ALAMEDA, Calif. — The battle over the future of redevelopment may be one of the most polarizing issues in what could be a landmark year in California’s long-running budget drama.

If Gov. Jerry Brown gets his way, every redevelopment agency in California — which collectively have more than $20 billion in outstanding debt — will be wound down, though outstanding debts would be honored.

The agencies, known as RDAs, function by capturing the growth in property tax increment after a redevelopment area is created, and much of the revenue is used to back bonds that finance improvements in those areas.

It’s a sizable market with a lot at stake for some participants. More than $1 billion in California tax-allocation bonds were sold in 2010, according to Thomson Reuters data. More than $4 billion were sold in 2003, the peak year on record.

The elimination of RDAs was one piece of a much larger budget proposal to cut general-fund spending by more than 8% next year, while asking lawmakers to send voters a ballot measure extending several temporary taxes by five years.

The questions Brown has raised about the future of redevelopment have already cooled the secondary market for redevelopment debt, according to  Bud Byrnes, chief executive at Encino, Calif.-based RH Investment Corp., a broker-dealer specializing in California municipal bonds.

“It’s having a profound effect on the bid side of the market,” Byrnes said. “The bid for redevelopment agency debt is profoundly off those for other essential-services bonds.”

Brown’s proposal to eliminate RDAs came barely two months after California voters approved a measure that appeared to protect them. Proposition 22 bars the state government from taking money from redevelopment agencies and other local government entities.

“The voters of California were very clear,” said John Shirey, executive ­director of the California Redevelopment Association. “By a 61% to 39% margin, they said don’t take local government money to pay for state budget problems.”

Brown administration officials believe their plan — simply to adopt a statute abolishing redevelopment agencies — is not affected by the language in ­Proposition 22.

Shirey said while his CRA legal team isn’t finished reviewing all the issues posed by the governor’s proposal, there are plenty of reasons to question it.

“I don’t think it’s as simple as the Brown administration thinks,” he said. While a state statute initially authorized the creation of redevelopment agencies, the issue has been complicated by subsequent constitutional amendments dating back to 1952, when voters adopted a ballot measure authorizing RDAs to use tax-increment financing.

Opponents of redevelopment are also gearing up to debate the merits of the practice. Assemblyman Chris Norby, an Orange County Republican, has been a critic of redevelopment since the beginning of his political career as a City Council member in Fullerton.

“I think it’s an opportunity to have a dialogue on this,” Norby said.

Until now, he said, much of the criticism of redevelopment in California has stemmed from agencies’ use and abuse of eminent domain powers.

Brown’s budget has broadened the ­discussion to encompass whether redevelopment is a wise use of money at all, ­according to Norby.

“There’s never been as focused a discussion as there is now as to where the money should be going,” he said.

The Department of Finance estimates that redevelopment tax increment takes in about $5 billion a year around the state. It estimates that ending redevelopment would free up about $1.9 billion annually, after accounting for debt service on ­existing redevelopment bonds and other contracts.

In fiscal 2012, most of that money would be used to balance the state budget; in ­subsequent years, it would flow to local governments and agencies as part of Brown’s broader plan to realign more funding and responsibilities to the local level from the state.

The administration wants the Legislature to pass a statute dissolving all existing RDAs — there are about 400 of them — by the end of the fiscal year.

Under the Brown proposal, new agencies would be formed as caretakers to manage the outstanding bond debt and contractual obligations of the old RDAs.

The governor also wants to ask voters to approve a constitutional amendment in 2012 to create a new economic development mechanism for local governments, which would require local voter approval.

But lawmakers should think twice about pulling the plug on one of the few tools local governments have to generate economic development, according to Stephen Heaney, managing director at Stone & Youngberg, the top underwriter of tax allocation debt in California.

“I completely understand the governor wanting to make shifts and restructure the levels of government and restructure revenues between local and state levels,” Heaney said. “At the same time, I’ve got to say from our observation redevelopment has been one of the very few tools local government has to address economic development and the infrastructure that’s necessary to generate economic development.”

Redevelopment debt over the years has financed many high-profile projects, including the revitalization of downtown San Diego, the Hollywood and Highland center in Los Angeles, and projects all over San Jose, including the HP Pavilion hockey arena.

Norby said he’s optimistic that ­lawmakers will pass Brown’s proposal to end redevelopment, but doesn’t think the story will end there.

“I imagine it will be challenged in court; everything is,” he said. “The CRA has a huge special interest behind it, bond brokers, lawyers, city governments, as well as big-box stores and developers who rely on redevelopment subsidies and eminent domain.”

While the political debate casts a pall over the secondary market for redevelopment debt, some opportunistic investors are sniffing around, sensing that bargains are there to be had, Byrnes said.

“Redevelopment agency debt is going to be under a lot of price pressure for the foreseeable future, especially as long as this is being debated,” he said.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.