No. 5 January 1998
Debt & New York’s Public Authorities: Borrowing Like There’s No Tomorrow
William J. Stern is a Contributing Editor of City Journal and former head of the New York State Urban Development Corporation under Governor Mario Cuomo.
Edwin Rubenstein is the Research Director of the Hudson Institute.
In 1975 the Urban Development Corporation (UDC), a public authority created in the late 1960s by the New York State Legislature, achieved a dubious distinction: it became the first major issuer of municipal bonds since the Great Depression to default on its obligations. The results were catastrophic. Private capital markets shut the door on the state virtually overnight, and New York City was thrown into a fiscal crisis whose destructive effects can still be seen today.
Unfortunately, when it comes to debt, New York has a dangerously short memory. Just two decades after the UDC fiasco, no other state can begin to match our borrowing. According to 1995 figures (the latest available), New York’s debt burden of $68.5 billion outstrips that of (much more populous) California by 50 percent; as a percentage of overall personal income, it exceeds the debt burden of Texas by 400 percent. Worse, New York’s appetite for borrowing shows every sign of growing. Since 1985 the state’s debt burden has shot up an astounding 241 percent, a fact that goes a long way toward explaining why the respected Moody’s Investor Services gives New York’s bonds the second-lowest investment rating in the nation, only a notch above that of Louisiana.*
Who is to blame for this staggering load of debt and the threat that it poses to the state’s economic health? The chief culprits are all-too-familiar: New York’s ever-expanding public authorities and the politicians and interest groups in Albany who benefit from their profligate ways.
Not All Debt Is Bad
Getting to the root of the problem requires that we first make some distinctions, because not every part of New York’s $68.5 billion in debt is equally troubling. In the first place, there are general-obligation bonds, the most traditional—and restricted—form of state debt. Such bonds are issued only upon the approval of the state’s voters. Moreover, under the state constitution, only one general-obligation debt question may appear on the ballot each year. To their credit, New Yorkers have been fairly skeptical of these measures. Between 1974 and 1996, they approved only six out of eleven of them, with the environmental bond issue of 1996 being the first to win their endorsement since 1988. Over the last decade, debt in this form has constituted a declining percentage of the state total; today it amounts to a manageable $5.2 billion.
The state also sells long-term bonds to finance the Local Government Assistance Corporation (LGAC), which was created in 1991 to help localities fund their operations when, as is increasingly the case, the Legislature fails to pass the state budget on time. Debt service for the LGAC is covered by one percent of the proceeds from the state sales tax. Admittedly, the LGAC is a regrettable expedient, made necessary by the irresponsibility of leaders in Albany. But given political reality in New York, such borrowing is a reasonable way to ensure that the state’s residents are not forced to endure regular interruptions in basic services. Moreover, like general-obligation bonds, LGAC bonds account for a small fraction of overall state indebtedness—just $4.3 billion.
Even when we arrive at the state’s public authorities, there is a certain amount of fairly innocent borrowing. Under the state constitution, New York may guarantee, with its full faith and credit, the bonds of only three of its public authorities—the Thruway Authority, the Job Development Authority, and the Port Authority. Such guaranteed debt, unlike debt issued by other authorities, is subject to voter-approved caps and other restrictions. As a result, it has never gotten out of hand and today amounts to a mere $400 million.
Too Much of the Wrong Kind of Debt Is a Serious Problem
So-called “moral-obligation” debt issued by the public authorities has a more colorful history, but it, too, does not pose a problem today. Such bonds are secured not by the state’s full faith and credit but by its non-binding promise—or moral obligation—to use state revenue to make up any shortfalls in debt service. During the 1960s and 1970s, this pledge enabled the authorities to overcome Wall Street’s reluctance to buy non-guaranteed revenue bonds. After the state was forced to assume responsibility for the UDC’s debts in 1975, however, the Legislature put an end to this practice. Accordingly, New York’s moral-obligation bonds, $8.2 billion of which are still outstanding, have long been shrinking as a share of total state debt.
Taken together, the sorts of borrowing described thus far comprise slightly more than 25 percent of New York’s total indebtedness. All the rest of the debt burden—and here we reach the heart of the problem—comes from just two other forms of borrowing by the state’s public authorities.
The largest category by far, today accounting for $32.4 billion, consists of revenue bonds. Generally speaking, an authority issues such bonds in order to finance a specific project and then uses the proceeds generated by that project to cover the debt service. Toll revenue, for example, pays off bonds for the Thruway Authority, just as payments to hospitals take care of bonds issued by the Medical Care Facilities Agency. In principle, of course, using revenue bonds to link debt to particular projects is an economically sound idea; it means that those who benefit are the ones who pay. In addition, because revenue bonds do not rely on the state itself for repayment, they do not directly affect the state’s fiscal affairs.
Regrettably, however, even a sensible financial instrument can be abused. Because revenue bonds do not even require the approval of the Legislature, they escape all forms of popular scrutiny. New Yorkers, in short, never get a chance to vote down revenue bonds, as they often choose to do with general-obligation debt. To understand what this means in practice, consider that Albany may soon allow the state’s Long Island Power Authority to issue $7 billion in revenue bonds in order to buy a portion of LILCO and retire debt acquired by the company’s Shoreham nuclear plant. If approved, it will be the largest single-debt offering by any state or municipality in U.S. history—and the citizens of New York will have had no real say in the matter.
