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How Much Debt Should a City Risk?

In Iowa, cities must balance their annual budgets, and little or none of the borrowing pays for the operation of government.

Little gets more talk on the national political stage than debt.

Republicans call for spending cuts by the federal government, while opposing tax increases on wealthier Americans. Democrats support such revenue-increasing taxes, while opposing spending cuts.

“The federal government is using debt to pay for operating expenses in a lot of cases,” said Cedar Rapids City Council member Kris Gulick, an accountant and business consultant and current president of the Iowa League of Cities. “That would be like us going out to borrow money for the Police Department to operate. That’s a bad business practice, but that’s what the federal government is doing.

“And it hurts (the city of Cedar Rapids) from a perception standpoint. The perception is that all debt is bad.”

In Iowa, cities must balance their annual budgets, and little or none of the borrowing they do pays for the operation of government.

Instead, municipal debt helps cities invest in streets, bridges, water and sewage plants, and other capital improvement projects, plus economic-development incentives and big-ticket equipment purchases like firetrucks.

Cedar Rapids reaches new debt high

Cedar Rapids took on more new debt this month in one day of bond sales than any time in its historyc$82 million in general-obligation bond debt and another $6 million from revenue bonds, to be paid back with fees from water users.

Much of the debt—about $60 million—is tied to renovation of the city-owned downtown hotel, the city’s share of costs for the $85 million convention complex, and a city parking ramp going up across the street. The hotel and convention complex are contentious subjects for some.

The bond sale also put a dent in the city’s armor—its top Aaa bond rating, which has protected the city with low interest rates for some 40 straight years. The city’s rating is still Aaa, but Moody’s Investors Service added a “negative outlook”—a caveat tied to the unknowns of the hotel and convention complex, slated to open in a year.

Mayor Ron Corbett acknowledges the new debt taken on by the city is more than and different from usual. He said it is understandable and manageable, though, as the city continues to recover from the 2008 flood and after the city was forced to buy downtown’s only hotel from creditors to save it.

“It’s kind of like a snake eating a big rat,” he said. “At first there’s a bulge in the body of the snake, but eventually, it works its way through. That’s where we are.”

Progress for future comes at a price

Mike Van Milligan, city manager in Dubuque, said that city has had its critics, too, when it comes to debt. He keeps close at hand a 60-page PowerPoint presentation that helped him this spring respond to doubters and persuade his city council to nearly double outstanding debt to $239 million.

In comparison, Cedar Rapids—which is more than twice as big as Dubuque, with a property valuation more than double Dubuque’s—estimates its total outstanding debt will be about $420 million on June 30, 2012, up from $370 million a year ago.

Dubuque has been adding to city debt for a flood protection system, sewage treatment plant, industrial park, airport terminal, transit facility with parking ramp, another downtown parking ramp, and more. Nearly all of it will be paid off with user fees, not property taxes.

In Cedar Rapids, revenue from the downtown hotel and parking ramp, as well as the incremental increase in property taxes in the city’s medical district, will pay off much of the new debt.

Van Milligan, who has been city manager in Dubuque for 19 years, said his city and Cedar Rapids are “two of the shining stars” among cities in the Midwest. “I’m tremendously impressed with your recovery activities from that unbelievably devastating flood,” he said.

Likewise, city leaders in Cedar Rapids have pointed to Dubuque as a place to model because it has seen a rebirth like few others in the state.

Change doesn’t come on its own, and it doesn’t come free, said Van Milligan.

“Progress has a price,” he said, “but I think stagnation has a greater price.”

When a city stagnates, he said, the costs of running a city are spread across a shrinking tax base, which can send a city’s employers looking elsewhere to invest. Children and grandchildren grow up and leave because there aren’t any jobs left.

“So, therefore, you start bringing down that strong family that we’re so proud of here in the state of Iowa,” he said. “So I think there’s a greater price to stagnation, but there is no doubt that progress has a price. And, yes, it does include issuing debt to be able to afford the major projects that need to happen to progress.”

Still, cities should exercise caution

Brian Richman offers a caution, though. He’s a former financial adviser for cities and other public entities, mostly in California, and now a lecturer and director of the Hawkinson Institute of Business Finance at the University of Iowa’s Henry B. Tippie College of Business.

Cities, he said, are no different from people when it comes to debt. Some are reasonable and responsible, others more speculative. By speculative, he said, he means communities that have invested in what can be reasonable-sounding economic development projects that come with the hope of increasing a city’s opportunities and tax base.

“You pick up the newspaper here, and you don’t have to read very long to see that there are governments in Iowa that tend to take on riskier projects,” said Richman, not specifying any one government.

“Economic development projects—whether it’s a hotel or a convention center or a stadium or an industrial park, whatever—are inherently more speculative and therefore somewhat more risky than what are called essential services—water, sewer, roads, schools,” he adds.

Take, for example, Coralville, whose bond rating dropped in April because of underperformance at the city-owned Coralville Marriott Hotel and Conference Center and because of the city’s overall debt.

Where the line is between safety and speculation, Richman said, is hard to know.

