal was to pay off the bonds in 25 years. Although the project initially went according to plan, politicians couldn't resist continually refinancing the bonds, siphoning revenues from the complex into the state budget, and using the good credit rating of the New Jersey Sports and Exposition authority to borrow for other, unsuccessful building schemes.

Today, the authority that runs the Meadowlands is in hock for $830 million, which it can't pay back. The state, facing its own cavernous budget deficits, has had to assume interest payments—about $100 million this year on bonds that still stretch for decades.

This tale of woe has become familiar in the world of municipal finance. Governments have loaded up on debt, stretched out repayment times, and used slick maneuvers to avoid constitutional borrowing limits. While the country's economic troubles have helped expose some of these practices, a sharp decline in tax revenues has prompted more abuse as politicians use long-term debt to kick short-term fiscal problems down the road.

It hasn't always been this way. Government debt has long fostered the expansion of the American republic, helping to build roads, bridges and water works to serve a growing population. But there have also been spectacular failures. In the mid-1970s, New York City almost defaulted on its debt after it used borrowing to fund an aggressive and ultimately unaffordable expansion of services (like the nation's most generous Medicaid program) inaugurated by Mayor John Lindsay. Gotham was bailed out by New York State and the federal government. But Cleveland, whose spending outpaced tax revenues thanks to borrowing, did default on $14 million in bonds in 1978.

The 1970s debt crises woke politicians up. Over the next 20 years the municipal fiscal picture improved, with debt rising only slightly. But memories of past busts have since faded, and outstanding debt has soared to $2.2 trillion today from $1.4 trillion in 2000. State and local borrowing as a percentage of the country's GDP has risen to an all-time high of 22% in 2010 from 15%, with projections that it will reach 24% by 2012.

Even more disconcerting is what the borrowing now often finances. One favorite scheme for muni debt is giant and risky development projects.

California's redevelopment regime is an object lesson. Starting in the 1950s, the state gave localities the right to create public agencies, funded by increases in property taxes, which can issue debt to finance redevelopment. A whopping 380 such entities now exist. They collect 10% of all property taxes—nearly $6 billion annually—and they have amassed $29 billion in debt never approved by voters for projects ranging from sports facilities to concert venues to retail malls, museums and convention centers.

Critics, including taxpayer groups, say most such agency projects add little economic value. Sometimes the outcome is much worse. In 1999, Fresno conceived plans to revive its downtown area with various projects, including a baseball stadium for the minor-league Grizzlies, which it had lured from Phoenix. The city's redevelopment agency floated some $46 million in bonds to build the stadium. But the Grizzlies fizzled in their new home, demanded a break on rent, threatening to skip town and stick taxpayers with the entire $3.4 million annual bond payment on the facility. The team is now receiving $700,000 in annual subsidies to stay in the city.

Adding to the city's woes: Last June, another development project, the Fresno Metropolitan Museum, went bust, leaving the city's taxpayers on the hook for three-quarters of a million dollars in annual debt payments.

Cities now also use taxpayer-financed debt to engage in fierce bidding wars that benefit private enterprises. Charlotte, N.C., for instance, won the bidding for the new Nascar Hall of Fame with a $154 million offer, funded by a new hotel tax dedicated to servicing bonds for constructing the hall. But the venue employs only about 115 people—and an economic development study estimated the increased annual tourism from the venture won't even equal what a single Nascar race generates.

Why did politicians offer the deal? For the dubious and hard-to-quantify purpose of "branding" the city with a major attraction, according to the Charlotte Observer.

Voters have wised up to the failings of many grand, politically inspired projects, and when given the chance they've defeated new taxes and borrowing for them. But much state and local debt now exists in independent authorities whose borrowings are not subject to voter approvals. Some of these agencies have operated recklessly.

In 2000, Massachusetts moved to make the entity that runs Boston area mass transit, the Massachusetts Bay Transportation Authority, financially independent. As part of the plan the authority was supposed to gradually pay down some $5.6 billion in debt and use cash from operations to finance capital projects.

Instead, the agency deferred payments on its debt, put off capital projects, and borrowed more money, so that it now owes $8.5 billion. Today, the authority is paying a staggering $500 million yearly in debt service, forcing it to neglect maintenance, shelve expansion plans, and cut service. Even so, last year the agency needed a $160 million bailout from taxpayers to close a budget deficit.

Another weapon in the debt arsenal is the so-called pension-obligation bond. For two decades, governments have played a risky arbitrage game in which they issue bonds and then deposit the money in their pension funds to be invested in the stock market with the hope that the money will outperform the interest rate on the bonds. In a stock market that's been stagnant for years, pension bonds have become fiscally toxic. As the Center for State and Local Government Excellence noted in a report earlier this year, most pension bonds issued since 1992 have been money losers for states and cities, exacerbating severe underfunding of pension systems in places like New Jersey.

These abuses came to a head in the second half of 2008, when spooked investors were unwilling to bet on more municipal debt after several insurers who typically back these bonds exited the market. Then Washington stepped in with a new Build America Bond (BAB), allowing states and municipalities to issue them. Thanks to a federal subsidy, they carry attractive interest rates. Last year municipalities used BABs to rack up another $58 billion in debt.

Taxpayers are only slowly realizing that their states and municipalities face long-term obligations that will be increasingly hard to meet. Rick Bookstaber, a senior policy adviser to the Securities and Exchange Commission, recently warned that the muni market has all the characteristics of a crisis that might unfold with "a widespread cascade in defaults." If that painful scenario materializes, it will be because we have too long ignored how some politicians have become addicted to debt.

Mr. Malanga is a senior fellow at the Manhattan Institute and the author of "Shakedown: The Continuing Conspiracy Against the American Taxpayer," forthcoming from Ivan R. Dee. This op-ed is adapted from the forthcoming issue of City Journal.

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