Edwin S. Rubenstein is an economist and an adjunct fellow of the Manhattan Institute. He also writes a column on economics for National Review. The research for this article was supported by the Brunie Fund for New York Journalism.
New York State was officially in debt by $29 billion at the end of fiscal 1991, according to the Comptroller’s Office. But the problem is actually far worse, because this figure ignores more than $28 billion of the $52 billion of debt owed by the state’s public authorities—nominally independent organizations such as the Port Authority and the Urban Development Corporation, whose budgets are separate from the state’s. When this debt is included, the total rises to nearly $58 billion. (By contrast, California, with 12 million more residents and a fiscal crisis of its own, had a total debt of only $29 billion in 1990, the most recent year for which data are available.)
The Comptroller’s Office excludes the $28 billion in authority debt because the state has no formal legal obligation to cover it if the authorities default. Yet history shows that when an authority cannot pay its debt, the state will do so even if no formal obligation exists. Indeed, the 1975 New York State fiscal crisis was triggered by the profligate borrowing of the Urban Development Corporation (UDC). When UDC defaulted on short-term notes not formally guaranteed by the state, Albany nonetheless stepped in and provided the necessary funds.
There is a growing danger of another such crisis. The total debt of New York’s public authorities has more than doubled during the Cuomo administration, rising considerably faster than inflation or state spending. The total was $52.1 billion as of September 30, 1990—nine times larger than the state’s general obligation debt.
This has happened because the original purpose of the authorities has been perverted. Public authorities were set up to insulate the public’s business from overt political pressures, making it possible to apply “the best techniques of private management to the operation of self-supporting or revenue-producing public enterprise,” in the words of Austin Tobin, executive director of the Port Authority from 1942 to 1971. Since they would not have to respond to the political pressures of the moment, public authorities would be able to carry out the sort of long-range planning necessary to run what are, in effect, large-scale businesses.
The Port Authority, established in 1921 as the first off-budget authority in New York State, has largely lived up to this promise. It operates much like a private company, providing transportation services and office space to customers on both sides of the Hudson. Its customers are generally well served, and it is an economically viable organization: Its bridges, tunnels, airports, and real estate ventures have always paid their own way, and taxpayer funds have never been required to pay off Port Authority bondholders. Moreover, in part because it must balance the interests of New York with those of New Jersey, the Port Authority has retained its independence from political pressure by state and local officials. Other authorities—generally those with a well-defined mission and a reliable source of revenue—have also remained above the political fray. Among these are the Power Authority, the Dormitory Authority, the Triborough Bridge and Tunnel Authority, and, despite its problems, the Metropolitan Transportation Authority.
But some state authorities have not retained a comparable degree of political independence. They are run like patronage mills rather than private businesses: Their payrolls are filled with political appointees, and the prime beneficiaries of their projects are big campaign contributors—investment bankers, contractors, real estate men, labor unions, and other political insiders. Their insulation from politics—essential to the operation of a good authority—also means that abuse is more difficult to detect and control. Thus, these authorities have become little more than “vehicles for the upward redistribution of income, shifting wealth from the average taxpayer to those who are best at accessing and manipulating government—usually more affluent New Yorkers,” according to William Stern, former chairman of the Urban Development Corporation.
State authorities have also become a means for New York politicians to go into debt, circumventing voters’ rejection of large bond issues to pay for costly projects. Because authority debt is technically not state debt, voter approval is not required. Yet these “back door” borrowings are often paid off with taxpayer funds appropriated by the Legislature.
Figure I illustrates the growth in authority debt. In 1960, state authorities accounted for only 45 percent of total state debt. During the 1960s, Nelson Rockefeller used the authorities to finance the construction of numerous public works projects; by 1970 the authorities accounted for 61 percent of the total debt. The demand for off-budget financing grew mightily during the tax revolt and fiscal crisis of the Seventies. By 1980 the authorities’ debt share had risen to 84 percent.
The Cuomo administration has continued to use authorities to escape the will of the voters: State authorities accounted for 89 percent of New York’s outstanding long-term debt in 1990, meaning that only 11 percent of the state’s debt was approved by the electorate. Since 1983 the debt of state authorities has risen three times faster than direct obligations of the state.
Out of Business?
Public authorities were originally envisioned as temporary entities. The Housing Finance Authority and the Dormitory Authority, for example, were created to finance particular facilities and projects. They were to issue bonds, hire contractors, manage the construction phase, and lease the completed facility back to the state, which was to operate it. Once the bonds were paid off, ownership of the facility reverted to the state. At that point the rationale for the public authority ceased to exist.
