No Blank Checks Initiative Raises Many Questions

By Treasurer John Chiang

California�s long history of passing laws at the ballot box is rife with unintended consequences.

The No Blank Checks initiative slated to go before voters in the November general election is consistent with that trend. Passing the ballot measure could create a series of unexpected problems, making it difficult for the state to issue revenue bonds* to pay for roads, schools, sewage plants and other public works.

The 1996 ballot measure Proposition 218 created such unforeseen impacts, declaring that voters must approve any proposed new taxes. So-called government fees could only be charged without a voter mandate if they could be linked directly to the value of services received by payers.

The unforeseen consequence was that courts later ruled local agencies could not charge tiered rates to encourage water conservation by billing a disproportionately high fee for large-volume consumers.

As state treasurer, I am California�s banker and oversee the annual sale of billions of dollars� worth of general obligation bonds and revenue bonds. With that responsibility in mind, I asked public finance and legal experts on my staff to analyze the potential effect of No Blank Checks. Last month, I presented those preliminary conclusions to the Governance and Finance Committee of the state Senate.

Thorny Questions

We found that No Blank Checks raises a number of thorny questions that could throttle efforts to sell bonds crucial to economic development, education, housing, public health and other vital government services.

But, first, let me explain what the proposition purports to do. Here is an overview of its key parts:

• No Blank Checks would require voter approval of all revenue bonds issued or sold by the state in an amount, singly or in the aggregate, over $2 billion. Any “project” must be “financed, owned, operated, or managed” by the state.
• “State” is defined as the state of California, any of its agencies or departments and any joint powers authority or similar body created by the state or in which the state is a member. State does not include local agencies, school districts, special districts or community college districts.
• A single project may not be divided into separate projects to avoid the voter approval requirement. Multiple projects constitute a single project where the separate projects are physically or geographically proximate to each other; the separate projects will be physically connected to each other; or one separate project cannot accomplish its stated purpose without completion of another separate project.

What Projects Might Be Impacted?

It has been reported by the press that the proponents of the No Blank Checks initiative primarily are concerned with obtaining voter approval for the “California Water Fix,” also known as the Delta Tunnels; and, for any future revenue bond financing for the High Speed Rail network. These two projects definitely would be impacted by the initiative.

The California Water Fix is anticipated to be financed with $15 billion or more in revenue bonds. The current draft business plan for High Speed Rail anticipates in excess of $5 billion in financing from revenues from Cap and Trade credit auctions.

But, if half a century of ballot-box lawmaking shows us anything, it is that initiatives often times can backfire. This is particularly important to understand in the case of No Blank Checks. Key provisions are undefined. As a result, projects that proponents never intended to involve could wind up being covered by the initiative. Resulting disputes could be stuck in the courts as part of lengthy and costly lawsuits. Prolonged litigation creates ambiguity and complexity in ways the state finances critical infrastructure.

Credit Rating Agency Concerns

Major credit rating agencies have long been aware of this phenomenon. They have commented nearly 100 times in the last decade about how the initiative process injects uncertainty into the state financing and budgeting. And they generally view this as a credit negative that increases borrowing costs for the state.

In an early comment on No Blank Checks, Fitch Ratings stated: “It would constrain infrastructure financing and likely result in reduced investment over time, particularly for major water projects.”

Those needs are growing. Just last year, California Forward, a private-sector think tank, estimated a need to invest nearly $900 billion in water, transportation and school infrastructure improvements over the next decade. In 2012, the American Society of Civil Engineers found that 34% of California roads are in poor condition, and more than 2,700 bridges are structurally deficient. The governor�s latest Five-Year Infrastructure Plan estimates the state�s deferred maintenance costs at more than $77 billion.

Possible Unintended Consequences

With the law of unintended consequences in mind, my office analyzed the initiative to identify types of projects that may be impacted. Here�s what we found:

