Tuesday, June 26, 2012

"Unknown Unknowns" for Unsuspecting Taxpayers ... Contingent Liabilities Associated with "Project" Guarantees

The highly publicized and well "known" U.S. national debt is ~$16 trillion and climbing another ~$1 trillion annually.

"Known" underfunded entitlement obligations such as Social Security, Medicare and Medicaid amount to another $100 trillion or so.

"Known" underfunded state and local public pension liabilities are perhaps another $3 trillion, exclusive of retiree health care costs.

That's a lot, to be sure.

But wait, there's more. Let's review the "known unknowns" and in many cases "unknown unknowns" associated with taxpayer "project" indebtedness guarantees.

These guarantees frequently are neither visible to, nor initially funded by, the taxpayers. Nevertheless, they represent very real potential future payment obligations of the taxpayers. These are often called contingent liabilities.

With No Vote, Taxpayers Stuck With Tab on Bonds says this about the "unknown unknown" contingent liability developing mess:

"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. See also A Town That Backed a Failed Project Refuses to Pay (June 26, 2012)

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.

The practice, meant to save governments money, has been gaining popularity without attracting much notice, and is creating problems for a small but growing number of cities.

Data from Thomson Reuters suggests that local taxpayers are backing so-called enterprise debt at five times the rate they did 10 years ago. The resulting municipal bonds are sometimes called “double barreled,” because they are backed by both the future revenue of a project and some sort of taxpayer backstop. The exact wording and mechanics can vary.

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.

“These are debts that do not show up clearly, no matter how closely you look at the balance sheets,” said Carmen M. Reinhart, an economist at the Peterson Institute for International Economics who has written extensively about government debt. They “come out of the woodwork in bad times.”

In a number of communities, especially in New Jersey, Michigan and Washington State, local officials have recently scrambled to work out fiscal emergencies caused by guarantees and similar promises. Hoboken dodged a bullet last year, for instance, when a buyer was found for a bankrupt hospital whose debt the city had guaranteed. Buena Vista, Va., narrowly missed a creditor foreclosure of its city hall and police building, after a park authority failed to repay the bonds for a golf course.

In other places, bond guarantees have been time bombs, causing problems too severe to be solved in a workout. Stockton may be headed for Chapter 9 bankruptcy this week after pledging taxpayer money to backstop authorities’ debts for a hockey arena and other showcase buildings. Scranton, a faded former coal center, touched off a full-blown debt crisis this month, losing access to the capital markets when its City Council refused to honor a taxpayer guarantee for a parking authority’s bonds.
Residents of Pennsylvania’s capital, Harrisburg, recently learned from a forensic audit that their city’s fiscal woes could be traced to a guarantee issued in 1998, for the bonds of a trash incinerator project. Every few years after that, the authority running the project issued more bonds, and the city guaranteed those as well."

My Take

Government guarantees aren't often noticed by taxpayers. Neither is the advice and consent of the taxpayers sought or given. Yet such things as hospitals, stadiums, arenas, parking garages, golf courses and countless other "revenue" based projects are approved and guaranteed by taxpayers, often unknowingly.

The contingent liability of taxpayers is based on the project not being successful with respect to getting enough fees form customers to be able to pay interest and retire the debt incurred to finance the project's construction initially. When this default happens, the guarantee kicks in, of course, and that simply means taxpayers to the failed project's rescue.

{NOTE: This primarily involves municipal and state guarantees. But there are more of a different and broader nature, of course. The federal government now stands behind student loan guarantees, home loan guarantees, "Solyndra" type guarantees and many other government "investments" whose failure will result in unexpected and unforeseen taxpayer costs.}

Summing Up 

My guess is that too little care is taken at the front end when project approval and financing occurs. That in turn often means that too much expense will be incurred in relation to revenue earned and that taxpayers will be the backstop in the end.

So the next time you hear about or see a new project or building in town, ask how it's being financed. And if the answer is that it's a private-public partnership or even something similar thereto, ask if there are any government, aka taxpayer, guarantees on the project's debt. And if there are, ask about the financial projections for the project.

Then prepare yourself and fellow taxpayers for the potential likelihood that you will be called upon in the future to clean up the financial mess, should it develop.

To me this "promise, close your eyes, and then hope" approach is fundamentally and even morally wrong.

Without effective and disciplined "pre-mortems" at the outset, there are going to be far too many taxpayer "bailouts" when the inevitable "post-mortems" for unsuccessful projects take place down the road.

And by that time, the opportunity to protect the taxpayers' money has long since passed. 

Thus, it's time to convert the "unknown unknowns" into "known knowns" as an established  way of conducting the people's business

Anything else is a just another case of fleecing the unsuspecting taxpayers. Haven't our pockets been picked enough already?

Thanks. Bob.

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