To our knowledge, however, no public authority in New York State has ever gone “out of business.” Instead they have become underground branches of government, free from the publicity and other restraints that regulate, however imperfectly, normal governmental operations. Today there are some thirty state authorities in all, of which 17 have significant debts outstanding (see box, page 20).
Indeed, the two fastest-growing authorities—the Medical Care Facilities Agency and the Energy Research and Development Authority—are virtually unknown to New Yorkers. The Medical Care Facilities Agency finances new plant and equipment for hospitals, nursing homes, HMOs, and mental health facilities. Its outstanding debt increased from $641 million to $5.89 billion, or more than nine times, over the past eight years. The Energy Research and Development Agency’s mission, according to the executive budget, is to “help ensure that the State has secure, economical and environmentally acceptable supplies of energy for the future.” The energy agency’s outstanding debt has risen more than tenfold since 1982, from $327 million to $3.7 billion. Despite their enormous growth, the Comptroller has not audited either authority since the early Eighties.
To complicate matters further, some state authorities have created sub-authority affiliates to handle particular aspects of their activities. The Urban Development Corporation has more than ninety such subsidiaries, creating about five per year since 1982. Their names range from the familiar 42nd Street Development Corporation to the more obscure Upper Lake Redevelopment Corporation, Fresh Produce Corporation, and even the Overcoat Development Corporation.
State authorities have become governments unto themselves, operating in virtual secrecy, answerable neither to the Legislature, the Comptroller, nor the voters. The media have largely ignored the issue. Neither political party seems willing to make the authorities a political issue, probably because both Democrats and Republicans reap enormous patronage opportunities from them.
John Mitchell’s Moral Obligation
It was John Mitchell, who was to become U.S. attorney general and a Watergate personage, who came up with the idea of using authorities to pay for programs that the voters rejected. The device he used was called moral obligation bonds. These bonds were secured by tolls, fees, rentals, or other revenues generated by a particular project. To protect bondholders, the state made a nonbinding promise—a “moral obligation”—to use its funds to make up any deficiencies in debt service reserve funds. In a 1984 interview with the Bond Buyer, Mitchell recalled how he originated the scheme:
[When] Nelson Rockefeller was elected the Governor of New York in 1958, the voters turned down all of the propositions that had to be voted [on] under the state constitution—for housing, mental health, etc. His director of housing was telling me about the state’s problems.
In order to keep the interest cost down and have a security that would be marketable, I transferred over to the Housing Finance Agency (HFA) a concept [of moral obligation bonds] that had been used temporarily in connection with school districts.
I just took that and adapted it to the Housing Finance Agency and structured the mechanics of it. It went very, very well and the bonds were marketable, the interest rates were more than reasonable, and, of course, we took it from there.
Within a few years HFA debt exceeded that of the state itself. By 1973 HFA had gone far beyond its original mandate of financing housing, becoming, in the words of Annmarie Walsh, author of The Public’s Business, “an investment banker for a varied mix of public and private agencies, financing not only housing but hospitals, nursing homes, mental health facilities, youth and day-care centers, senior citizen centers, and the state university.”
Meanwhile other authorities were created to pay for programs the voters had turned down. In 1961 voters rejected a higher-education bond issue for the fourth time; the Governor created the State University Construction Fund. In 1965 the voters rejected a low-income housing issue for the fifth time; the Urban Development Corporation (UDC) was established in 1968.
The moral obligation bond allowed Nelson Rockefeller to outrun both the voters and the state constitution. Agencies like HFA and UDC became explicit tools of the executive branch. Their operations are closely monitored by the Governor, who appoints their governing boards, and they are staffed in part by state personnel.
The unchecked rise in moral obligation debt was widely believed to be a major factor behind the 1975 fiscal crisis. (The New York City fiscal crisis, by contrast, was caused by the use of general obligation debt to cover operating expenses.) In 1976 the State Legislature passed a law banning further issues of moral obligation debt.
Despite the ban on moral obligation bonds, however, state officials have devised ways of using public authorities to go into debt without voter approval. One such method is the lease-purchase agreement.
Under lease-purchase agreements, authorities sell bonds secured by long-term leases with the state. The leases are structured so that the annual rent paid to the authority exactly coincides with the amount of money needed to service the bonds. When the lease expires, ownership reverts to the state. Although called “leases,” their impact on state finances is similar to that of direct state debt: They commit the Legislature to annual appropriations over the life of the bonds, or for as long as thirty years. The only difference is that the state’s obligation in a lease-purchase agreement is to the authority itself rather than to the bondholders.
