Entrenched debt

Entrenched debt

As a going concern, the business produces profit and cash flow to repay a loan without betting on the come. In terms of poker, a come hand is a hand that needs to improve with a draw. Betting on the come simply means that you’re betting on a hand that you don’t yet have. You expect it to materialize when you draw a card.

—Accounting, Finance and Presentation for Small Business by R. Blake Hendrix

The Reno City Council was in a 10-minute break. After making a phone call, Councilmember Jenny Brekhus sought out city finance director Robert Chisel and chatted for a few moments. Soon they were laughing. It probably took the edge off the tough questions Brekhus had needed to ask Chisel during the meeting, particularly during agenda item G2, the latest patch on the financing for the Reno railroad trench that had been built at the behest of downtown casinos.

One of her questions: “Have you ever seen bond documents like that?”

The council at that Aug. 14 meeting was dealing with what amounted to the second re-financing of the bonds for the huge project of lowering the railroad tracks through Reno into a trench, a project launched with some shadowy maneuvers in 1998 and completed in 2005. Trains now run through the trench, but no one can say when the bonds will be paid off. And that is unfortunate, because at one time, everything was—please excuse this verbiage—right on track.

“If you look at the original financing package for the train trench, it was done,” Brekhus said in an interview. “It was set. And they went to the credit markets, and Goldman Sachs, [for] an instrument that kind of takes money out. … It was almost like, you know, you had your house paid for, and they re-fi’d it, basically. That’s what happened with the trench.”

She wasn’t describing the original trench bonds, nor was she describing the new trench bonds that were at issue at the August 14 meeting where she questioned Chisel. She was describing a second set of bonds that created problems that had to be solved with the third set.

“And that’s not these [current] bonds here,” she said. “These bonds were to get out of that instrument that was the re-fi.”

For decades, there had been debate in Reno about doing something about the ground-level railroad tracks. Originally, they ran parallel to—and created—Reno’s main street, Commercial Row. But as the city evolved, Virginia Street became the main street. Instead of running alongside the main street, the tracks now crossed it.

For much of the city’s history the railroad was its lifeline, bringing tourists and divorce seekers in an era when there were no coast-to-coast highways. But in more recent decades, they became an aesthetic problem and the new casinos hated them—not enough to pay to do something about it, but enough to pressure city governments to tax residents to pay to do something about it.

In 1980, it finally appeared on the ballot. But led by Mayor Barbara Bennett, who said that if the casinos wanted the tracks changed they should pay a substantial portion of the tab, residents voted it down by a landslide. There the matter rested until the late 1990s, when the casinos used a railroad merger to press the urgency of lowering the tracks.

Once again the casinos would not pay for it, so officialdom put together a package of sources—a one-eighth sales tax hike, a hotel room tax, a downtown assessment district, city bonds and federal money. The railroad offered $17 million, but mostly in land. And the one-eighth sales tax hike was actually a one-fourth hike—the extra money was part of a deal to bring the Washoe County Commission on board and would be used for flood control. The $119 million in bonds was guaranteed by sales and room taxes.

The project was designed to cost $218 million. It ended up costing $265 million.

Many residents assumed, apparently naively, that because the voters had turned down the project previously, any revival would go before the voters. That was a particular concern because of how many residents objected not to the project but to how it would be financed. In fact, city and council officials carefully planned how to avoid a public vote.

But there was another way for the public to be heard. It was through other lines on the ballot.

The trench project had to be a city/county project and in the November 1998 election, the big issue in county commission races was the casino trench. The incumbent commissioners had cast preliminary votes for the trench, even though it meant communities like Washoe City, Lockwood and Gerlach would end up paying higher taxes for a Reno project. (Three years later, Reno Mayor Jeff Griffin complained in these pages that Reno citizens were paying for county services that they didn’t get. “Reno wants its money back” by Jeff Griffin, RN&R, June 7, 2001).

But the incumbent county commissioners put off a final vote until after the election, hoping for some political cover from voters. They didn’t get it.

Trench supporters Mike Mouliot and Sue Camp were defeated by Ted Short and Pete Sferrazza, who both opposed the trench unless residents were given a vote. (A one-eighth cent sales tax in Las Vegas that same month was approved by voters.)

