The recent Washington, D.C. Metro disaster that left nine people dead also brought back into the spotlght the role of lease-back agreements used by transit agencies to generate cash years ago. Apparently, the metro cars that collapsed like accordians were part of one of these deals. According to the Wall Street Journal, these deals discouraged Wasington Metro from retiring the rail cars and replace them with safer, upgraded models.
In essence, transit agencies sold their capital stock–metro rail cars, buses, etc.–to an investor (often a bank) who would then lease the cars back to the transit agency. The sale generated cash for the transit agency which it could use for maintence, capital improvements or, in many cases, operating costs during lean years. Investors benefited by being able to write off the depreciation on the capital asset (becoming a tax shelter). These deals were outlawed in 2004 because they effectively robbed Peter to pay Paul; they were short-sighted ways to raise cash for operating costs and often left transit agencies with few capital assets.
Metro was advised to phase out the metro cars several years ago because they were less safe than more modern cars. Metro didn’t because the financial penalties for backing out of the deal were significant. Unfortunately, in a sign of the current times, Congress is now considering legislation that would effectively wipe the economic benefits of these contracts to the private investors.
“If the agency had wanted to break the leases, said Chief Financial Officer Carol Kissal, it would likely have had to pay penalties and fees on top of the cost of buying newer rail cars.
“Such shelters, known as “sale in lease out” or “lease in lease out” deals, were outlawed in 2004. But some deals made before that date remain in effect.
“Sen. Robert Menendez (D., N.J.) introduced legislation on Thursday that would apply a 100% excise tax on “windfall proceeds” banks reap from the transactions, giving them incentives to unwind the deals.
“And Sen. Charles Grassley (R., Iowa) said in a letter to House Majority Leader Steny Hoyer that any new funding for the Washington transit agency shouldn’t go to tax-shelter counterparties. Mr. Hoyer is supporting legislation that would provide $1.5 billion in federal funding to the Metro system over 10 years.”
While the frustraton with the way transit agencies have mismanaged their finances is understandable, the solution is not simply to abrogate contracts after the fact. These were contracts voluntarily entered into. They were (and are) legal. Simply nullifying the contract because they had unanticipated consequences, not matter how tragic, is bad public policy and could significantly undermine the ability of transit agencies to borrow from the private investor market in the future.
The lease-backs, it turns out, were bad deals. But trust and respect for contract is crucial to the functioning of any business enterprise, public or private. A knee-jerk, legislative backlash will only hamper their ability to function effectively in the future.