Like a junkie seeking money for his next fix, the cash-strapped state of Arizona has pawned its possessions – prisons, government office buildings and other real estate – in an effort to balance a budget shortfall, through lease revenue bonds. Likewise, Florida has used lease revenue bonds for its prison system, which, according to a recent report, resulted in increased costs to taxpayers.

Arizona’s fiscal problems began in 2007 and took a severe downturn the following year with the collapse of the housing bubble. Throughout 2009 the state continued operating in the red. With no relief in sight, the legislature approved the sale of various state-owned properties in an attempt to balance the budget in 2010.

Here’s how the process works. The state sells its assets to investors via Certificates of Participation (COPS), a form of lease revenue bonds. The state maintains control of the buildings and leases them back at 4.37 to 4.75% interest over a maturity period ranging up to 30 years. If all of the payments are made, ownership of the buildings reverts back to the state.

Arizona raised $735 million for its general fund through the first issue of COPS in January 2010, which included the sale and lease-back of the Executive Tower, legislative buildings, a state hospital, the Veterans Memorial Coliseum and six state prison buildings in Florence. A second round of sell-offs in June 2010 raised an additional $300 million by pawning the state’s Supreme Court building and other properties.

This is not easy money, though; the state will have to pay hundreds of million of dollars in interest on the bonds. In fact, this short-sighted solution to the state’s fiscal crisis drew criticism from several financial institutions.

On December 23, 2009, Moody’s Investors Service downgraded the state’s bond issue rating from A1 to A3. That same day, Standard & Poor downgraded Arizona’s rating from AA to AA-minus.

Also critical of the legislature’s decision to sell state properties was Arizona Treasurer Dean Martin. “It was a mistake to sell ... our state buildings because it continues to put our state’s credit rating at risk, and looks foolish to the rest of the country,” Martin said, stating the obvious.

In addition to selling off state properties in an effort to balance its budget, Arizona is expanding its contracts with private prison companies, ostensibly to save money. After a 2009 effort to privatize most of the state’s prison system didn’t pan out, Arizona officials issued a request for proposals seeking 5,000 more private prison beds. Four companies responded, although no action is being taken until after the state finishes a report on a comparison of public and private prisons. Arizona already houses around 6,000 of its 40,000 prisoners in privately-operated facilities.

In Florida, the use of lease revenue bonds to finance prison construction “has obscured both the near- and long-term costs of failing to make needed policy changes.” That was the main conclusion drawn in an April 2011 report titled “A Billion Dollars and Growing: Why Prison Bonding is Tougher on Florida’s Taxpayers Than on Crime,” by the Collins Center on Public Policy and Florida Tax Watch.

Florida’s prison population has grown from 20,000 prisoners in the 1980s to 102,000 in 2010. Over that same time period the cost to Florida taxpayers to fund the state’s prison system has ballooned from $169 million to $2.4 billion annually.

Prior to 1993, Florida used fixed capital appropriations of general funds, or pay-as-you-go, to build and expand state prisons. The legislature created the Correctional Privatization Commission (CPC) in 1995 “for the purpose of entering into contracts for the design, construction and operation of prisons in Florida,” with a requirement that private prisons cost at least seven percent less than state facilities. Studies have been unable to substantiate such cost savings.

The CPC quickly became involved in financing the construction of private prisons. COPS were used to fund the construction, and the state would make the lease payments out of general funds.

Many states, including Florida, require voter approval to issue general obligation bonds. A California law firm came up with lease revenue bonds, which traditionally were used to build projects such as toll roads, bridges, hospitals, parking facilities, recreational projects, telephone systems and colleges “that generate revenue to pay off the [bond] obligation.”

According to a 2008 Forbes article, “crafty state treasurers” devised a plan to create a way for prisons to generate revenue. An entity or agency is created to build prisons, which it does by issuing lease revenue bonds. It then leases the prisons to the state, which pays the lease payments that service the bond debt.

“Essentially, the state takes money from one pocket (the general fund appropriations to the prison system) and puts it into another (the agency created for the facility), and then the agency distributes the money to bondholders,” Forbes wrote in describing the scheme.
Similar to taking out a mortgage on a house, the state must pay the principal on the loan as well as interest on the principal.

