Hard Times at City Hall

Two weeks ago Gov. Tim Pawlenty fired the first shot in what promises to be a protracted battle between the state ofMinnesota and its local governments. Announcing his plans for erasing a huge state budget deficit, Pawlenty proposed to cut funding for Local Government Aid--the state assistance that goes to cities for general operations--by 22 percent over the next two years. Assuming the tough fiscal language of a CEO, the governor suggested that any city leader who couldn't find ways to deal with the cuts should be fired.

Minneapolis mayor R.T. Rybak immediately cried foul, as did a host of city council members. Nearly half of Minneapolis's $260 million general fund is dependent on lga, and with the projected cuts, the city would stand to lose $81 million over the next two years. Since the legislative session began in January, a large delegation from the city has been pleading with lawmakers at the capitol to spare the funding.

It is one more tale of fiscal woe for Minneapolis, which is seeing its worst financial crisis in memory. But the lga cuts may provide one consolation for local officials: They will offer up a politically convenient scapegoat for the city's looming financial problems. Even before the Pawlenty budget, Minneapolis was mismanaging on its own quite nicely. It has spent lavishly on development projects in the past decade, most recently on such high-profile development deals as the downtown Target and the new Block E complex across from City Center. The city has been juggling a growing debt load for years, and now the crisis is becoming manifest.

The magnitude of the problem can scarcely be overstated. Most at the capitol had seen Pawlenty's proposed LGA cuts as a foregone conclusion. To gird themselves, Minneapolis leaders recently adopted the city's first-ever five-year financial plan, designed to address what was projected as a $55 million shortfall over the next five years. But those numbers assume that the LGA money--some $89 million last year--would continue to flow unabated. And no matter how deep the cuts prove in the end, that will certainly not be the case.

But cuts in state aid are just the beginning of the problem. Minneapolis's expenditures have exceeded its revenues every year since 1990. Several departmental funds have been operating at a loss for nearly a decade. And the city's debt service--the money required to make annual payments, with interest, on borrowed money--will be $122 million in 2003, a sum that is almost 75 percent of the city's projected revenue from property taxes.

The problem is compounded by another state fiat: In 2001, legislators cut taxes for businesses, historically a strong source of revenue for the city, even as Minneapolis office vacancies kept on climbing. (Meanwhile, city leaders have vowed to keep residential property tax increases capped at eight percent through 2010.) And health care and pension costs for employees are draining municipal coffers like never before.

So austerity and "streamlining" are the orders of the day in city government, from the capping of employee salaries to the combining of departments and the reduction of police and fire department budgets. "Everything's on the table," says Barb Johnson, chair of the city council's Ways and Means/Budget Committee. "There's no way people can hold on to things the way they used to be. The days of kingdoms and not sharing and not working together are done. People have to realize that some of the things that they hold dear about Minneapolis are not going to be around anymore."

Others are less sanguine. Some simply say that Minneapolis, for all intents and purposes, is broke.


In 1970 the city of Minneapolis was solvent. Indeed, the revenues for the year, $61.3 million, were actually a little higher than predicted. The city earned more that $1.7 million in interest on investments alone--an all-time high, according to the city treasurer's note in the annual budget report. And debt service was only $35,000, leaving the city with ample cash flow to help cushion the effects of the mid-'70s recession.

By contrast, the city's 2003 budget, with revenues forecast at $1.22 billion--20 times what they were in 1970--offers at best a shaky plan for breaking even. By the end of 2001, the city's total debt had reached $1.5 billion; the $122 million in debt service due to be paid this year is 10 percent of the city's overall budget.

Minneapolis is hardly the same aging mill town it was in the Nixon era. The Metrodome wasn't here in 1970. Neither was the IDS tower, City Center, the Target Center, or the Convention Center. Or Orchestra Hall. That was built in 1973 with a 30-year bond for $9.2 million. It was one of the first significant bonds the city used for a marquee downtown development; in the coming years, taking on bond debt to develop and redevelop the city became routine.  

