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Runaway Train 

Why is Muni in such a hurry to win approval for a blindingly complex, potentially risky, $1 billion plan to privatize the city's rail fleet?

Wednesday, Apr 10 2002

Page 2 of 3

Sound complicated? Judging from the way Muni appears to be attempting to whisk this past the city's supervisors, you'd imagine it was as simple as signing on a dotted line. Muni officials first explained the deal to members of the current Board of Supervisors' Finance Committee just two weeks ago. Muni's documents on the deal suggest it should be made law by April 12.

"They're saying they're under time pressure, and they're saying the investors may drop out any minute," a board source told me Monday. "They've really been riding this thing kind of hard."

In the world of ordinary, prudent municipal finance, complicated transactions are structured in a way that allows time for elected officials to carefully consider them before passage. In the case of the Breda tax-break transaction, the board is having the deal stuffed down its collective throat, gift-wrapped. But it's not as if the proposal hasn't been kicking around the halls of government for a while.

The Mayor's Office has been lobbying the Assembly for legislation that would provide special state tax breaks specifically designed for this deal -- for the last two years! The law passed late last year, came into effect in October 2001, and will expire in January 2004 -- apparently made to measure for San Francisco. Muni says it has been negotiating with bankers, investors, brokers, consultants, and so on for more than 18 months.

If the Muni records I've seen are any indication, Muni General Manager Michael Burns will present the Breda lease-leaseback as a done deal and a wonderful windfall produced by a piece of "innovative financing" that provides the closest thing there is to free money. The deal might look risky, he'll note, but the risks have been managed and tamed through hundreds of millions of dollars of corollary financial transactions. Other cities have done this type of deal -- dozens of cities even -- and nothing bad has happened, Willie Brown's Muni minions will likely say. Then they'll provide a list of transit agencies that have gone this way before.

But Muni's $1 billion bit of tax-shelter privatization flimflam could create more problems than it solves. Its pitfalls are fairly simple.

First, there's the matter of the length of the lease. Muni must promise to lease the Breda cars back from investors for 27 years. Even Muni's own, highly optimistic analysis says that if the "proposed transaction terminates early, the cost to the City would be enormous." If the cars were to wear out before the lease was up, Muni could end up owing huge sums of money -- perhaps more than $100 million.

To assuage supervisors, Muni Deputy Manager for Finance Gigi Harrington says that "none of the more than 20 similar transactions nationwide involving transit agencies have terminated early for any reason," according to a report by the city's budget analyst.

Yet Muni officials fail to note that the vast majority of these deals were consummated during the past few years -- meaning there hasn't been enough time to know if the cars would wear out before the 30-year life span the Muni-Breda lease assumes they would have. The real test will come 15 or so years from now; many of the rail cars in Muni's previous fleet, built by a Boeing subsidiary, were all but worthless within that time.

When I asked why Muni thought the Breda cars would last 30 years, spokeswoman Maggie Lynch faxed me two words: "Industry practice."

If the cars were to fail, and the deal blew up as a result, Muni would have little recourse but to take a huge financial hit: City documents show the agency has relinquished the right to a jury trial in the event the transaction somehow goes bad. Lynch explained that such a waiver is also standard industry practice. Greg Dorbeck, a financial consultant who specializes in representing lessees in municipal and corporate lease financing transactions, explains it another way.

"That's saying, "OK, I'm going to relinquish all my legal rights,'" he says. "That's silly."

Then there's the pesky matter of the Internal Revenue Service.

Three years ago, the IRS issued a ruling that effectively prohibits tax-exempt entities (such as Muni) from engaging in financial transactions (such as lease-leaseback arrangements) that are designed primarily to enable private investors to avoid payment of federal income taxes.

In its push for the Breda lease-leaseback, Muni appears not to address the ruling.

When I asked Muni about the IRS's recent lease-leaseback ruling, spokeswoman Maggie Lynch answered thus: "The IRS requires that the lease be tax-positive over the life of the transaction, and this lease will fulfill that requirement."

Her statement might be understood in several ways. For example, Muni's "investors" are mostly subsidiaries of foreign banks; it's possible they will use their lease of the Breda cars to receive tax benefits under the laws of their home countries, and, somehow, leave the deal "tax-positive" in the United States.

Muni hadn't responded to a request for clarification by my press deadline.

Four years ago, Massachusetts considered a lease-leaseback transaction that would have rented the assets of that state's Water Resources Authority to private interests, which would have rented them right back to the state to gain federal tax deductions. The state's primary watchdog agency, the Inspector General's Office, cried foul.

"In such cases, the federal government views such transactions as shams meant to disguise a tax avoidance scheme," the inspector general said in his report on the matter.

Ultimately, the question of whether the Board of Supervisors should rush to approve Muni's $1 billion proposal to lease most of its rail fleet into a series of tax shelters isn't about philosophy, or morality, or even smelliness. It's a matter of examining readily ascertainable facts.

About The Author

Matt Smith


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