2004 San Jose City Council Campaign: Enron-style financing of City Hall
A good way to look into the Enron-style financing practices of the city council is to review how these techniques interface with the design and construction of the new city hall. In the interest of full disclosure, let me say that I was one of the three signers of the ballot argument against the proposal (Measure I) that permitted the city council to move city hall. (The other two signers were Kathy Chavez Napoli and Robert C. Becklund.)
Once Measure I was approved in November 1996, the city council immediately set to work to secure construction of a new city hall, a non-critical structure if there ever was one. (If the same energy went into improving streets, trees, creeks, parks, sidewalks, education and training facilities, neighborhood libraries, and firefighter stations, this city would be a paradise.)
Redevelopment Agency Funding Sought
Even though state law explicitly bars use of redevelopment agency funds for building new city halls, the city council at once sought to use redevelopment (blight control) funding to build the new city hall.
Were it not for former Mayor Al Ruffo, who brought a legal action against the city to require it to obey the redevelopment agency law, we would have been witnesses to an Enron-style, totally illegal misappropriation of redevelopment agency funds to build the new city hall.
Lease Revenue Bond Funding Sought
Next, the city council went to its fallback financing strategy, the use of lease revenue bonds to acquire the money to build the new city hall. Lease revenue bonds are issued by an agency of the city (the financing authority) to raise money to construct, repair, or improve a capital asset that generates revenue. So, for example, and theoretically, lease revenue bonds could, more or less, legitimately be issued for a money-making ice skating rink or a fee-paying convention center,
the idea being that the revenues raised by the capital asset would pay off the principal, interest, and costs of the bond issue over time.
There is no vote by the public on these bonds, just as there is no vote by the public on redevelopment agency bonds.
The city council, however, decided on the legal fiction that the current city hall on North First Street was just such a revenue generating asset by leasing the current city hall to the financing authority for a fee, and then by leasing back the current city hall from the financing authority for a different fee.
Theoretically, because the transaction was for different rates, an income stream was created from the city to the financing authority which would satisfy bond buyers who went ahead and bought millions of dollars worth of bonds from the financing authority, and the money was used, more or less, for the design costs of the new city hall.
This is not the use that the state statute intended financing authorities to be used for.
A Word About The Financing Authority
The financing authority is an artificial agency authorized under state law for situations when two existing entities (like the City of San Jose and the County of Santa Clara) wish to have a means for issuing lease revenue bonds for a shared revenue-raising, joint capital project.
San Jose has construed the law to mean that the city and its own redevelopment agency can be the two legal entities entitled to create a financing authority, which it did in December 1992. A court may, of course, find this to be an illegal use of the statute that allows financing authorities because there is no genuine difference between the governing board of the city (the city council members), the redevelopment agency (the city council members), and the governing board of the financing authority (the city council members).
Yes, this is very similar to the statute-bending techniques used by Enron.
New Lease Revenue Bonds Last Year
I've explained that the first set of lease revenue bonds depended on the legal fiction that the old city hall was a revenue generating capital asset with a revenue stream that satisfied bond buyers of bonds to acquire funding for the design stage of the new city hall.
In 2002, the city council created a new legal fiction by using the physical state of the new city hall itself (a very large hole on Santa Clara Street) to become the new revenue generating capital asset through the same lease/lease back device. New lease revenue bonds were sold by the financing authority for construction purposes of the new city hall (the design phase having ended).
Why No Interest Or Principal Payments Shown In The City Budget?
Interest payments and principal repayments will come out of the general fund, of course, for these lease revenue bonds, but the city has constructed an Enron-like repayment plan to keep the indebtedness off the city's budget for four or five years by the simple device of not paying back any interest or principal out of the general fund during that time. This keeps the costs of this financing out of the public eye until the last year of the mayor's final term in office. It's just like Enron's off-the-books debts.
This is done by the device of "capitalized interest." This scheme means that all interest payments and principal repayments for the next few years come from new capital investment. That is, more bonds are sold to pay interest and principal to prior bond holders. This used to be called a Ponzi scheme, but no one in city government questions it.
Financial Cost Of New City Hall Versus Construction Cost
According to the city's own figures, the total financial real cost of designing and building the new city hall will be $452 million in principal plus $342 million in interest, for a grand total of $794 million -- all to acquire a new city hall costing out at $343 million for design and construction.
Lease Revenue Bonds Overall
These lease revenue bonds (with the lease/lease back formula) are an extremely dangerous form of municipal financing and can easily come back to haunt city taxpayers who will have to bail out the city for these bonds (A) through loss of public services ordinarily supposed to be paid by the general fund, (B) by the creation of a multitude of special purpose districts with taxing authority, or (C) by demands for new parcel taxes.
A good question to ask about all this Enron-style financing is why the San Jose Mercury News and elected officials never report on it in depth in news articles, newspaper columns, email messages, or mailed newsletters. Could our media and elected officials be failing us in not pressing the city for reform in this highly important area?
A leader would lead on financial reform.