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Commentary By Nicole Gelinas

Bell’s Debt Tolls

Economics Tax & Budget

The California city’s problems go beyond a $787,637 man.

Nearly a month ago, the Los Angeles Times ran an article with an attention-grabbing headline: “Is a city manager worth $800,000?” The story exposed how the city of Bell, in Los Angeles County, quietly paid its top two appointed managers and its police chief a collective $1.62 million annually. Reporters have observed that Bell took advantage of a poor, Hispanic populace whose “civic engagement traditionally has been muted.” The Bell story is not just about unengaged residents, though, but about supposedly sophisticated investors whose indifference to a deeper problem—untenable debt levels—is even less excusable.

As the Times report awakened local political activism, retail politics has solved Bell’s most obvious problem: city manager Robert Rizzo (annual salary, $787,637), deputy manager Angela Spaccia ($376,288), and police chief Randy Adams ($457,000) promptly quit. Protestors have marched against Bell’s near-six-figure mayor and city council members, demanding their resignations, too. California attorney general Jerry Brown will investigate Bell’s disclosure and election practices. State comptroller John Chiang has decreed that cities and counties henceforth must report salary data for public posting. No small-time municipal hack in Southern California can expect a big-time corporate salary anytime soon.

But Bell’s chronic problems fester. Bell homeowners, with a per-capita income less than half California’s average, pay the second-highest property taxes in Los Angeles County, 34 percent above the norm, the Times reported recently. Tax rates have soared in the past decade, and running a few overpaid hacks out of town won’t solve the problem.

Taxes will continue to climb in this poor city for one reason: debt. By the end of the credit and real-estate bubbles, Bell—population 38,000, 88 percent of whom speak a language besides English at home—had amassed more than $77 million in direct debt. The city’s debt burden clocks in at nearly three times its annual revenues; debt in New York City, by contrast, is less than one and a half times revenues. Bell’s debt burden is more than 16 percent of city residents’ modest personal income, whereas debt in New York makes up 15 percent of residents’ much higher personal income. Bell’s residents approved this debt, much of it through a 2003 voter referendum that, among other things, allows the city to raise property taxes, if necessary, under a debt-service exemption to California’s constitutional property-tax limit. But sophisticated underwriters, guarantors, and bondholders were the city’s willing enablers then and since.

In late 2005, Bell had a problem. It owed money to CalPERS, California’s state-pension system, for retirement benefits that the city’s public-safety workers had already earned. Bell didn’t have the cash on hand—so it borrowed more than $9.2 million through a bond offering. The deal should have raised questions among the underwriters at Wedbush Morgan, the Los Angeles firm that bought the bonds from Bell and resold them. They should have wondered why, if Bell was already struggling to pay for past benefits, the city had agreed to expand pensions for non-union workers in 2003—including an extra 1 percent cost-of-living allowance for city council retirees only, 50 percent higher than other workers got. The underwriters also should have balked at Bell’s plan for $1.5 million of the borrowed funds: the city wanted to use them to refinance a similar pension bond done five years previously. Moreover, Bell expanded its indebtedness in this manner even as its long-term debt burden had increased by 15 percent in the previous year—a big jump for a little town. Finally, Bell issued the bonds not directly, but through a public authority—yes, a poor city of just 38,000 can have its own public authority—whose debt is not even an official city obligation.

Two years later, Bell nearly increased its outstanding debt by half, borrowing another $35 million to expand a sports complex, build a theater, and improve parks. Citigroup, the underwriter, did the deal, despite the fact that in the previous year, Bell had hiked its long-term debt obligations by another 17.6 percent. Advisers and investors didn’t worry that Bell’s citizens were taking on an ambitious public-works program relative to the city’s experience. Nor did they wonder whether Bell would have the capacity to repay the debt and provide public services once the bill came due. The due date, anyway, was pretty far in the future: just like some subprime mortgages, the bond deal came with four years’ worth of interest-only payments. Annual costs will rise abruptly by 42 percent late next year.

Why the lack of concern? California was in the last throes of a free-money boom. In its bond-offering documents, Bell boasted that its property values had soared by double-digit values in just one year, even as most of the county experienced only single-digit gains; the torrid growth rate was supposedly a sign of health. Bell’s general-fund revenues, buoyed by taxes on higher property values, skyrocketed by 28 percent after inflation between 2000 and 2006. As it embarked on its borrowing spree, Bell was running double-digit budget surpluses. Ensconced in a bubble, underwriters and investors, if they thought about it at all, figured that if Bell had a cash crunch, the city could refinance—as it had done with its initial 1998 pension bonds.

Underwriters and investors had another reason to be complacent: the bonds they sold had triple-A ratings, the safest in the world. Though the ratings agencies, Standard & Poor’s and Fitch, had been rightly skeptical and given the bonds much lower ratings, Bell and its advisors circumvented this limit by taking out bond “insurance.” For a fee, insurer Ambac used its own triple-A rating to guarantee Bell’s $9.2 million pension debt; a competitor, CIFG, similarly guaranteed the $35 million public-improvement debt. That is, the insurers agreed that they would reimburse investors for any default losses. From the investors’ perspective, then, this business was risk-free. For their part, the insurers provided these guarantees because, they figured, municipalities almost never renege on their debt. In the years since, the bond insurers, having applied the same theory to the mortgage markets, lost their triple-A ratings.

Where does Bell go from here? Taxes will continue to climb; one assessment tax for the pension debt has already risen by nearly 50 percent in the past four years. Will residents be able to pay it? Even as officials were paying themselves handsomely, they slashed public services, as public money was already finite. Will voters be willing to pay—or will they perceive underwriters and investors as the cynical enablers of corrupt politicians?

How many Bells are out there, posing a silent risk to the financial system and to economic recovery? The costs far exceed $787,637.

This piece originally appeared in City Journal

This piece originally appeared in City Journal