Not all bonding projects have been as successful as Orchestra Hall, however. Minneapolis built its original skyway system with "self-supported" bonds--meaning that tax revenue from the vendors who occupied the skyways was supposed to pay off the borrowed money--but the city ended up picking up the tab. Through the years a number of high-profile redevelopment projects have run into trouble, but there's no question that the bulk of Minneapolis's present fiscal troubles are rooted in the relatively recent past.

In 1991, in the midst of the last true nationwide recession, Mayor Don Fraser warned of "belt-tightening" ahead in his annual budget address. Fraser oversaw a city that was then around half a billion dollars in debt for bonding projects. At the same time, Minneapolis's cash expenditures were consistently exceeding its revenues, by as much as $84 million in 1991. By the time Fraser left office in 1993, the debt had grown to $726 million.

But those numbers would soon seem modest. After Fraser, the debt spun out of control. City leaders began balancing the books through a combination of bonded debt and debt-shifting maneuvers that were the equivalent of paying off a MasterCard with a Visa. Led by then-mayor Sharon Sayles Belton and a city council obsessed with big development projects, the city plunged ahead. In 1995, Minneapolis spent $132 million more than it made. It didn't stop there. By the time Sayles Belton left office, in 2001, the city's debt was approximately $1.5 billion, and Minneapolis paid $137 million in debt service that year.

From 1990 to 2001, there wasn't a single year in which the city's expenditures didn't exceed its revenues. (The city's 2002 financial statement is not yet available.) The year the budget came closest to being balanced, at the height of boomtime in 1997, the city spent $427.7 million and took in $427.4 million. All told, in those 12 years the city spent $644.7 million more--not including debt--than it took in. And the amount of its total indebtedness--between $1.1 billion and $1.5 billion, depending on how you count--more than doubled.


"Bingo," says former council member Steve Minn, explaining that accumulating expenditures are the reason for the city's economic duress. "There are accounting loopholes, but that's really what you have to look at. At the end of the day, running a city is no different than running a checkbook."

That is not exactly true. Running a city is like simultaneously running a great many checkbooks that are all supposed to reconcile when added together. There is enormous potential for creative accounting. Minneapolis, for example, has various departments and funds that operate individually; to make the bottom line come out right, the city relies heavily on "intergovernmental transfers" from various sources to prop up the general fund, while particular departments, such as the fund for insuring city employees, are allowed to dip into the red.

Minn, who left the city council in 1999, says he tried repeatedly to warn of his colleagues' spendthrift ways. "The debt service incrementally rose, and I was saying, 'We have to stop this and be responsible,'" Minn recalls. "It's an evil process."

Ken Kriz, who teaches public finance at the University of Nebraska-Omaha and consulted for the city when he taught at the University of Minnesota's Humphrey Institute from 2000 to 2002, is more reluctant to place blame. "The previous administration was not necessarily irresponsible, because the way local governments account has a lot to do with fund transfers from year to year," Kriz says. "The trouble was, they didn't plan for the worst-case scenario. I don't think anyone on a state, county, or local level saw revenues disappearing so quickly."

Kriz contends that aside from being dependent on LGA, the city has been far too reliant on "unstable" sources of revenue, such as licensing, permits, and inspections. "In a bad economy," he says, "those revenues go down, because there's not as much construction, building, money for sewer hook-ups, and things like that." From 1992 to 2001, the city's revenues for licenses and permits grew from $9 million to $20 million--a trend that's not likely to continue, Kriz says, in a sour economy. But LGA cuts are still the immediate back-breaker: Minneapolis currently gets almost half of its $260 million operating budget from the state. (Other cities are less dependent, notes Kriz: Omaha, for example, receives only four percent of its general funding from the state of Nebraska.)

Both Minn and Kriz complain that Minneapolis has badly mismanaged its Internal Services Funds, which provides money for insuring city employees, paying for "equipment services" such as computer upgrades and police cars, and maintaining a fleet of fire department and construction vehicles. "The critical moment for that fund was in 1995, when we needed to buy new squad cars," Minn recalls. "We needed a new fleet, and that was fine. I wanted to spend cash on it. But the council wanted to pay for it by bonding, and that's what they did."  