• The Department of Water Resources (DWR) has issued revenue bonds for the State Water Project. The system of dams, reservoirs, aqueducts, pumping stations and electric generation facilities was constructed to develop a water supply and convey water to areas in need. To date, the project has been financed with more than $10 billion in revenue bonds. DWR says it needs an additional $1.1 billion in revenue bond financing to complete existing projects. These figures do not include the proposed Delta tunnels or other dams and water storage projects. Thus, additional debt could be subject to a statewide vote.
• The initiative may also have an impact on bridges and roads. For example, most bridges in California are owned by the state. If significant retrofitting or reconstruction is needed, voter approval may be required. If the damage is caused by an earthquake or natural disaster, the state likely will need to borrow money for repairs. Federal government financial assistance could turn out to be insufficient or delayed. Even short-term borrowing, such as commercial paper, used for interim financing pending reimbursement from the federal government, might be threatened.
• Whether identified for campus-specific or system-wide projects, future public higher education projects may be subject to the initiative. At the campus level, it is possible that total revenue bonds issued for the various projects to meet student growth and to update facilities eventually could exceed the $2 billion threshold. At the system level, it is possible that one or both of the university systems could get sideways with the initiative’s issuance limits. For instance, what if the University of California system wanted to consolidate all of its dormitory facilities into a system-wide financing? Due to the lack of clarity in the initiative, it is possible these types of financings would require voter approval.
• Given the inter-connected prison health care system, revenue bonds issued to finance elements of that system could require voter approval.
• When a state-level financing authority, such as the California Health Facilities Financing Authority, issues bonds for the benefit of private or nonprofit borrowers, those bonds could be subject to the initiative. I note that this authority has five borrowers that each has issued in excess of $2 billion of revenue bonds. As a result, the initiative could impose limitations on the ability of these borrowers to access tax exempt bond financings through a state conduit financing authority, even though the borrower that has the sole responsibility for the debt service payments is a private entity.
• In recent years, the state has engaged in securitization financings in which bonds were issued based on future, anticipated revenues. The proceeds of those bonds helped the state meet existing budgetary needs. Tobacco bonds are an example. Similar, future efforts may need voter approval, if the initiative passes.

Based on my office’s preliminary review, I believe the No Blank Checks initiative raises a number of questions that need to be explored by policymakers and voters. Those include the following:

• The initiative risks an erosion or distortion of local control over fiscal decisions. Many projects that may hit the threshold have no statewide impact, even if they are financed or owned by the state. For instance, should voters in all parts of the state have a say if we decide to replace the Coronado Bridge and pay for it with revenue bonds paid by tolls, mainly from San Diego motorists? By requiring a statewide vote on such projects, the initiative might erode local control of projects that have only a regional impact, making it more costly and difficult for projects to be built.
• The initiative may lead to the state losing flexibility in time of disasters or crises. There is often no certainty regarding alternative funding sources when costly emergencies occur. During the electric power crisis of the early 2000s, the state issued $11.3 billion of revenue bonds through the Department of Water Resources to keep the lights on. A statewide election could delay a quick and effective response to a man-made or natural calamity. It could take a year or more for a statewide vote. Even under normal circumstances, let alone emergency situations, such a delay would increase costs and uncertainties.
• By allowing the threshold to be met by bonds issued in the aggregate for a project, the initiative fails to recognize the concept of lifecycle financing. The initiative specifically places its $2 billion threshold on bonds issued singly or in the aggregate for a project. In many cases, a project is built and then some years later, renovated or expanded with additional financing. For example, what if a bridge is constructed for $1.2 billion in revenue bond financing and 15 years later, renovations are needed that will cost another $1 billion. Does the aggregate amount require voter approval for the second financing?
• The initiative does not include an exception for bonds issued to refund or refinance existing debt. In 2015, my office refinanced more than $4.5 billion in previously issued revenue bonds. The resulting savings to California is more than $600 million. Simply issuing refunding bonds to lower borrowing costs could require voter approval if the aggregate amount of the refunding bonds, combined with the already issued bonds, exceeds $2 billion.
• The initiative provides that the $2 billion threshold will be adjusted to reflect increases in the Consumer Price Index. But consumer prices are a poor proxy for construction costs on public projects, which typically increase at a higher rate. A project that cost $200 million 50 years ago could cost as much as 10 times that amount today, simply as a result of inflation. That same scenario would apply going forward.
• The initiative creates uncertainty regarding how large infrastructure projects will be financed in the future. Given the connection between the state’s economy and its extensive infrastructure needs, any uncertainty regarding how those needs will be financed may result in higher interest rates.

As I mentioned earlier, Fitch warned that the initiative could hamper crucial investments. Constraining financing and reducing investment is costly and an impediment to fixing our crumbling public works.

The reason my office�s analysis remains preliminary is because key provisions of the measure are ill-defined and ambiguous. Many of the questions raised by the initiative will only be resolved through litigation and judicial interpretation of these uncertain provisions.

If what is past is prologue, these are the types of circumstances that are the breeding ground for unintended consequences and the injection of complexity and uncertainty into the state�s financing and budgeting.

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* Revenue bonds are paid off from fees paid by users, such as tolls for crossing a bridge. General obligation bonds are retired with payments from the state�s treasury.