The Ghost of Scandals Past

Previous "creative financing" debacles should haunt city officials who've approved a risky $1 billion lease of Muni streetcars

I was sitting in a smallish, undecorated conference room with a city bureaucrat, discussing a plan to lease the city's fleet of light-rail cars to private investors, when the walls came alive with ancient spirits. I saw images of former government officials from Nevada County to Pittsburg, from Tehachapi to Palm Springs. Their legs clanked with the shackles of creative municipal financing deals long ago gone sour; they moaned in voices deeper than the deepest city coffer: "Everybody's doing it. It's standard industry practice."

I had arrived at the offices of the Municipal Railway to ask Muni Deputy Manager for Finance Gigi Harrington about a Cayman Islands shell company that will be the city's go-between in an offshore corporate tax shelter involving a complex lease/leaseback of the city's 118 Breda streetcars.

"Tell me everything you know about Premier International Funding Corporation," I said, referring to an entity that will handle more than $1 billion in Muni money over 27 years, an entity that takes its mail in care of QSPV Limited, which is -- apparently unbeknownst to Harrington -- a subsidiary of the same Cayman Islands law firm that set up the "LJM Cayman" shell companies that played a role in ruining Enron.

"They exist, as I understand it, for purposes of, um, the payment, and they're, uh," Harrington said, before pausing to start over again. "I don't know. When we went to procure the surety, and the, um, debt portion of the transaction, all these components were bid together, so the entity in the Caymans is part of FSA, who bid on this proposal." Harrington's voice trailed off into an unfinished haze of inaccurate statements, then she abruptly said she had another meeting to attend.

And that's when the ghosts entered the room.


It's only trivially relevant that Maples and Calder, the Cayman Islands law firm that owns QSPV Limited and set up Enron's Cayman Islands shell firms, appears to be involved in Muni's shell firms, too. But it's deeply troubling to me that Muni's finance director doesn't seem particularly interested in knowing who we're dealing with in this complex plan to lease, and then lease back, city rail cars, or what, exactly, the 2-inch-high pile of contracts that she's recommending the city enter into will commit the city to do.

Harrington's attitude, shared by other Muni officials and advisers, seems to be underpinned by a type of logic that has driven financial fads through time, whether tulips or Internet stocks or junk bonds: As long as everyone else is doing it, ignorance is bliss. In this case, the attitude says that it isn't important whether Muni bureaucrats truly understand the details of a deal (approved Monday by the San Francisco Board of Supervisors) that has Muni leasing its Breda light-rail cars to wealthy investors, who will lease them right back to the city, in the process gaining what they hope will be the privilege to write off on their federal tax returns tens of millions of dollars of streetcar wear and tear, or depreciation.

What matters most, Muni officials have said in interviews, in testimony before the board, and in documents summarizing the leasing transaction for the public, is that Muni will receive $33 million in immediate benefit from the deal; that 60 other transit systems have already completed similar deals; that many elements of the Muni deal are "standard industry practice"; and that neither the public nor its elected representatives ought be concerned with facts beyond these.

But there are facts, and risks, that can't and shouldn't be ignored.

This series of contractual agreements, which ties Muni to the aforementioned Cayman Islands shell companies, to a group of foreign banks, to their trusts, their trustees, and their lawyers, appears to place the city in a truly amazing situation, even by the high-wire-act standards of creative municipal financing.

The agreements make the city legally responsible for guaranteeing private investors a perfect tax shelter, one that must consistently pass muster with the IRS, one that must not fall apart in a few years, one that does not contain details that will somehow cause investors to achieve less of a tax write-off than they had initially hoped for. If, for a laundry list of reasons spelled out in the agreements, the IRS does not allow the investors as big a tax break as they had planned, these contracts explain in excruciating detail how we, the taxpayers of San Francisco, must pay the investors enough money so that their balance sheets read as if they did have the perfect tax shelter they had hoped for. If the tax shelter fails, and the investors take the IRS to court, we pay their legal fees. If the investors claim their tax write-off is faulty, and we don't believe them, we are specifically prohibited from examining their books.

In signing these agreements, the city has entered a legal house of mirrors. If the IRS determines that the great Breda lease/ leaseback is purely a tax shelter of the type prohibited under the U.S. tax code (and there is at least one recent IRS ruling running in that direction), the Breda deal will become less of a tax shelter for investors, and taxpayers will, apparently, have to pay the investors enough to offset the increased taxes the investors will owe. And "enough" could wind up being tens of millions of dollars.

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