A plea for help from the U.S. Treasury Department
It's widely known that the federal government's initial $85 billion capital injection in New York-based American International Group (AIG) in September 2008 was motivated by fear of the effect of an AIG bankruptcy on the international banking system. Less understood, however, has been the impact of AIG's troubles on scores of U.S. municipalities and government agencies, which are facing the prospect of billions of dollars in liabilities unless the U.S. Treasury Department and rating agencies take a few simple steps.
AIG was an integral participant in the "sale lease-back agreements" that enabled public agencies to transfer otherwise worthless tax benefits, essentially depreciation deductions, to private partners in return for lump sum payments. Largely completed from 1995 to 2004, the deals helped government entities, particularly transportation andagencies, raise hundreds of millions of dollars for infrastructure investments.
The Federal Transit Administration actively encouragedagencies to pursue the deals as a source of much-needed capital for mass transit. For municipal and regional wastewater authorities, the transactions funded -mandated upgrades to treatment and collection systems. Small wonder that public agencies, such as the Washington Metropolitan Area Transit Authority, New York City's Metropolitan Transit Authority, New Jersey Transit, Chicago Transit Authority and many others, completed $60 to $80 billion of the transactions.
AIG, acting like a municipal bond insurer, guaranteed the government entities' lease payments, which enabled private partners to assemble portfolios of the transactions with relatively uniform credit exposure. The smooth functioning of the transactions depended on AIG's triple-A rating as the guarantor, a rating that all parties considered a solid assumption. In September 2008, however, AIG's credit ratings were downgraded below double-A, and public agencies suddenly found themselves facing technical default because the agreements called for the deals to be guaranteed by at least a double-A-rated institution.
Given market conditions, it proved impossible to replace AIG with another acceptably rated insurance policy or letter of credit. Many private investors began to attempt to unwind the deals, entitling them to payments equivalent to the full value of their tax credits, even though the terms of the transactions were being honored and not a single payment to investors had been missed. Motivating investors was a 2004 change in the law disallowing their tax benefits. In a bizarre twist, the technical default enables them to recoup from the public agencies the value of the tax benefits subsequently denied under the new law. Had AIG retained its triple-A rating, that avenue would not be open to them today.
If forced to pay the full value of the transactions, public agencies will have to come up with billions of dollars at a time when they are losing revenue. The financial burden of the contracts will be borne entirely by ratepayers and taxpayers. To add salt to the wound, the payments — cash windfalls of significant amounts — will be made to financial institutions that have already received billions of dollars from the Troubled Asset Relief Program. It is astonishing that well-functioning transactions are in danger of imploding, not because payments are being missed or rescue capital is needed, but simply because of a technical issue.
There is, however, a simple solution. AIG, 79.9 percent owned by taxpayers and its payment-making ability clearly being underwritten by the federal government, should be considered triple-A by market participants. The Treasury Department should make it clear to the rating agencies that it stands behind AIG in these structured lease transactions. In turn, the rating agencies would simply acknowledge, in a public statement, that the government's controlling stake in AIG is tantamount to a federal guarantee of the company's role in the transactions, thus effectively restoring triple-A backing to the deals.
Those steps would cost nothing, but they would relieve hundreds of public agencies across the country from the threat of being forced to prematurely unwind sound, low-risk transactions at the cost of millions of taxpayer dollars, perversely destined for the pockets of financial intermediaries. In November 2009, the U.S. Senate failed to address the issue, but the U.S. Treasury should do so without delay.
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Richard J. Wolff, Ph.D., is chairman of the North Hudson (N.J.) Sewerage Authority.