The reason, Kriz figures, is that the city wanted to balance its general fund (which pays for everything from police services to public works), and spending money out of pocket to buy the new fleet would have made that impossible. So once again a bond issue disguised a budget problem by deferring it to another day. "They acquired debt there so the general revenue fund wouldn't go down, and they could hold down property taxes," he says. "The internal fund became kind of a disaster, but it saved the general fund for years. And it essentially enabled the mayor to not increase property taxes."

But running the Internal Services Funds into the ground came at a price. Toward the end of Sayles Belton's final term, Moody's (one of three bond houses that give credit ratings to cities) downgraded Minneapolis's long-standing perfect rating of AAA down to Aa1. The result? An increase in the interest the city has to pay on its bonds. If the city had a 20-year, $100 million bond, for example, the increased interest would be around half a million dollars, which could quickly add up for a city with bond debt of more than a billion dollars.

The city report to Moody's paints a bleak picture. Since 1997, it notes, the Internal Services Funds has lost an average of $4.2 million a year, just on new equipment. And in 2000, the fund was $24.6 million short.

Merely one example of poor fiscal policy, Kriz notes, is that between 1993 and 1999, the city issued $3 million in bonds for legal settlements. "Three million dollars is not a large sum of money to issue bonds over, and it would be wiser to just pay it off," Kriz claims. "What you have here is the city essentially borrowing money from itself, from fund to fund, and it looks bad to bond houses."

The city does not have an inordinate amount of debt from "general obligation" bonds, which are repaid with property taxes. But it does have a large portfolio of "self-supporting" bonds, which are supposed to be paid off with revenues raised by the project in question, such as the Convention Center or Orchestra Hall. If those developments perform sluggishly or fail altogether, the city is stuck paying off the bonds with other funds. In 2001 Minneapolis had $829 million in bonds that were supposed to be self-supporting but wound up being counted as general obligation bonds, to be repaid with tax dollars.

Any further downgrades could make it hard for the city to issue additional bonds; right now the other two bond-rating houses, Standard and Poor's and Fitch, are looking long and hard at the city's account balances. "The city is in tremendous jeopardy," Minn concludes. "I believe they'll lose their AAA rating [with the two other bond houses] and continue to be downgraded."


Business lobbyists and fiscal conservatives hammered at property tax issues all through the 1990s, and during those years holding the line on property tax increases was a political imperative for the Sayles Belton administration and the city council. But the Moody's downgrade bolstered widespread suspicions that no one at city hall was minding Minneapolis's bottom line. In 2001 R.T. Rybak and candidates for several open council seats campaigned hard on the bond-rating issue and won.

The newcomers inherited a long-fermenting fiscal mess. When Rybak came to office a year ago, his first state of the city address sounded a grave note, and he immediately set out to make up deficits in the 2002 budget left by his predecessor. Rybak and the council passed a 2003 budget that dealt major cuts to many departments, and city leaders said they would continue dealing with shortfalls in future years. (The 2003 budget is balanced on paper, but that involves some wishful accounting: $268 million in collections is marked to come from "other" and "other funds." And another $158 million is believed to be coming from the state.)

But make no mistake--the problems aren't solved. The debt hangs over practically every meeting, memo, and water cooler conversation at city hall. On January 30, tempers flared during a city council Committee of the Whole meeting when talk turned to adoption of Minneapolis's proposed five-year plan. The plan essentially puts the brakes on spending out of the general fund by stipulating that the annual growth in expenditures, previously projected at seven percent per year, should be limited to 4.2 percent instead. The plan likewise proposes to limit the growth of spending on police services, but at least there will be increases; other funds, like health and family services, are slated to remain virtually flat.  

Debate eventually turned to the plan's emphasis on continued public safety funding at the likely expense of social services and economic development. Barret Lane (13th Ward) became livid; the council, he said, was engaging in class warfare rather than dealing with financial realities.

"You can assume that I don't understand these issues, and that's fine," Lane told his colleagues. "But we have got to get our act together. The people who will suffer are the people who can least afford it. If we don't have everybody in this city pulling on the same oar, we will all go down the same tube."