As with moral obligation bonds, lease-purchase deals offer politicians a way to bypass taxpayer opposition. For instance, after New Yorkers rejected a $500 million prison bond issue in a 1981 referendum, the Legislature authorized the Urban Development Corporation to float bonds and begin construction. Building prisons was probably not what UDCs founders had in mind when they established the corporation “to facilitate the development of affordable housing for low-income persons.”
SUNY and CUNY buildings, hospitals and mental health facilities, and even the maintenance of state roads and prisons have been financed by such deals. Governor Cuomo’s recently proposed infrastructure project would require state authorities to finance new tunnels, rail links, housing, and other public infrastructure with lease-purchase agreements.
Citizens groups have sued the state, arguing that this device deprives the public of its constitutional right to vote on the creation of state debt. The State Supreme Court has dismissed these suits, holding that taxpayers lack standing to contest the matter.
The Attica Shell Game
Lease-purchase agreements have been used not only to build unpopular projects, but also to provide infusions of cash into the state treasury. The politicization of state authorities reached a new peak in June 1990, when the Legislature instructed UDC to “buy” Attica prison from the state. The proceeds were to help close a $2 billion budget gap.
To raise the cash UDC sold $241.7 million worth of thirty-year bonds. The bonds were discounted by $10.7 million, so the authority sold them for $231 million. The state pocketed $200 million, the “purchase price” for Attica. A debt-service reserve fund and capitalized interest accounted for $29 million of total proceeds. Legal fees and administrative expenses came to roughly $500,000. The remaining $1.5 million went to the Wall Street bankers who set the deal up.
In effect, the state used UDC bonds to pay for current operating expenses. Over the next thirty years the Attica “sale” will cost state taxpayers $490 million in principal and interest payments.
Looting the Tollbooth
The Attica deal, at least, had a veneer of legitimacy. A capital item was involved, if only as a pretext for selling bonds. The same cannot be said of a scheme involving the New York State Thruway Authority.
In July 1991, Governor Cuomo and the Legislature ordered the Thruway Authority to sell $80 million worth of bonds to pay for its 1991 capital program. The authority didn’t need the money: It already had that much in toll revenues sitting in its Dedicated Transportation Fund.
The idea was for the accumulated toll monies to be transferred to the state as an $80 million revenue “one-shot.” The bonds, meanwhile, were to be paid off with future tolls.
On July 17, 1991, Comptroller Edward Regan announced he would sue to block the bond sale. He described the scheme as “the worst and most blatant in a long line of budget-balancing financing gimmicks” and one that “stretches the legal underpinnings of these types of transactions to the limit.”
“It now appears that the real reason for the authority’s toll hikes was to provide additional state operating funds, making the action nothing more than a sophisticated, albeit presumably legal, money laundering scheme between the state and the authority,” Regan said.
The Wall Street Connection
State politicians are not the only ones who benefit from these arrangements. Setting them up has become big business. In 1990 New York’s public authorities sold $9.2 billion worth of bonds in eighty separate bond issues. To arrange the financing, the agencies paid more than $94 million to investment banks. On top of this an estimated $4 million to $5 million was paid to bond counsels for legal advice, and millions more to rating agencies, printing firms, and other services associated with bond sales.
In the Attica deal, for instance, the team of underwriters, lead by Bear Stearns & Co., netted $1.5 million in the “gross spread,” the amount of proceeds from the bond sale the underwriters keep as compensation. Another $485,000 went to pay other expenses, most of which went to lawyers, financial consultants, and bond-rating agencies. There was no competition for this deal—the team had been underwriting UDC prison construction bonds for years.
This was nothing unusual. Decisions about how such contracts are awarded are shrouded in secrecy. Most state and local governments select their investment bankers on a strictly competitive basis: The one offering the lowest interest cost wins the bond contract. Not so for New York’s authorities. The interest cost on most authority bonds is negotiated with a managing underwriter selected by the authority. The managing underwriter then sets the spread by consulting other bankers in the syndicate.