At the same time, the public authorities that are accumulating this debt receive very little oversight from Albany. The Public Authority Control Commission ostensibly does this job, but it has few investigative or disciplinary powers. Nor do the responsible committees of the Legislature do any better, almost never holding hearings or issuing reports. With so little supervision, the day may well come when one of the authorities can no longer meet its obligations with its revenues alone, at which point the Legislature, despite having no legal responsibility for this debt, would have to step in.
This, in fact, is exactly what finally happened with the UDC in 1975. Though the agency was supposed to be self-supporting (through the rents collected on its projects), when its bonds failed the Legislature realized that the credibility of all state debt was at stake. Public authorities may be financially independent on paper, but the state always has responsibility for them in the end.
The Most Dangerous Form of Debt Is Also the Fastest Growing
If there is nothing especially objectionable about revenue bonds in themselves, the same cannot be said of the fastest-growing form of borrowing by the state’s public authorities: lease-purchase agreements. Under these deals, which now total some $18 billion, authorities issue debt in order to purchase or construct facilities or purchase equipment that is, in turn, leased back to the state at a price that can cover debt service.
Unsurprisingly, such arrangements are often little more than a fiscal shell game. During the Cuomo administration, when this outrageous practice peaked, Albany “sold” Attica Prison and a portion of Interstate 287 to the UDC. The state got a quick $200 million, which helped balance the budget. And New York taxpayers? They found themselves saddled with a serious long-term liability: a commitment to pay $600 million over the life of the 30-year bonds issued by the UDC. Short of outright malfeasance, it is hard to imagine a more flagrant misuse of capital funding.
A Self-Serving Elite Blocks Solutions
Can anything be done to end such reckless borrowing? Many have suggested amending the New York State constitution in order to make all debt subject to approval by the voters and to impose a cap on debt based on some percentage of either the state’s overall personal income or its gross domestic product. Such amendments would have to come through a state constitutional convention or the Legislature, and would then need to be ratified by the voters.
Both these ideas, taken on their merits, have much to recommend them. Politically, however, they are nonstarters. In the first place, New Yorkers are uninterested in calling a constitutional convention, as they showed at the ballot box this past November. More fundamentally, even if such a convention were held, it is unlikely that it would do anything about the state’s borrowing problems. The fact is, any constitutional convention would be controlled by the very same political insiders in Albany who ran up the state’s debt in the first place. Needless to say, these insiders are the reason too that no meaningful constitutional amendment related to debt is likely to come from the Legislature.
Why are New York’s political leaders so determined to protect the borrowing powers of the authorities? The answer lies with the state’s “nomenklatura,” a term first used to describe the small class of politically connected individuals who benefited personally from the centrally controlled economies of the Communist bloc. In much the same way, New York’s public authorities, with their virtually unlimited ability to spend, offer extraordinary benefits to those with the necessary political access. Our nomenklatura consists of a long list of prominent consulting, accounting, public-relations, and law firms, all of whom take in millions of dollars in revenue from the various debt-financed projects of the authorities. What’s in it for the state’s politicians? All the rewards at the disposal of the nomenklatura, from campaign contributions and favorable press coverage to lucrative jobs once they leave office. With the public largely indifferent to the uncontrolled borrowing of the state’s authorities, it is not surprising that leaders in Albany have been unwilling to antagonize such attentive friends.
A Federal Flat Tax May Be The Only Answer
That leaves the possibility of getting at New York’s debt problem from the federal level. Here one idea is key: doing away with the tax-free status of interest on municipal bonds. Simple though it may sound, this would instantly impose discipline on the state’s borrowing. Faced with having to pay a much higher rate of interest to attract investors, Albany would have no choice but to restrain itself. Otherwise, debt service would skyrocket both for the state and the authorities themselves, making necessary either higher taxes or increased fees for authority services—alternatives unattractive to the state’s political class.
The trick here, as with proposals at the state level, is how to achieve such a reform politically. Getting rid of the preferential treatment for municipal bonds could succeed on its own and would certainly be worth trying. Unfortunately, the few who would be hurt by such a change are far more likely to exert political pressure than the many who would benefit from it. Its best chance of success would be as part of a broader movement, one with widespread popular support. Here, the brightest star to which it might be hitched is the growing movement for a flat federal income tax. If such a plan were to pass, income from municipal bonds would be treated just like income from any other source.
It is, of course, a sad commentary on political life in New York that our best hope for reform lies outside the state. But unless New York experiences another crisis in borrowing—what is known as an “event” in the lingo of the bond market—it is unlikely that the Legislature will rein in the authorities any time soon. Only the immediate prospect of economic chaos seems capable of shaking Albany from its self-interested slumber.
* New York City and other localities, it should be noted, share the state’s bad borrowing habits and have accumulated some $50 billion in debt on their own—but that’s a subject for another day.