Revenue Bonds Issued by State and Local Governments Are Not Backed by Taxpayer Guarantees – Unless They Are

But If They Are – No Taxpayers Get Told

A Short But Painful Lesson in Municipal Finance

Generally speaking bonds issued by state and local governments come in two flavors.  General Obligation or GO bonds are back by the full faith and credit of the governmental unit, and are the obligations of the taxpayers.  Revenue Bonds are issued to support specific projects, and are backed by the revenues (and assets) from those projects, hence the name.  The attractive part of Revenue Bonds is that the taxpayers are not on the hook for the obligations.

But it turns out many local governments and state governments have put taxpayers on the hook for Revenue Bonds, and, oh yes, forgotten to mention it to the voters.

Surprised local taxpayers from Stockton, Calif., to Scranton, Pa., are finding themselves obligated for parking garages, hockey arenas and other enterprises that can no longer pay their debts.

Officials have signed them up unknowingly to backstop the bonds of independent authorities, the special bodies of government that run projects like toll roads and power plants.

In all but a few situations this does not really matter, because the project can support the debt.  But when the project cannot support the debt, uh oh.

With many cities now preoccupied with other crushing costs — pension obligations, retiree health care, accumulated unpaid bills — a sudden call to honor a long-forgotten bond guarantee can be a bolt from the blue, precipitating a crisis. The obligations mostly lurk in the dark. State laws requiring voter pre-approval of bonds don’t generally apply to guarantees. Local governments typically don’t include them in their own financial statements or set aside reserves to honor them.

Case in point is Scranton, Pa. where the city at first refused to honor its guarantees.

Scranton’s version of a debt crisis began when a local parking authority said it couldn’t make a bond payment coming due in June, calling on the city’s guarantee. The authority had issued bonds in 2004, 2006 and 2007 to finance parking garages that the city had used in a campaign to woo Hilton Hotels and Resorts to operate a conference center downtown.

Each time the authority issued more bonds, the city backed them with a powerful “full faith and credit” guarantee. But by 2008 the authority had $54 million in bonds outstanding, and was spending about 60 percent of its budget on debt service — so much that it could not cut parking rates to compete with private companies that set up cheaper parking lots nearby.

A majority on the City Council refused to honor the guarantee, saying the authority’s finances were in disarray and they wanted to strike a blow for fiscal rectitude.

That did not turn out well.

Suddenly, Scranton, which has been in dire fiscal straits for years, was a pariah. Only one bank had been willing to help it raise money, and it backed out of a $16 million deal to provide short-term financing. Without that cash, the mayor said Scranton couldn’t make its next payroll. The city’s fuel supplier threatened to halt deliveries of gasoline, which would idle the police cars and garbage trucks. More than a dozen other vendors cut off the city’s credit.

A bond insurer, Radian Asset Assurance, started a 30-day countdown to foreclosure on the authority’s parking garages. The trustee for the bondholders, Bank of New York Mellon, warned that it would get a court-ordered tax increase.

Taken aback, the mayor and City Council changed course, saying Scranton would pay the parking authority’s debts after all. But the damage was done. The initial decision to not make the $1 million bond payment had tainted Scranton’s credit on all of its debts for the foreseeable future.

A large part of this is taxpayer’s fault.  No it is not their fault that they were not told or warned of the off the books guarantees, it is their fault because they voted for craven politicians who promised near unlimited government services and projects with no tax increases. 

And no, most voters have still not learned that lesson.