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Blowing Smoke 

WARNING: Gov. Davis' plan to use tobacco lawsuit money to fill a budget gap is dangerous to our financial health

Wednesday, Jun 26 2002
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Within seconds of their first cigarette puff, smokers absorb nicotine through millions of alveoli, the tiny pouches that seep oxygen into the blood. The drug travels through the blood to the brain, producing brief feelings of energy, clarity, even invincibility. Elsewhere the smoke is less benevolent. Black, gooey tar plasters, then cripples, the bronchial tubes. The alveoli clog. Carbon monoxide replaces oxygen in the blood. With time, the body suffocates.

Which is funny, because this is also a pretty apt description of the effect on California's body politic should Gov. Gray Davis pursue a plan to inhale $4.5 billion in future tobacco lawsuit revenues into this year's state budget. Davis proposes selling investors the right to collect as much as $10 billion of California's portion of money from a 1998 lawsuit against Big Tobacco in exchange for a one-time payment of $4.5 billion. As one might expect, getting the money immediately, rather than over the 25 years stipulated by the settlement, will produce temporary feelings of clarity and invincibility relating to $17.5 billion in projected state budget shortfalls. But California's inner financial tis- sues won't fare nearly so well. The deal, to be handled by the San Francisco political insider law and lobbying firm Orrick, Herrington & Sutcliffe, and promoted by political money matron Carole Migden, promises to gut future state budgets of money that would go to health care for the poor, while feeding the form of political cancer known as insider deal-making.


To back up a little, in 1998 all 50 states won a $246 billion settlement with the major tobacco companies. This money, $12.5 billion of which went to the California state government, was described as recompense for the billions of dollars governments had spent on medical care for victims of tobacco-related illnesses. As it was originally touted in California, this money was to go to health programs for the poor, the battle against cancer, and anti-tobacco campaigns. In practice, only a portion has so far gone to these causes. And this funding source appears doomed to close for good. Three years ago states and counties began auctioning off these future payments to investors. In finance, any revenue stream, whether bridge tolls or estimated future record sales, can be sold for an up-front lump sum. With tobacco money, law firms and investment banks specializing in this type of "securitization," as the practice is called, have long been promoting to governments the supposed benefits of selling revenues from the 1998 settlement in exchange for a one-time lump sum. Tobacco companies might go bankrupt and never pay, these arguments say. Governments should shift the risk to investors. (Naturally, these arguments don't mention the fact that financial analysts believe Big Tobacco is here to stay.) By securitizing tobacco revenues, investors, rather than governments, would be dependent on the evil tobacco industry, these arguments go. (Without explaining why it's better to be dependent on tobacco companies for a single year's costly budget fix than for generations of health care spending.) And -- here's the closer -- politicians would get lots of one-time free money to do with as they please.

One of these arguments' main proponents has been San Francisco's Orrick, Herrington & Sutcliffe, a financial services specialist that serves as bond counsel for California. According to the legal newspaper the Recorder, in the past year Orrick has led deals to securitize tobacco proceeds for Wisconsin, South Carolina, the District of Columbia, and the California counties of San Diego, Sacramento, and Sonoma.

For governments, the logic for these deals is thin. Even proponents, such as S.F. Assemblywoman Carole Migden, who has carried the bill that would authorize the deal, acknowledge the dangers of borrowing from the future to pay for current budget problems.

"Nobody's saying that this is a good thing to do except in hugely fiscally problematic times," explains Alan LoFaso, chief aide to Migden, who has been acting as Davis' water carrier for the tobacco lawsuit sellout. "We're trying to prevent deep cuts in medical and health care. We're trying to keep the kinds of programs that allow people to survive, like food stamps."

But this save-the-children rationale -- which appears to lack vigorous opposition from either Democrats or Republicans -- obscures the fact that Davis proposes robbing the budget of future revenues just as the state budget analyst is telling legislators that our current fiscal crisis will probably last several years.

"Our general concern is just that, by general agreement, the state is facing an ongoing budget problem," says Jean Ross, executive director of the California Budget Project. "It's more than just this year. It's at least several years into the future. By borrowing against this pot of money that was designed to be available over the next 25-odd years, and spending this money all next year, it won't be available in coming years. Our opinion is that if you have a revenue problem, you should solve that revenue problem."

Presumably, Davis or his replacement will have to resort to similar forms of budget legerdemain next year, and the following, and the year after that. Tobacco securitization is an expensive form of borrowing, too; tobacco lawsuit payments are an untested revenue stream, and the state will have to offer a significant discount to get investors to pay cash up front. Lawyers, meanwhile, will get to charge a bundle in fees, far more than for ordinary government bonds. This deal isn't merely like getting a bank loan to pay for groceries -- it's like going to a loan shark.

"We're taking off a huge amount of the settlement money, and it's not available for health care access and tobacco prevention," says the American Lung Association's Paul Knepprath.

While the benefit of tobacco securitization may be questionable for governments, for Orrick it's as plain as a baseball-size carcinoma. For its Sacramento deal, in which the county sold off $200 million in tobacco revenues, Orrick earned $1 million, or around 18 times the amount the firm earns on less exotic government bond issues. The Sacramento transaction benefited from Orrick's role as Sacramento's longtime bond counsel; it may also have benefited from contributions to local political campaigns, according to the Recorder story. The proposed California deal appears to be a similar situation writ large. These political dealings, more than the deal's bad fiscal effects, represent tobacco securitization's most carcinogenic side. Orrick, which serves as California's bond counsel, will likewise handle the securitization deal.

Big Tobacco lawsuit-revenue securitization doesn't necessarily fall within Orrick's duties as bond counsel, according to the Recorder. But it would coincide with Orrick's role as a major contributor to the three politicians who will oversee the transaction: Since the last governor's campaign, Orrick has given $132,250 to State Treasurer Phil Angelides, $58,000 to Gov. Davis, and $17,000 to Controller Kathleen Connell. The client list of Orrick's Sacramento-based lobbying arm, meanwhile, reads like an official roll call of entities that would have a keen interest in the flurry of underwriting, selling, and reselling of Davis' $4.5 billion in new tobacco bonds.


While unseemly, Gray Davis' $4.5 billion budget maneuver is not unusual: Like a movie of the week, it tells a story ripped from today's headlines -- "Rite Aid Execs Charged With Fraud," "Global Crossing Denies Shredding," "Tyco Sues Former Officials," "Enron Execs Reap $744 Million," "Arthur Andersen Self-Destructs."

Davis proposes to replicate the phony-accounting malaise that threatens America's financial system, then repackage it as a responsible approach to the California state budget crisis. To play the role of consultant with conflicts of interest, Davis has enlisted the services of a self-interested San Francisco law firm with a penchant for giving money to key state officials. In place of Enron's Cayman Islands-based balance sheet chicanery, Davis will push $4.5 billion worth of state budget shortfall "off book" and into the future, forcing future state governments to somehow make up for the $10 billion this borrowing would eventually cost.

Like his shifty peers in corporate America, our governor isn't reinventing the wheel. Davis' predecessor, Pete Wilson, seemed to make dubious budget accounting a sort of gubernatorial mission. In 1992 Californians passed a ballot proposition specifically aimed at keeping Wilson from continuing to raid state workers' pension funds. Courts in 1995 twice ruled to halt Wilson from improperly diverting special sales taxes collected on cigarettes.

In a year when Americans are looking to their government to repair a financial system ruined by corrupt conflicts of interest, shouldn't this sort of business-as-usual come to an end?

About The Author

Matt Smith

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