The Florida Supreme Court has held that such financing does not violate the state’s constitutional requirement of voter approval of debt, as the legislature can decide to cancel the bond payments; thus, the payments are not “real debt” because there is no definitive legal agreement to repay the bond obligation. Yet should the state default “on making the lease payments, its credit rating would suffer, and future debt would be incurred at higher rates.”

With six Florida prisons built using COPS by 1996, of which all but one were private, millions of dollars were flowing to the CPC. Corruption ensued due to a lack of oversight. The head of the CPC, Mark Hodges, resigned in 2002 “amid a state ethics probe in which he ultimately was fined $10,000. That investigation concluded he was profiting from business relationships with prison contractors outside his role as a privatization director.” [See: PLN, Oct. 2003, p.21].

The scandal did not end there. Another former CPC director, Alan B. Duffee, pleaded guilty in 2006 to siphoning more than $200,000 from a maintenance fund set up for private prisons. He eventually received a 33-month federal prison sentence. [See: PLN, May 2006, p.11]. The CPC was dissolved and the Bureau of Private Prison Monitoring, housed in the Department of Management Services, was created to oversee private prison contracts.

The CPC had created the Florida Correctional Finance Corporation (FCFC) to issue COPS for prison construction. The FCFC was housed under the Division of Bond Finance of the State Board of Administration, which initially had no oversight role but took over when the CPC was dissolved.

“Between FY 2006-2007 and FY 2009-10, the Florida legislature appropriated a total of $716,956,421 to the Depart-ment of Corrections (DOC) for construction and expansion expenses,” the report stated. “This figure includes both ‘pay-as-you-go’ appropriations for prison construction costs and rental costs, but does not include the debt-service (or interest payment) obligations on past construction borrowing.”

With those obligations included, the total cost is $1.5 billion. Florida taxpayers still owe more than $1 billion on the outstanding bonds and corresponding debt service payments. The state has spent $100 million annually on prison construction or expansion between 2006 and 2010, and the rate of bond issues to fund such construction has increased by 43 percent.

Lease revenue bonds have also obligated taxpayers to pay for unneeded prison beds. To meet an estimated prison population of 111,836 by FY 2011-12, the 2009 General Appropriations Act obligated taxpayers to cover $340 million in debt to construct 17 prisons. Since then, estimates for the prison population have declined to 101,833 for FY 2011-12. “However, the bonds to finance this construction have already been issued and sold, obligating taxpayers despite this changing need,” the report noted.

In spite of the fact that Florida has seen a decrease in both violent and non-violent crime since 2007, the state’s incarceration rate has not declined. “In fact, Florida arguably leads the nation in incarceration rates and stringency in law and sentencing, making it the most punitive of the 50 states as measured by more than 40 variables, including average prison sentences, life imprisonment, and prison conditions.”

Over the last 40 years, Florida’s rate of incarceration, which is the percentage of the state’s population in prison, has quadrupled from .13 percent to .54 percent. Tough-on-crime policy decisions have driven this increase – including the elimination of parole, longer sentences, mandatory minimum sentences, incarceration for technical probation violations and the use of prison instead of community-based alternatives.

The report found that 18 states have enacted criminal justice reforms designed to reduce costs and increase public safety, highlighting changes made by Texas, Mississippi and South Carolina. The report recommended that Florida join those states, urging legislators to review the state’s criminal justice policies and practices, and calling for a moratorium on prison construction.

The current system allows Florida’s elected officials to avoid hard choices related to prison building by using COPS funding, even though this results in greater long-term expenses for prison construction and operation. “Our political leaders are forfeiting our present and future by authorizing the underwriting of these costs as if the public debt was an open-ended credit card,” the report stated. “However, the bill to taxpayers will come due when these political leaders have moved on and no longer can be held accountable.”

Sources: “A Billion Dollars and Growing: Why Prison Bonding is Tougher on Florida’s Taxpayers Than on Crime,” Collins Center / Florida TaxWatch Special Report (April 2011); www.forbes.com; The Bond Buyer; www.businessweek.com; Arizona Republic

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