Bonds, Bankruptcy and Bad Luck
When a public-purpose project fails, should taxpayers pick up the bill?
What happens in Vegas, doesn't necessarily stay there -- at least not when it's a court ruling that deals with bankruptcy, tax-exempt bonds and an infrastructure project that isn't paying for itself. Any state or locality that issues municipal bonds for public-purpose projects that are built and run by private corporations will find this case of interest. How closely are the government's fortunes and obligations tied to the welfare of the project?
The case in point: Las Vegas' Monorail, a 4-mile-long transit system that runs from one end of the hotel- and casino-filled strip to the other. The company that built the monorail and now operates it, Las Vegas Monorail Company, is responsible for repayment of the $650 million tax-exempt bond, which was issued under the auspices of Nevada's Department of Building and Industry and insured by Ambac. With ridership falling below forecasts -- the Great Recession took a toll on Las Vegas hotels and casinos -- LVMC has run into financial difficulties. More precisely, although fares bring in enough to cover operating expenses, there's not enough money coming in to repay bondholders.
LVMC, a private, nonprofit entity, has filed for bankruptcy under Chapter 11. But Ambac, the company that insured the bonds, believes that LVMC should file for bankruptcy under Chapter 9, the section of the bankruptcy code that applies to government entities. Under Chapter 9, bondholders and bond insurers have a history of being treated more favorably.
This argument landed LMVC and Ambac in court. In its motion, which was joined by Wells Fargo Bank, Ambac argued that Las Vegas Monorail has a franchise agreement with the county and that the state's governor has authority to appoint and remove board members -- and that means LVMC is a public entity for purposes of the bankruptcy filing. "Since these are governmental-purpose bonds, the debts need to be adjusted in a forum in which the state of Nevada at least participates," William Smith, an attorney representing Ambac, said. "The bonds could only have been issued if this was an instrumentality of the state of Nevada."
Nevada sided with LVMC. In a brief filed by the state building and industry department, the state argued that it is common for essentially private corporations to take advantage of tax-exempt financing "without rendering them 'governmental units' or 'municipalities' within the meaning of the Bankruptcy Code." Further, the state argued, "an entity may enter into agreements to take advantage of tax-exempt bonds without rendering itself an instrumentality of the state for all purposes." Taxpayer groups were also concerned about the suit, fearing that citizens would end up bailing out the monorail.
All those arguments came to a head in a decision released by the bankruptcy court at the end of April. The judge ruled that while LVMC serves a public purpose, one that requires an analysis of the state's level of control over the company, Nevada's ability to control LVMC was "attenuated" and that LVMC "operates its day-to-day business in significant isolation from the State." Bottom line: "The state has exercised a 'low level' of control which did not rise to the level required for LVMC to be deemed a municipality."
The monorail is not the only infrastructure project backed by muni bonds that may end up bringing its host state or city into bankruptcy court. South Carolina's Greenville Southern Connector toll road -- a 16-mile, four-lane beltway -- defaulted in January on a $200 million bond debt and was, according to a report in February by a bond trustee, considering a bankruptcy filing under either Chapter 9 or Chapter 11 to restructure its debt. The toll road was built as a public-private partnership between the state's department of transportation and a nonprofit corporation.
Over in Pennsylvania, the Harrisburg City Council is also struggling to pay off debt for the city's incinerator, which was financed by a tax-exempt bond. The city guaranteed a portion of the bond; the other portion was insured. That guarantee has left it liable for $68 million in repayments in 2010, an amount that is several million more than the city's operating budget. Recently, the council voted down a proposal to sell assets to cover debt payments. Officials say they may not meet the obligation.
The Great Recession has taken a toll on bonds for the private developers of a public-purpose project. In 2007, 31 tax-exempt issuers defaulted on $348 million of bonds. Last year, the numbers were up to 183 defaulting on $6.35 billion of securities, according to the Distressed Debt Securities Newsletter. In the past, a state or city might have stepped up to help out, but now the states are in too much fiscal trouble to lend a hand. Whether this inability to intervene will slop over into a lesser view of a state's credit-worthiness on its own bonds remains to be seen.
Economists agree: the Great Recession is over. They also agree we'll see a sluggish return to health. And nowhere has it been more sluggish than on the economic factors that most affect state and local revenues: retail sales, housing prices and jobs. So where are the glimmers of hope?
On retail and spending: The Redbook index, which tracks national retail sales growths and declines, reports a picked-up pace -- 3.3 percent year over year in the first week of May. That gain was higher than the previous week's and better than April's 2.4 percent. Real consumer spending picked up in the first quarter -- a 3.6 percent jump at an annual rate -- thanks to increased business confidence, a stabilizing labor market and improvement in the economic outlook. Not to look a gift horse in the mouth, the question is whether Q1 numbers have been exaggerated because of pent-up demand?
On income: The private sector began hiring again in April with private payrolls rising by 231,000 with the government adding an additional 59,000 jobs. Thanks you, U.S. Census.
On housing: Although housing prices won't be returning to their 2005 peak any time soon, housing permits and housing starts have been climbing in the past couple of months. In March, new home sales were higher than they had been for a while.