As council members continued to debate the financial plan, they deferred time and again to Patrick Born, the city's finance director. One of the main architects of the five-year plan, Born has lately been a central figure at city hall, a reassuring presence capable of rendering the complexities of city finance in plain English. One of the things city leaders have been most eager to quiz Born about is the viability of extending the payment term on many of the city's bonds--the practicality, in other words, of deferring debts down the road yet again. Born and other city budget staffers had come up with a plan to extend some bond payments from five years to seven and a half years; did this mean that extending them further, to 10 or 20 years, would erase the short-term pain?

Born told them that it would be a double-edged sword. Some purchases, he explained, have an "asset life," and it wouldn't make sense for the city to be paying for something that it had stopped using years before. "Let's take a fire truck, something I know virtually nothing about, other than I can recognize one," Born offered. "Let's assume its average life is 20 years. We would borrow for a period not exceeding 20 years. But when we issue bonds, we typically pay annually, so by the 10th year, we will have paid 50 percent of what we borrowed. Likewise, the truck will have depreciated 50 percent. We've probably upgraded the truck along the line, maybe it needed a new bumper. But I will tell you, in general, we're not going to use it for more than 20 years.

"If we replace that in 20 years, and we extend the bond, then we're paying for something we don't have anymore," Born continued. "We'd be paying for a new asset and paying off the old one at the same time, and we don't want that double payment out there--where the asset is gone, but the payment is still there."

The five-year plan was finely tuned, Born concluded, and failure to act decisively on it could deliver more hits to the city's credit rating. "It's hard to tell you if going three months past our seven years is going to send us over the top in debt service," he admitted. "But I can tell you that it's likely. If we are borrowing for periods longer that the asset's life, that's a big no-no in the credit-rating world. It could cause some change downward in the rating."

Born, who speaks with a quiet authority, hardly comes across as someone caught in the midst of a catastrophic storm, but that's probably because he's right in the eye of the hurricane. He has been with the city for two years, and before that he was a financial consultant in the private sector. In the early 1980s, he worked in the state's finance department, and he remembers a time when Minnesota may have been in worse financial shape than now and managed to pull through.

Born is ever eager to sing the praises of Rybak for working closely with the council and staff on a long-term property-tax policy and the five-year plan, two things Born considers historic achievements for the city. If the proposed cuts to LGA happen, he says, simply, "We'd have to go back to the drawing board on that." When pressed, he concedes the city would have no choice but to start laying off 900 of the city's 4,500 employees. But by and large, Born maintains that the city has charted a course that will remedy the problem by 2008.

"Previously, decisions were made to do things and pay later," Born says. "There was an appetite to do things that was more important than good financial management would permit. This is not happening anymore."


All this bean-counting notwithstanding, the public perception is that the city's fiscal mismanagement can be seen on most any street corner in downtown Minneapolis. A quarter-century ago, City Center was funded with a $50 million subsidy; in 1998 the city pitched in $62 million for the Target facility on Nicollet Mall; little more than a year later it ponied up $39 million for Block E.  

But despite what the public may think, Ken Kriz maintains that bankrolling big development is not the main source of the city's woes. "It has a little bit of an effect, but not much," Kriz claims. "I've done studies that show for every million dollars invested in these projects, they only cost the city $40,000 in the long run. You can't just look at the dollars siphoned away from the tax base, but look to jobs created. I've looked at cities that spend on these projects and then face financial trouble, and there's almost no correlation."

Instead, Kriz argues, much of the problem can be found in tax-increment financing (TIF) and the city department that oversees it, the Minneapolis Community Development Agency. The purpose of TIF, an idea hatched in California in the 1940s, is to develop abandoned or underperforming parcels of land and to invest in upgrading city property. TIF schemes allow government bodies, in this case the MCDA, to designate specific geographic areas in need of development. The city lends money to developers for projects deemed to be in the public interest; the amount of tax dollars to be paid from that development into the city's general fund get locked in from year one. But meanwhile the real taxes paid on TIF properties increase. The additional revenues bypass the general fund and get pumped back into additional development.

