For about a decade, the Hercules Municipal Utility (HMU) in Hercules, California has been bleeding money. Journalists Bob Porterfield and Jackie Ginley have been following the story since last summer when City Hall officials met to discuss how to deal with the drain on the city’s budget.
Hercules Municipal Utility was created to be a profitable venture for the city: a subsidized utility with the power to issue debt. And it is only one of several publicly funded (and uncompleted) projects on Hercules’ books. Porterfield and Ginley report that the city has spent $16 million over the course of a decade for an unbuilt substation. HMU represents $13 million in bond debt for Hercules. The redevelopment agency is $18 million in debt. The city has cut services, laid off workers, and watched its credit downgraded to junk by S&P.
The problems of Hercules stem from a few sources. First, as Porterfield and Ginley note the town mixed its general fund budget with the budgets of special authorities. A related problem is the how such quasi-public entities are used to avoid debt limits by municipal governments. Allowed to issue debt that is then backed by the authorities’ revenues, in the event the authority cannot pay, revenue debt becomes the “moral obligation” of the municipal government. (I discuss the history of the moral obligation bond here. They were a creation of the Nelson Rockefeller gubernatorial administration. Revenue bonds now far outstrip General Obligation bonds as a total of state debt.)
Why was HMU created? Rising electricity prices were another attraction for the city council. In 2003 they reasoned operating a utility would deliver cheaper prices to consumers. But the deal was a money-loser. The plant wasn’t built. Revenues did not flow. And then the finances got even more convoluted.
The city tried to pay back the bonds with revenue-lease bonds from a swim facility using the Hercules Public Financing Authority (PFA) as the borrower (on paper) to raise money. The PFA issued the bonds which were to be repaid from revenues from a specific project: a swim complex built a few years earlier totaling $7.4 million.This maneuver was to avoid the 2/3rds majority needed for the city to issue General Obligation bonds. In fact, the city of Hercules was the borrower, not the PFA, and the city remains responsible for paying back the $7 million it raised through the deal to finance the electric utility.
(This kind of sidestep to avoid issuing GO debt and getting around tax and spending limits is one of the reasons off-budget enterprises have proliferated in state and local governments as Bennett and DiLorenzo note in their study. OBEs have increased to 37,389 entities over the past several decades.)
Porterfield and Ginley detail what happened next. The project ran up costs, made almost no money with 840 customers and will continue to operate at a loss. For 2010 the city must pay $750,000 in interest on the HMU bonds (far more than it brings in) plus $10 million in interest and principle on other borrowed money. Hercules’ general fund budget is about $15 million. Read here for more details on the various debt-backed projects of Hercules