In spite of the election results, trench backers raced to use the votes of the two lame duck commissioners before their terms ended to ram the sales tax hike through the Washoe County Commission, and then sell the bonds before courts could stop it. That’s exactly what happened.

The trench was an unusual project. Bowling alleys and convention centers are revenue producers. But the city was now planning to pour a whopping $265 million into a project that would produce no revenue but would please the casinos, who reportedly wanted to shield the guests in their hotels from train whistles. It was quite a commitment.

In 2006, the city converted the first set of trench bonds to auction rate securities, which Chisel describes as “a long term bond with short term rates. … Short term rates are usually lower interest rates. And so the idea would be to take advantage of those lower rates, and so every 45, 60 days—depending on your auction rate security—the bond would be kind of resold on the open market.”

What bothered Brekhus was that she believed that the old council took money out from the second set of bonds as a result of the lower interest rates “to do the sort of projects that the council wanted at that time.”

“There was some money taken out, I believe, for some [trench-] related projects,” Chisel said last week. “I think, you know, some artwork, and maybe some other items like that.” He said all spending from those funds had to be related to the trench, though he acknowledged that all kinds of things could fall under trench spending, such as anything within the acreage involved in the trench project.

And the downtown casinos were not finished running up city debt, nor was officialdom at an end of going along with the casinos’ wishes. Having given the casinos the trench, the city then issued $120 millions in bonds to pay for a casino-demanded events center (and to pay off bowling stadium debt) for which the casinos didn’t want to pay.

In both the trench and events center project, the city was throwing money at the downtown’s declining casino center, at a time when it was the outlying casinos that were showing dynamism and growth.

The second set of bonds resulted in a lawsuit by the city against Goldman Sachs. Chisel said, “And this is the issue we had with the auction rate securities—there really was not a market for [them]. It was a false market. … Goldman was doing it themselves. And so it was creating the impression that there was a market.”

It was during this period that the recession began. No state was more damaged by it than Nevada, which had the highest foreclosure rate in the nation. Businesses were closing. For half a century Nevada had been the fastest growing state. Now people were leaving. Retail goods sales plunged, and the sales tax was the means of repaying the bonds.

In 2008, there was a third set of bonds issued to replace the previous two. “This issuance refunded the 2006 bonds to a variable rate demand bond issue with credit enhancement and liquidity backing through the LOC,” according to a city memo. “This action was successful in reducing the city’s interest rate exposure associated with auction rate bonds during the collapse of the financial markets.” (Incredibly, during the conversion, the casinos got a tax break—the room tax was dropped as a bond repayment source.)

The recession was taking its toll. The sales tax was falling short of debt service on the bonds, a problem that was entirely predictable at the time the trench project was railroaded through.

In 2011, Chisel’s predecessor Jill Olsen said, “Nobody foresaw a recession such as what we experienced” (“We told you so,” RN&R, July 14, 2011). She meant it as an excuse, but it was actually an indictment. There was no excuse for not planning for hard times, given the state’s history since it adopted an unstable tax system 32 years ago. State and local governments have been plagued by budget crises since the 1981 tax shift that moved Nevada to heavy sales tax reliance. Planning the trench without anticipating a recession was reckless.

There were certainly officials who knew of the problem. Officials like City Councilmember Pierre Hascheff had experienced recessions in 1981-82 and 1990-91 that sent state and local governments into fiscal tailspins. But County Commissioner Jim Galloway was one of the few officials who tried to publicize the likely risks of future economic downturns. In addition, tribal gambling on a wide scale was expected in California—Reno casinos’ big market—as soon as court challenges were cleared.

The shortfall that began with the 2007 recession was entirely foreseeable. But all planning was for endless good times instead of for inevitable bad times. More to the point, taking time to plan might well have delayed the project, which the casinos did not want, or provided time for public pressure on the casinos to pay for it.

But while shortsightedness played a role, Brekhus does not blame the problem just on that. She said a functioning, working formula was tampered with.

“The fact that the train trench was done on budget and under time was a success,” she said last week. “But there was a subsequent effort to pull more money out of that and that got us not this [third financial] product but the product that was really killing us in 2008 [the short term securities]. So this is the third generation of financing for the train trench, essentially. And it was really kind of a mortgage or a re-fi on the train trench moneys to use this. So that was not good planning. One might even say that going to the credit markets for an exotic instrument like this on the train trench could be a symptom of our very narrow tax base to do the sort of projects that the council wanted at that time.

