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Train Wreck 

Major public transit agencies around the country — including San Francisco's — may pay billions for risky deals with bankers.

Wednesday, Nov 5 2008
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When San Francisco is forced during the coming months to triple bus fares, let parks turn to weeds, fire librarians en masse, and allow criminals to run the streets, it will be worth considering the brighter prospects the city might have enjoyed, had it only listened to supervisor Chris Daly, former supervisor Matt Gonzalez — and me.

"It seemed like a sketchy financing mechanism," said Daly, recalling spring 2002, when a group of bankers offered San Francisco a $33 million bonanza that should have seemed too good to be true. "There was something that didn't make sense. It seemed like a federal giveaway."

Gonzalez, who was Ralph Nader's vice-presidential running mate in this year's election, remembers that the deal "had a Cayman Islands quality to it. I didn't, obviously, predict this other financial crisis stuff would lead to a critique of the entire system. But it seemed like the municipality was gaining a benefit by helping a corporate entity evade taxes."

These supposedly radical left-wing politicians are now looking less like Che Guevara and more like Warren Buffett, who in 2002 warned that mortgage-based derivative contracts could become "financial weapons of mass destruction."

San Francisco is suddenly at risk of paying $140 million to bankers who six years ago convinced the city to use its Muni trains in a $1 billion sham tax shelter. Back then, it seemed like a good idea for Muni to let bankers lease its light rail cars, so that they could then write the vehicles' wear and tear off their federal income taxes as a depreciation expense. But city bureaucrats apparently hadn't read the fine print of these complex transactions, which put the city on the hook for massive payouts if something were to go wrong. And it has: Insurance companies guaranteeing the deals are failing, thus triggering massive payments by municipalities and transit agencies.

Cities such as Los Angeles, Washington, D.C., and New York are suddenly facing between $1 billion and $4 billion in potential payouts. Those cities consummated deals similar to San Francisco's.

The threat these tax shelter deals pose to cities nationwide is so dire that members of Congress are now in the embarrassing position of lobbying the U.S. Treasury to save cities by bailing out sham tax shelters, which were originally designed for a specific purpose: ripping off the U.S. Treasury.

As an earnest good-government columnist, I suppose I should be whining about how city mental health programs may be cut thanks to this debacle, or how a gutted public works department will allow potholes to spread like mold.

But somehow, all I can come up with is: "I told ya so."

On April 15, 2002, a cluster of bankers' attorneys entered the Board of Supervisors chamber to impatiently hear Daly ask questions about the deal, questions which were first raised in a column I wrote at the time.

I made a point of sitting behind the attorneys.

One of them brought in an issue of SF Weekly, and turned to a column titled "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?" His companion took the copy and turned to the adult-oriented advertising pages at the back of the paper. They looked at each other and chuckled. Not long afterward, their tax shelter deal passed on a 7-4 vote.

This raises an important policy point: Who's laughing now, motherfuckers?


Maybe nothing about the Bush administration should surprise us anymore, but these bogus public-transit tax shelters were actually encouraged by the federal government. Of course, they had to be made to look like something other than tax-evasion schemes, so lawyers constructed a financial house of mirrors involving Cayman Island trust firms, international insurance brokers, and a paper-only transaction whereby the city leased its light-rail cars to bankers, and the bankers leased them back to the city over 30 years. The final touch added to give the phony leases an air of legitimacy was creating a special entity to make payments, and hiring an insurance company to guarantee that they were made.

But the deals carried risk. In San Francisco's case, the city would have to make a payment of $140 million if its chosen insurance company — in this case, Financial Security Assurance Inc. (FSA) — were ever to appear anything less than risk free. (Specifically, if the firm's rating were to slide from its current credit rating, Standard & Poor's pristine AAA, down to merely high-grade AA-, the city would be liable for the money).

Already, deals covered by bankrupt insurer AIG have gone belly up, potentially costing municipalities and transit agencies nationwide billions of dollars. For example, the Washington Metropolitan Area Transit Authority faces $400 million in payments on leaseback transactions, after a downgrade in AIG's credit rating.

San Francisco was saved from just such a catastrophe a month ago when the governments of Belgium, France, and Luxembourg joined forces to provide an $8.8 billion bailout to FSA's Belgium-based parent bank, Dexia. But the insurance subsidy suffered massive losses in connection with the U.S. sub-prime loan crisis. Analysts now say the Dexia-FSA rescue is a work in progress; San Francisco may not be out of the woods yet.

"The belief is that FSA will soon be in that category as well," The Bond Buyer quoted Washington transportation attorney Jeffrey Boothe as saying last week. "As they take more hits, and more and more issues arise, others will follow AIG."

Muni, for its part, sent me the following statement:

"While FSA's ratings are on credit watch for a potential downgrade, we cannot predict if FSA will, in fact, be downgraded. We continue to investigate all options, including potential alternatives to FSA."


Things are much worse at other transit agencies. New Jersey is on the hook for $150 million. Los Angeles is being stuck for $300 million. In total, cities now stand to pay between $1 billion and $4 billion to banks that invested in these deals.

In response, Barbara Boxer and other U.S. senators are now lobbying the U.S. Treasury to bail out these tax shelters, which were declared illegal shams by the IRS in 2003. And House Speaker Nancy Pelosi has reportedly met with BART officials about the need for a possible bailout of these deals (BART, which cut a leaseback deal insured by AIG in 2002, could owe $40 million). But San Francisco won't be helped by a U.S. bailout since its deal is backed by an insurance subsidiary of a Belgium-based bank.

As America enters into a new political era, it's worth taking away a few lessons from these botched tax scams.

One lesson is that when people question bizarre, opaque, high-risk public-private ventures, it's worth listening to them, even if they're known as fringe leftists on the Board of Supervisors, or if they write for an alternative-weekly newspaper.

About The Author

Matt Smith

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