“Those are really policy decisions,” Richman said. “How much debt is a particular city comfortable with? And more importantly, what is the vision for the city? What is the citizenry’s vision? What is the city council’s vision? What do they want the city to be? And when you know where you want to be, how do you get there and how do you pay for it? Then the question is, how much can you actually afford?”

Richman points to the Iowa State Treasurer’s website, which shows public debt in Iowa is up 6.6 percent in the past year and up in nearly every category—city, county, community college, school district—over the past five years.

He said the trend could mean good growth in those local communities, so government has needed to provide more services, but it also could show how local jurisdictions have turned to borrowing to fill gaps in their budgets. A city that used to buy police cars each year with annual revenues, for instance, may now borrow to buy them, he said.

He adds that cities also have pension and related obligations, which are an additional kind of debt.

A look at the financial reports of some of Iowa’s largest cities shows that debt is on the rise. For the fiscal year that ended June 30, 2011, overall outstanding debt for Des Moines rose 10.3 percent; Davenport, 13.5 percent; Dubuque, 43.2 percent; and Sioux City, 16.6 percent.

In Cedar Rapids, the total outstanding debt (this does not include the recent bond sale or the payment on debt over the past year) increased by 3.2 percent, while Iowa City’s debt rose 1.4 percent and Waterloo’s dropped by 1.2 percent.

Postponing expenditures can’t be done forever

Kevin O’Malley, the finance director for Iowa City, said one argument for taking on debt and paying it off over time is that people who benefit by what is built—improvements in Iowa City to a water or wastewater system, for instance—are the ones who are paying for it over 20 or 25 years.

By contrast, a city could try to save money before construction, but people contributing may die or move before the project begins, he said.

O’Malley said cities like Iowa City—which also has a top Aaa bond rating—are being asked to take on debt in ways they haven’t in the past. He cites as examples two downtown development projects in which developers have proposed Iowa City take on debt to front money for the construction.

The city, he said, prefers the developer take on the debt, build the project and pay property taxes, and a portion of the taxes then are returned to the developer for a time to help pay off the developer’s debt.

“When you get into upfront money, to me it’s higher risk,” O’Malley said.

He said developers argue that banks won’t lend them money, so they want the city to do so. “So we have to ask questions like a banker,” he said.

Cedar Rapids changed its form of government in 2006 to a city manager and a part-time City Council. Council member Gulick, who joined the council that year, remembers that the council and then city manager, Jim Prosser, agreed Cedar Rapids had deferred infrastructure improvements for years and needed to change that.

Putting off improvements, he adds, came with an upside. When the flood of 2008 hit, the city had built up sizable cash reserves, which helped the city front some disaster-program costs while waiting for reimbursement from the federal government.

Gulick said the city’s large bond sale this month is unusual, but Cedar Rapids is taking on debt for a number of post-flood building projects for which the federal and state governments are paying much of the cost. He is confident that the city can manage the debt.

In its recent analysis of Cedar Rapids’ finances, Moody’s Investors Service credited the city with financial flexibility. The city is assisted in its effort to manage debt and balance its budget by new fees—about $3 million a year in tickets from traffic cameras, another $500,000 or so paid by those who have vehicles towed after arrests, and $3.4 million from a 1 percent franchise fee on electric and gas use in the city.

Making investments to benefit city’s future

Former city manager Prosser, who left in early 2010, was a proponent of revenue flexibility. As he constantly said, “Cities are forever.” City Council member Monica Vernon frequently repeats the forever refrain.

Council members, Vernon said, have to make investments that will benefit the community for years to come.

“You got to have these glasses that get you out 20 and 30 years, because we’re bonding for things for a long time—10, 20, and 30 years,” Vernon said.

“...Cedar Rapids has been sitting here on the banks of the Cedar River since the 1840s, and it’s not going anywhere,” she said, “and in the 2040s, which is essentially what we’re moving toward right now, Cedar Rapids will be here. And we want to ensure that it will be successful, progressive, and a good place to live, work, and play.”

Dubuque’s Van Milligan said a city that is unwilling to take on debt is like a person who decides not to take out a home mortgage. The person might save up a little at a time and finally have enough for a home by age 60, but the person would have lived most of life in something else.

“I think just having a policy of not taking on any debt is inviting mediocrity and stagnation,” he said.

The UI’s Richman agrees that today’s policymakers have an obligation to provide future generations with a quality of life that they are providing to current generations.

“And in order to do that, your finances need to be sound,” he said.

So which is it? Should city leaders intent on positioning a city for the future take on debt to update and refresh, or should a city also make sure it doesn’t take on too much debt?

“I suppose the answer to that question might differ for different people,” Richman said. “For me, it’s the latter.”

Vernon said she was raised to dislike debt. As a homeowner, she said, the goal is to get rid of the mortgage, for example.

“And when you look at the size of the debt of even a well-run city like Cedar Rapids, out of context, it can be frightening,” she said. “For someone paying off a home mortgage and then to look at (city) debt in the millions, that’s scary, but it’s the collective investment we’ve made in the future of our community.”

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