Negotiated financing is sometimes to the advantage of the authorities. Most authorities do not have the financial expertise needed to structure large, complicated revenue bond issues. The managing underwriter often serves as the authority’s financial adviser, designing innovative indentures that make the financing possible. In negotiated sales, investment bankers can test the market before sale and cut the interest rate on those bonds that are expected to sell particularly well. The cozy relationship between authorities and investment bankers can at times help avert disaster. In late 1991, for example, the New York State Power Authority had the misfortune to schedule a bond sale at the very moment the Budget Bureau was announcing a massive increase in the state’s deficit. The bond market panicked; interest rates rose. Within a few days, however, the Power Authority’s investment bankers reassured potential investors that the authority’s bonds were unaffected by the state’s budget problem, since they were secured by the authority’s own revenue stream. Interest rates on the $295 million bond issue then fell significantly.
Negotiated bond sales, however, are usually more expensive than those that are financed competitively: The average spread is higher. With these costs in mind, the Government Finance Officers Association urges that negotiated financing be used only for “large, irregular, and difficult-to-place issues.”
As one bond dealer, quoted by Joe Mysak and George Marlin in The Guide to Municipal Bonds, put it, “The more negotiated the business is, the more corrupt: it makes the greedy greedier. We know what happens when the Pentagon doesn’t take bids; you wind up with $94 hammers.”
Why, then, are more than 90 percent of New York State authority bonds sold via negotiation? As with other aspects of public authorities, politics plays a major role. Banking firms make campaign contributions to key political figures and give dinners, tickets, junkets, and other perks to authority executives. These officials hand out business, including spots on negotiated syndicates, bond counsel contracts, and financial advisory work. This apparent quid pro quo couldn’t take place if the underwriters were selected on the basis of competitive bidding.
Girard Miller, a top municipal bond dealer, has criticized the heavy reliance on negotiated financing for years. “Nothing has changed,” he says. “There’s still the potential for political abuse with negotiation. Competitive sales on plain vanilla deals are still the preferable way to go. On negotiated issues, you have to worry about the backslapping and arm-twisting that brought the deal in the door.”
Negotiated financing also makes it easier for politicians to borrow money “off the books.” Many budget “one-shots” are originally dreamt up by investment bankers, who are subsequently rewarded by being named managing underwriter in the bond sale.
Money is not the only thing politicians seek to influence via the selection of underwriters. A questionnaire sent by New York City to various investment banking firms in 1990 asked about the percentage of women and minorities on the board and in management, investment in South Africa, plans to relocate out of the city, charitable grants, and support of housing projects.
But in most instances, the business goes to firms that contribute heavily to the winning candidate. Says one New York banker: “It’s gotten to the point where senior people are coughing up $15,000 and more, and spending half their time at fundraisers,” as the price of doing business and winning good spots on underwriting syndicates. As long as there is no explicit deal between a candidate and a contributor, all this is perfectly legal. It does, however, raise serious conflict-of-interest questions involving top New York State officeholders.
Contractors and Unions
Authority projects also mean work for outside contractors and construction workers, as well as architects, engineers, consultants, and firms that supply the materials and services used by these groups. Questions again arise about how authority business is doled out.
A 1984 law requires all statewide authorities to adopt and publish “comprehensive” guidelines covering personnel service contracts, but gives them considerable discretion to specify “circumstances in which the board may by resolution waive competition.” Some authorities have used this waiver to exclude entire categories of contracts from competition, including those the statute says must be included. The Battery Park City Authority requires a minimum of three bids only “where practicable”; the Job Development Authority requires its president to use his “best efforts” to solicit competing proposals; the Niagara Frontier Transportation Agency requires a minimum of three bidders, but only if “competitive ... selection is considered to be in the best interests of the authority.”
Although information about each contract must be filed with the Comptroller, his preapproval is not required (as it is with state agencies), and there is no enforcement mechanism, other than sporadic audits by the Comptroller, to ensure compliance with the guidelines. The Commission on Governmental Integrity’s 1990 report found that many authorities had not been audited since 1984, and that in general, audits were “not exercised often enough and comprehensively enough to ensure that the statute’s intent is being carried out.”
Not surprisingly, competition is not the norm. Authority contracts have become thinly disguised awards for political contributions. For example, 64 of the 68 engineering firms solicited by the Friends of Mario Cuomo fund-raising committee between 1982 and 1987 made contributions to the committee during that period. All but 11 of the 64 contributors secured consulting contracts with either the Thruway Authority or the New York State Department of Transportation between 1984 and 1987, according to the Commission on Government Integrity.