“So I’m starting to think that maybe the lack of broad revenue sources maybe at some point was a driver to the city to get into financial instruments that they might not have otherwise gotten into. And so that’ll be a historical analysis that some political scientist will look at at some point, but I’m starting to work off of that hunch right now.”

Chisel and City Manager Andrew Clinger both came on board after the trench project was already finished, at a time when the city had piled up so much debt on the trench and other projects that there seemed no way out.

“The revenue is not sufficient to meet the bond payments,” Chisel said last week. “The hope is that—.” He paused.

Recovery?

“Recovery,” he said. “And I believe there is still that possibility.”

Betting on the come.

At the Aug. 14 meeting the members of the Reno City Council had to approve a letter of credit in order to obtain “forbearance”—a suspension of payments on the bonds until June 1, 2015, to give the city more time, though the meter will still be running on interest all the time the forbearance runs. The term “had to” is the proper one. The city was in a corner and councilmembers had no choice. If they had not approved the letter of credit (a kind of insurance for the credit provider), it would have meant a bond default.

The council is very changed. Term limits took hold with considerable force in the last election, and a majority of the council is new. Some members have brought a different approach to city issues. Brekhus, in particular, has a way of asking questions about the way the city has done things in the past. She seemed frustrated by what she had read in the backup materials to item G2, by the answers she was receiving, and by the city’s habit of pushing the date of bond payoff out into the future. “Do we need to do some financial thinking …?” she asked.

She wondered why more progress had not been made on paying off the bonds, and Chisel mentioned the collapse of sales tax numbers since the recession began in late 2006 or early 2007. A staff briefing document that was before the councilmembers read, “Though sales tax revenues have been improving, they have not improved to the point that debt service is covered for [the trench bonds].”

As for planning for paying off more of the bonds, city bond counsel Kendra Follett pointed out that the legislature keeps municipal governments on a short leash, meaning they cannot respond quickly to events and the legislature meets only every other year: “You’re not in control of that revenue stream.” Seldom has there been a clearer view of the consequences of short, biennial sessions of the Nevada Legislature.

As it happened, the city may also no longer be in control of another aspect, either. A condition of the city getting the new letter of credit is that it approach the Legislature for a sales tax hike. It is worded in a circuitous way, but that’s how the agreement the City Council approved reads:

“Section 1120 Additional Covenants. The City covenants for the benefit of the Credit Provider that the Finance Director [Chisel] will request an item on the City Council agenda that the City Council request that the State Legislature increase the Sales Tax pledged to repayment of the Bonds … The City covenants for the benefit of the Credit Provider that on a monthly basis commencing August 1, 2013, the Assistant City Manager responsible for oversight of Government Affairs shall consult and provide advice, guidance and feedback to the Credit Provider on legislative strategies aimed at securing additional revenues for the repayment of the Bonds.”

The covenant does not say merely “increase taxes.” It specifies “increase the sales tax.” It expresses a preference for a particular type of tax, an odd condition for a New York bank.

But that is not the city’s only remedy. It can reinstate the room tax as a source of repayment, and would not need legislative action for that. If it fails to do that, there are other taxes at the disposal of the Legislature that could be tapped.

When the trench project was launched in 1997, Washoe County had the state’s highest sales tax—7 percent—even before it was raised to pay for the trench. Sales taxes are notorious for soaking low income workers. The Nevada Legislature will not meet again until January 2015. The covenant amounts to advance notice that the state’s working poor face another hit from the legislature.

As of June 30, the city of Reno’s total debt, not just the trench debt, was $576,545,529.

Many of Nevada’s chronic structural flaws came together in the trench financing—its reliance on a single industry, its reliance on sales taxes, a legislature that seldom meets. Brekhus and Chisel both ponder the length of time the bonds could linger on.

“I have children, and my kid—I don’t want him paying for it,” Chisel said.

Brekhus said she thinks the public needs a better understanding of how much the structural failings have cost taxpayers.

“You know, understanding history is so important, and Nevada is the classic boom/bust state economy and so they should be teaching that in every school and every political science class ever, because that cycle is definitely not broken.”

Such knowledge would certainly beat betting on the come.