J.P. Morgan the man is no longer here, but the global financial services firm he founded has a firm grip on its Letter of Credit with the city of San Jose.
Last week, I participated as the alternate for Mayor Chuck Reed on the oversight board for the
Successor Agency to the Redevelopment Agency (SARA). The primary focus of the meeting concerned the approval of a one-year extension to the existing Letter of Credit (LOC) with JP Morgan bank. This extension had already been passed by the City Council, but it was still up to the SARA Oversight Board to approve the extension as well.
Back in 1996 and 2003, the council, acting as the Redevelopment Agency (RDA), issued a total of $119 million in variable rate bonds—this does not include the millions in fixed-rate bonds issued during the same time period. The city then entered into a LOC arrangement as an insurance measure to guard against the higher interest rate trigger inherent in variable rate bonds. The LOC approval enabled the council to borrow even more money. The annual fee for this LOC is $2.4 million, and the only way to avoid this annual fee is to come up with the $90 million required to pay off the remaining balance on the bonds. The final payment of these bonds is scheduled for 2032, which will be a continuing challenge for future city leaders.
Unfortunately, we have little leverage in negotiation with the bank and are beholden to its terms. Just as excessive debt can reduce a person’s individual freedom, the same is true in municipal finance: Onerous debt obligations can impede the ability of government to provide vital community services.
In the event that the city were to default on the LOC, the general fund would be on the hook for at least a decade to cover the full annual debt payments on the convention center and fourth street garage, which is currently $18.7 million. In addition, JPMorgan would charge an 11.5 percent penalty on the outstanding balance, further compounding the problem. JP Morgan, understanding the inherent risk involved, presently holds $5 million of San Jose SARA funds in escrow should there be a default. The bank is also listed second on deed of eighteen city properties that could be sold. This form of collateral was negotiated in a prior LOC extension.
The other item discussed at the same meeting concerned the fact that State Controller John Chiang had informed city officials that the SERAF loan is not an enforceable obligation. If this is the case, then the RDA tax increment cannot be used to repay the source of the funds borrowed.
Once again in 2011, the state grabbed money from RDA agencies statewide. Cities were allowed the flexibility to use housing funds to make the SERAF payment. At the time, I stated that we should utilize all funds from the housing department in order to make the payment, since funds were available at that time. The option was either to create more non-tax paying affordable housing developments, or fund economic development projects for companies that employ residents and pay taxes, such as Brocade, Maxim and SunPower. For me, the choice was clear—without tax revenue, we can not employ police officers or pave roads.
However the rest of the council disagreed with me, and decided instead to put the general fund at risk by borrowing $10 million in commercial paper instead of using available housing funds to make the SERAF payment. Another way of looking at it is the council voted to borrow money to provide more affordable housing instead of funding future police and roads. At the time of the council vote, there was more than $10 million available from the Housing Department to borrow without putting the general fund at risk. I wrote about how I was the only no vote on this item back in May 2011.
Back in December 2009, I sat through another borrowing binge to the tune of $25 million. A proposal from my council colleagues passed, which allowed for the borrowing of $25 million at a time when housing funds were available to cover this amount. On this occasion Mayor Reed and Councilmember Pete Constant joined me in voting “no.”
If the State Controller’s finding stands, approximately $52 million would now be dedicated to paying down the RDA debt, and sooner than currently anticipated. A consequence of this, however, is that the housing department would not be repaid the $42 million that was borrowed, and the general fund of San Jose would not be repaid for the $10 million issued in commercial paper. Inevitably, litigation may be required to resolve this issue, and the future policy direction will depend on a vote from the council.
If we do go down the route of litigation, I would be satisfied with a judgment that protects the general fund and its $10 million, and allows the remaining $42 million to be dedicated towards paying down the RDA debt. This debt reduction would also help the general fund in a future fiscal year.
By attending meetings such as SARA, I am able to hear firsthand about the issues of the day and analyze the information that is shared. This is what led me to find a way to save the general fund $10 million: After my article was published on San Jose Inside, city staff reversed their original decision, and I’m happy to announce the General Fund was spared $10 million as a result.
But what will happen this time?