As Shakespeare tells the story in his famous play Hamlet, the Prince of Denmark (Hamlet) wanted desperately to impart some fatherly wisdom to his son who was leaving for a trip to France (perhaps for a junior year abroad?) when he uttered the immortal phrase “[n]either a borrower nor a lender be, for loan oft loses both itself and friend…” Where is Hamlet when we need him today?
The Governor and just about every other source tell us at least two (if not actually three) of the legislative leaders are flirting with the idea of the state incurring more operating debt by borrowing from a wide range of local government and other voter approved and protected funds. Some legislators and legislative staffers are even saying as recently as yesterday that the state would even pay local governments’ costs to “securitize” the state’s promise to repay them. Does it sound too good to be true? It is and it’s also reckless and expensive.
Fortunately Governor Schwarzenegger and Senator Perata remain staunchly opposed to more borrowing, saying the state can’t afford more operating debt (remember the outstanding Economic Recovery bonds?) and pointing out correctly that it will deepen the state’s already damaging structural deficit. They are right for another very important reason, however, that no one is talking about yet: borrowing from these protected funds is prohibitively and outrageously expensive for taxpayers, and it is important that the full story be told.
Both 2004 Proposition 1A (protecting property taxes) and the 2006 Proposition 1A (protecting the sales tax on motor fuels) passed by overwhelming majorities–84% and 77% respectively. The voters clearly expressed a preference for protecting these important sources of local and state funding—except in times of dire emergency.
Both ballot measures have provisions that allow the legislature to “borrow” these funds for up to three years if the Governor declares a “severe state fiscal hardship” and the legislature passes a statute that provides for full repayment of the revenue loss within three years “…including interest as provided by law.” As Shakespeare had Hamlet say, however, “aye, there’s the rub!” The interest cost for such loans is staggering.
According to Bloomberg, the current interest rate on a 3-year U.S. Treasury Note is 4.875%.—the rate at which our federal government can borrow money from investors. In comparison, Article 15, Section 1 of the California Constitution requires the legislature to repay any amounts “borrowed” from local property tax and transportation funds at a fixed interest rate of seven (7) percent per year during the life of the loan—a 2.125% premium for the privilege of borrowing from local governments.
Moreover, for those who are recklessly stating that local governments could easily “securitize” the “loan” repayment obligation of the state, nothing could be further from the truth. The facts are that borrowing against the state’s promise of repayment would be outrageously expensive—possibly as much as 15% of the cost of the amount “borrowed.”
In 2003 when the VLF “trigger” was pulled, eliminating the VLF backfill payments to cities and counties of $1.2 billion for June 20 – October 30, 2003, the state agreed to repay this amount over the next three years. The legislature passed special legislation authorizing cities and counties to securitize the promise of repayment, but only 146 cities and counties (of the approximately 500 affected) opted to do so–selling “VLF backfill securities” to investors through a statewide JPA that serves local governments.
The VLF backfill securities were issued at the lowest possible cost, with fees only covering minimal legal work, underwriting and bond insurance. The bond insurance was necessary because investors needed assurance that the fiscally troubled state government would indeed repay local governments (and them). Even with bond insurance lowering the cost of issuing the securities, the total costs equaled approximately 8% of the total amount, meaning local entities were only able to collect 92 cents on the dollar owed by the state.
Would it be reasonable to expect the same costs today? It would if you didn’t know about the drastic changes in both the bond insurance industry and the chaos in the bond market in general since the subprime mortgage crisis caused certain insured bonds to lose significant value and most bond insurance companies to become insolvent. The bond underwriters who handled the 2004 VLF financing tell us today that these changes in the market could result in total costs equaling 10 – 15% of total loan amount, with the higher figure being more likely.
What does all this mean for the legislature, cities and counties? First, it means that the state will have to pay, at a minimum, a 7% annual interest premium if it borrows local property taxes or transportation funds to finance its operating deficit. Moreover, it means that if a local agency is so strapped for cash due to the “loan” to the state that it must sell (i.e., “securitize”) the state’s loan repayment commitment (or receivable), the state could face an additional costs of 7– 12% for the securitization (after discounting the anticipated interest cost on the security by approximately 3%)—or 14 – 19% total. We know that whether securitization costs are borne by the state or local governments, the same taxpayer pays. Any way you look at it, it stinks and sounds like a really bad credit card interest rate. It also sounds unconscionable, reckless and irresponsible.
The legislature should join the Governor and Senator Perata in rejecting these financially irresponsible borrowing schemes and use the traditional, tried and true, tools policy makers have used for centuries to make sure operating costs and revenues are in line: balance spending and revenues by making tough choices about spending and revenues. There are no easy choices—simply responsible and irresponsible ones. Borrowing for operating expenses clearly falls into the latter category.
“Neither a borrower nor a lender be…”