The Jury Talks Back


Why do we sell bonds only after a project is near completion?

Filed under: California Politics — aphrael @ 12:15 pm

As a result of California’s deteriorating budget situation, the Pooled Money Investment Board has apparently voted to stop funding infrastructure projects; the projects in question are ones which are supposed to be funded by the sale of voter-approved infrastructure bonds.

Apparently, while a naive citizen like myself would assume that the projects are actually paid for from money raised by the bonds, this is not the case. The state’s General Fund loans out money to pay for the projects, and then once the projects are underway and nearing completion, the state sells the bonds, and the bond money is used to repay the General Fund. Since the General Fund is about to run out of money, the PMIB said, it can’t loan money to the projects at this time.

To me, this seems like a bizarre way to do things. But, according to one of the guests on This morning’s Forum, it’s required by federal law.

I’m having a hard time believing this is true. Does anyone know what federal law it is that requires states to only sell bonds after the projects the bonds are paying for are almost complete? And does the policy decision embedded in such a law make sense to anyone? (Because, whether it’s required by federal law or not, the state of California is doing it; and while i hesitate to think that they are doing something with no rationale, it really seems like a boneheaded policy to me.)


  1. aphrael – . . .while i hesitate to think that they are doing something with no rationale

    Welcome to California.

    Comment by Apogee — 12/18/2008 @ 2:06 pm

  2. Even people doing stupid things tend to believe there is some rationale which justifies it. I don’t think anyone except the clinically insane make decisions without some rationale.

    What I’m curious about here is, what’s the rationale for doing it this way? The guy on the radio said “federal law requires it”, but that just kicks the question over to someone else.

    Comment by aphrael — 12/18/2008 @ 2:42 pm

  3. Let’s look at a purely hypothetical example of why you would not issue bonds until a project is complete.

    Imagine that I want about $3 billion in funds in order to start up an. . . oh, I don’t know. . . how about a stem cell research group. Imagine that I got the bond issue passed by promising everyone that we would be finding amazing cures almost immediately, and that all sorts of venture capital money would be pouring in to make this a very profitable enterprise for our state. Now let’s say that the bond money was immediately released, and I then spent two or three years dickering around with the politics of which schools would get the research labs, which scientists would be appointed to head up which labs, what sort of legislative oversight would I have, and all that other bureaucratic stuff. What if we never got around to doing any real science? Wouldn’t you, as a bond-holder, feel screwed? What would happen if all the bond-holders got together to sue for fraud? Who would be the defendant, and from whom would they collect the money?

    It’s arguably much better to require completion of the project first, so that investors can at least have a sense that something tangible will come out of this.

    Comment by JVW — 12/18/2008 @ 2:46 pm

  4. I tend to agree with JVW, although differently in the details. I would suggest bonds can’t realistically be issued until you have (or think you have) a pretty firm grip on what the costs are, and therefore know how much you need to raise in bonds. During the preconstruction phases, there’s a lot that up in the air–even a definite plan will need approvals, will need sometimes to purchase property through eminent domain or through some other, more legitimate process*, will need to go through a bidding process, etc. The time the first shovelful of dirt is turned is relatively late in the process, unless it’s something like Boston’s Big Dig. (Think of the criticisms of Obama’s stimulus proposals as being stuff that won’t have an impact until too far down the road.)
    I don’t know about there being a Federal law, but it wouldn’t surprise me if there were laws regulating the issuance of bonds in the interest of minimizing hanky panky.

    *Yes, eminent domain used to be a legitimate process, but nowadays…

    Comment by kishnevi — 12/18/2008 @ 5:45 pm

  5. Issuing long-term debt like bonds is the norm in project finance and other kinds of infrastructure finance, including real estate projects. The construction is funded by loans.

    Why, you ask? Simple. Let’s say you have a two year construction period. If you issue the bonds at the project inception, you pay interest on money that is sitting in a bank account.

    In addition, as already stated, you have a hard time issuing bonds for a project whose costs are not fixed.

    As for a federal law requiring this, I am not aware of a blanket law on this point, but several parts of the Revenue Code force this result for certain kinds of projects if the state wants to retain tax exemption for the bonds.

    Comment by Cyrus Sanai — 12/19/2008 @ 12:22 am

  6. aphrael – I don’t think anyone except the clinically insane make decisions without some rationale.

    Again, welcome to California’s political landscape.

    Agreed with Kishnevi & JVW’s idea – that costs must be established before issuing the bonds. However, unless there’s an actual accounting that’s thorough regarding the costs, then the elimination of ‘hanky-panky’ is moot, as it wouldn’t emerge whatever the project/bond issue order.

    I don’t see why bonds couldn’t be issued to cover the first portion of expenses, with the stipulation that the money recovered will be used to finish the project.

    Comment by Apogee — 12/19/2008 @ 12:44 am

  7. Apogee; that would be my expectation; bonds could be issued to cover the first portion of expenses or, at the very least, as soon as there was a reasonable projection of costs.

    The idea that the state loans the project money which the project then repays with bond sales is bizarre to me.

    Comment by aphrael — 12/19/2008 @ 8:31 am

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