The report found “no evidence to suggest that Friends of Mario Cuomo fundraisers ever stated or implied that these firms’ business fortunes in New York State would be affected by their contributions.” Interviews with the contributing firms found that although no solicitors suggested a link between state business and contributions, virtually all the engineers thought it unwise “to take a chance and not contribute.”
Still Out of Control
Some reforms have already been made in public authority financing. But they have not been adequate. The fiscal crisis of the Seventies, and especially the UDC default, made clear the dangers of unregulated debt issuance. That episode led to the banning of moral obligation debt, called a “dangerous and misleading illusion” by the commission impaneled to study the abuses of state credit. As illustrated above, the subsequent use of lease-back debt has effectively undermined the ban on moral obligation debt.
Another reform spurred by the commission’s recommendation was the creation, in 1976, of the Public Authorities Control Board (PACB). The PACB reviews proposed financing or construction commitments for virtually all programs proposed by many of the state’s authorities.
Unfortunately, PACB’s oversight responsibility is limited to the financial viability of bond issues. It does a good job of protecting bondholders from possible default, but cannot shield taxpayers from the misuse of public funds. The board undertakes exhaustive reviews of each proposed project, vetoing those that do not appear to be self-supporting. But it cannot deal with such issues as political favoritism in awarding contracts. Further, the question of whether a proposed project is in the public interest, or whether it is better done by a normal government agency or by the private sector, is “left to the Legislature.”
The PACB can also serve as a convenient scapegoat for state politicians seeking to avoid responsibility for unpopular policy decisions. For example, the board might determine that a transit fare hike is necessary to cover the debt service on Metropolitan Transportation Authority bonds. Legislators would then avoid taking the heat by blaming the PACB.
Legislation has been proposed repeatedly over the years to strengthen the PACB’s oversight authority. Because it is a politically appointed body, however, its ability to control political abuse, even with such reforms, is limited.
One helpful reform would be to amend the state constitution to require voter approval of lease-purchase agreements and any other authority debt issues that are effectively guaranteed by the state. This would help bring irresponsible political use of authorities under control.
The ultimate solution, however, is to abolish those authorities that do not have a clear mission and a reliable source of revenue. This would stop the political abuse of public authorities and allow them to serve their original purpose: shielding the public interest from the vagaries of politics.
AUTHORITIES WITH SUBSTANTIAL DEBT OUTSTANDING
Listed here are the 17 New York State public authorities that had substantial debt outstanding as of September 30, 1990. The amount of debt, in millions, is shown in parentheses.
Dormitory Authority. Handles financing, construction management, and equipment purchasing for higher education, health care, and other institutions. ($9,589)
Municipal Assistance Corporation (MAC). Created in 1975 to provide emergency financing for New York City and to oversee its fiscal affairs. ($6,901)
Medical Care Facilities Agency. Provides low-cost financing (through tax-exempt bonds) for hospitals, nursing homes, HMOs, and state and municipal health facilities. ($5,894)
Port Authority. Manages airports and port facilities in the New York metropolitan area, as well as Hudson River bridges and tunnels, the PATH rail system, and the World Trade Center. ($4,570)
Metropolitan Transportation Authority. Responsible for mass transit in the New York metropolitan area. ($4,008)
Power Authority. Finances, builds, and operates electric generating and transmission facilities. ($3,897)
Energy Research and Development Authority. Responsible for energy research and development, pollution-control and energy project financing, landfill and energy site management. ($3,700)
Triborough Bridge and Tunnel Authority. Oversees toll bridges and tunnels in New York City. ($3,292)
Housing Finance Agency. Finances public housing as well as nonprofit hospitals, nursing homes, municipal health, and state university facilities. ($2,915)
Mortgage Agency. Helps make mortgages and mortgage insurance available to first-time homebuyers. ($2,655)
Urban Development Corporation. Provides financing and technical assistance for industrial, commercial, and residential development projects. In recent years UDC has also financed state prison construction. ($2,327)
Battery Park City Authority. Created to manage the commercial and residential development of 92 acres of landfill in lower Manhattan. ($698)
Environmental Facilities Corporation. Provides financing and technical assistance to enable government and private industry to comply with environmental laws. ($574)
Thruway Authority. Operates the 559-mile New York State Thruway. ($348)
Job Development Authority. Makes low-interest mortgage loans to local industrial development agencies to finance private business and industrial projects. ($343)
Project Finance Agency. Provides long-term financing not otherwise available for UDC projects. ($197)
U.N. Development Corporation. Finances office space, hotels, and other facilities for the United Nations. ($161)