For instance, if a new entertainment complex built in a TIF district originally taxed at $1 million a year pulls in $10 million in real revenue, $9 million goes to the MCDA to put money back into infrastructure in the area and to service the debt incurred. In other words, some critics argue, with TIF bonds the city is giving money right back to the developers at the expense of its own fiscal health. (Both Block E and Target deals used TIF money.)

"In some cases it's a wonderful tool," Kriz notes, citing TIF as a boon for environmental cleanup projects in particular. "But it's become more of a general development tool. Cities are too quick to designate TIF districts, give developers a break, when the land might have been developed anyway. But they don't want to hear that a lot might sit empty for four years before somebody does something with it; they want to get something on it right away. It only works best when there's no chance that the land would develop without the city's help."

Then there is the case of the MCDA. The agency ostensibly exists as a one-stop shop for development projects, providing sites for housing, preserving affordable housing stock, and financing land for new businesses. But at times the MCDA has appeared more interested in brokering sweetheart deals for contractors and developers who don't necessarily need them. And critics charge that the agency is immune from public scrutiny, often shifting various loans and grants around to account for its finances. (It should be noted that the MCDA is quietly being phased into a new city department, Community Planning and Economic Development.)

The MCDA has the potential to be flush with cash, according to Kriz, who calls the agency a "600-pound gorilla." "They're running huge balances that are not pledged to resources," he claims, referring to various funds that could be turned into cash. "It could go a long way."

Kriz stops short of saying the MCDA should quit designating TIF districts. Rather, he says, it should take a look at the districts already in place. In his view the problem is that TIF benefits continue to flow to the districts long after the area ceases to need the tax break. More often than not, TIF money just gets funneled into new big-money developments rather than rerouted to areas that are truly blighted. "That's the back-end problem with TIF," Kriz says. "How long do you need it for a certain area?"

At the same time, Kriz and others question the impact of the city's Neighborhood Revitalization Program. NRP started in 1991 as a $400 million, 20-year effort designed to let neighborhoods decide how to spend development monies allotted to their area. But the 2001 property tax law passed by the legislature has lowered the taxes gained from redevelopment projects that finance much of NRP. Only $42 million of the $136 million to be spent in NRP's second phase has been budgeted, and Rybak has recently hinted that some of that money could be used elsewhere.  

Kriz, while deeming NRP "a very worthy program" in some regards, sees no harm in using the money to solve the city's cash-flow problem. "If you're not going to allocate that money that's just sitting there, what good is it?" he argues. "There's $60 million sitting there, and you can spend $5 million or $6 million of it without doing damage to the fund."

Steve Minn agrees, and he goes so far as to call NRP a failure. "The MCDA's problems began when its money was rerouted to the NRP," Minn says. "It's a noble idea whose time has never come."

The idea of restructuring NRP to wrest control away from neighborhoods may well be blasphemy to many affordable housing advocates and activists in the city. Others may positively view the MCDA as being a centralized agency for development. And TIF has cleaned up some spots of blight. But it's also true that whatever the intentions of such programs and agencies, the city has a long history of mismanaging development.

More important, these are desperate times, sure to be followed by desperate measures. "Bad investments have put us in a box," says city council Ways and Means chair Johnson, adding that she believes that some big-ticket developments, like the downtown Target, have been good for Minneapolis. Still, she says, "This has been a massive shake-up, and we can't just lurch from budget to budget anymore. Tough decisions have to be made now."

Kriz says the city's problems are so severe that simply trimming costs and capping salaries won't help. "If LGA gets cut, all bets are off," he says. "You can't just renegotiate contracts. You have to come up with a whole new plan of cuts to save money."

He even wonders if the city should go ahead and default on some of its bonds to shed a measure of debt. It happened in parts of California in the mid-1990s, and the scenario might not be so far-fetched for Minneapolis. "Is the city going to walk away from bonds or jump in and pay them?" he asks. "It's certainly a question that must be raised. Is it worth ruining the credit rating and ability to get more bonds? That's the million-dollar question."

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