We decry the decrepit state of our “crumbling” infrastructure, but we have yet to adopt legal rules needed to provide for its ongoing maintenance and repair.
A glance at the law governing enforcement of municipal bond obligations suggests a possible strategy for solving the maintenance problem, one that could be developed by state and local officials, bond lawyers, and other financial professionals.
Despite the drift of political and editorial rhetoric, the solution here is probably not to increase federal spending. Rather, it probably lies in the more tedious exercise of changing state and local finance laws nationwide to give maintenance spending the same priority, the same legal protection from political plunder, as debt service. This, even though maintenance spending is usually considered part of the annual operating budget separate and distinct from payments to bondholders.
Typically, bondholders are a “permanent” minority. In James Madison’s terms, they are a “faction” of lenders, always outnumbered by the (debtor) faction of voters. If bondholders had to rely for payment on the annual budget log-roll, they would, like any other permanent minority, almost always lose. They would need constitutional safeguards or other effective protection. Indeed, it’s precisely the existence of constitutional protection — or in some cases, an equivalently sturdy economic incentive — that permits states and localities to attract long-term lenders to finance capital projects.
Throughout the late 19th and most of the 20th centuries, bondholders relied largely on the non-impairment provision of the contract clause of the Constitution (and similar interpretations of state constitutions) for protection of their interests. Courts would generally enforce debt-service payment obligations against states and localities, even in the face of periodic political decisions to the contrary.
In the late 19th century, for instance, the docket of the U.S. Supreme Court was crowded with municipal bond enforcement cases. And not too long ago, in 1977, the contract clause protected covenants barring mass transit spending by the Port Authority of New York and New Jersey in the U. S. Trust case.
For more than a century, legal enforceability induced lenders to bear political risks that could result not only in payment default but also in a covenant breach. The muni bond market flourished and grew.
More recently, as shown by the explosive growth of “subject-to-appropriation” or “back-door” credits — where a legal obligation to pay arises only after an appropriation has been made in the fiscal period when payment is due — bondholders have come to rely on the expected draconian consequences of “repudiation” by a (sovereign) state.
If a state should fail to appropriate debt service for an authorized subject-to-appropriation credit, then, for all practical purposes, the market would consider that to be a repudiation of the state’s own debt. As a result, the state would lose access to credit markets, at least until the repudiation itself was repudiated by full payment. Loss of access is an altogether unacceptable risk, one imposing essentially the same payment discipline as legal enforceability.
For locals, markets generally don’t accept repudiation risk as an effective safeguard for long-term lending, in part because locals are in no relevant sense sovereign in our federal system, and in part because no one can confidently predict what they may do. After all, Los Angeles is now boycotting Arizona, and the West 67th Street Block Association in New York City once had its own foreign policy.
Those factors raise two questions about infrastructure maintenance:
• Are supporters of current maintenance those who oppose “deferred maintenance,” a permanent minority in need of constitutional protection in our political system, just like bondholders themselves?
• Are special projects like limited-access highways and toll bridges — which produce cash revenue to pay bondholders and where that cash is not normally required to be spent only in the budget appropriation process — in a different analytical position from ordinary infrastructure projects like local roads, bridges, schools, and parks, which produce no cash revenue and where general obligation or other tax-supported bondholders get paid even if the project falls apart?
As to the first question, deferred maintenance is hardly a laudable public-policy goal, despite the pledge of one desperate candidate to be the veritable champion of deferred maintenance. Rather, deferred maintenance is to be avoided if all that crumbling infrastructure is to be avoided.
No one can tell when maintenance is deferred, without granular expertise in capital and operating budgets. As a result, the repudiation risk has no bite. Everyone wants infrastructure to be maintained, but everyone also has multiple higher priorities. No special interest groups or political action committees organize around pro-maintenance slogans. Indeed, interest groups frequently target funds otherwise earmarked for maintenance as a funding source for their own wages, benefits, or transfer payments. Also, few ribbon-cutting photo-ops are held to herald maintenance programs.
So, yes, proponents of current maintenance and opponents of deferred maintenance constitute a permanent minority in need of constitutional protection in the normal budget process.
For the second question, comparing how we finance revenue-generating projects with how we finance ordinary infrastructure suggests a fix. Revenue bond indentures effectively protect maintenance requirements as if they were debt-service requirements by building the former into coverage ratios for the latter. Investors fear projects that are not maintained will fail to generate the requisite revenue to pay debt service.
Generally, no money is released from the lien of a revenue bond indenture unless debt service is paid and operations and maintenance requirements are met. Enforceable covenants require issuers to raise tolls, fares or other charges sufficiently to meet both those requirements.
By contrast, GO and other tax-supported debt instruments are not generally issued with enforceable claims for current maintenance. Ordinary infrastructure projects produce returns in the form of public goods, not cash — public goods that benefit taxpayers, not bondholders. Those projects’ bonds are paid for by taxpayers, not direct users, and taxing and spending for payment are part of the annual budget process, where any pro-maintenance lobby is a perpetual minority.
So, yes, we should consider reconfiguring state and local finance laws, jurisdiction by jurisdiction, to provide the equivalent of debt service protection for maintenance requirements, by authorizing financing mechanisms for ordinary infrastructure that recognize enforceable claims for current maintenance and repair. This would entail authorizing a parallel structure to a revenue-bond financing structure.
The aim here would be for budget-makers to provide for maintenance spending, along with debt service spending, before recognizing other claims on annual revenue. A one-size-fits-all model or uniform law would probably not work for 50 states.
This is not to suggest that maintenance claims are more important than the compelling and competing claims of teachers, police, or sick children. It is, however, to suggest that maintenance claims — like the claims of bondholders — are unlikely ever to be met in the normal political process without structural fiscal safeguards. So, unless we change the rules of the game, we’ll probably have to live with our “crumbling” infrastructure.
Eugene W. Harper Jr., a retired New York bond lawyer, teaches infrastructure finance at the Baruch College, City University of New York, School of Public Affairs.