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Working Paper 42 - Community Development Authorities
Thursday, April 24th, 2014
Submitted on behalf of the Author: Mary M. Báthory Vidaver
Community Development Authorities
Community Development Authorities (CDAs) are quasi-governmental entities established by a local government at the request of private landowners to construct, maintain, and operate multiple types of public infrastructure within a specified district. Such infrastructure may include roads, water and sewer systems, schools, stadiums, and other public buildings. An authority finances its projects through the issuance of tax-exempt municipal bonds. Revenue streams for repayment of the bonds typically derive from special assessments or tax levies on the property owners within the district. Since the bonds are typically secured by the value of the land within the district, they are often referred to as “dirt bonds.” CDA’s were used in California, Colorado, and Texas during the late eighties and early nineties, sometimes to great success and sometimes to dismal failure. They reemerged with the same mixed results during the late nineties and early- to mid-aughts.
Institutional Corruptions Pitfalls
In May 2004 a municipality announced its selection of a regional developer with local ties to undertake an affordable housing project. The city authorized the creation of a CDA in September 2005 and, in April 2007, the CDA issued $20 million in bonds to pay for road improvements, water and sewer lines, and a parking lot. The bonds were guaranteed by the real property with annual special assessments serving as the revenue stream for repayment. After pledging the land and a personal guaranty, the developer received a $30 million construction loan from a major bank. The bonds’ sales documents contained the usual boilerplate language about risk and due diligence, but failed to note (discoverable through a simple on-line search of the developer’s name) news stories of the developer’s financial problems, including a $78 million loan default in August 2004. In June 2008, the developer ceased paying real estate taxes, placing the bonds in technical default, and began negotiating with the bank to restructure its loan. In July and August unpaid sub-contractors filed mechanic’s liens on the property. Construction ceased as these 5-plus groups negotiated a path forward.
Such “disasters” are not uncommon. In a study of the Virginia CDA bond issuances between 1997 and 2007, 50% were in some form of default as of December 2013 and only slightly more than half had completed the planned infrastructure. The problem can often be traced to institutional corruption, “the consequence of an influence within an economy of influence that illegitimately weakens the effectiveness of an institution especially by weakening the public trust of the institution.”
A large number of industries participate in a CDA, although the most active individuals in this economy of influence are often few. In the Virginia study eleven law firms handle all the legal work; ten financial firms handle all the underwriting and sales. This creates frequent conflicts of interest. Rarely do these knowledgeable, experienced participants independently represent local officials. Elected officials depend on their finance staff, who may not remember earlier debacles. This creates an uneven playing field favoring those who hope to create a CDA and issue its bonds.
Typically, the developers are allowed to select a majority of the CDA Board members. As a result, the CDA Board may prioritize the developer’s interests, rather than those of the locality or the bondholders especially in times of trouble. If so, local officials may find themselves forced to bail out the CDA with tax revenues to eliminate an unfinished eyesore, protect the health of local businesses, and maintain their bond ratings.
Despite the troubling history, some CDAs do succeed and there are proactive steps government officials can take to protect citizens’ interests.
Retain outside financial and legal advisors, whose duty is to the locality and not “the deal.”
Request realistic financial forecasts, including a worst case scenario, that do not rely on future property development to generate the revenues necessary to retire the bonds.
Avoid projects with a small numbers of property owners and/or a value-of-undeveloped-land-to-lien ratio higher than 3:1.
Ensure that the developer has “skin in the game,” such as a Letter of Credit or cash investment.
Undertake independent research on the developer’s financial health, including such simple tasks as Google searches and checks for mechanics’ liens at the courthouse.
Ensure that the locality has a majority voice on the CDA Board.
Prohibit the lands’ use as collateral for any debt other than the CDA bonds.
Consider prepayment mechanisms, especially where a project involves residential units.
Do not pledge the locality’s moral obligation for the bonds’ repayment.
Retain approval authority over the issuance of additional debt in excess of the original agreement.
 Mary M. Báthory Vidaver, “Community Development Authorities: A Further Exploration of Institutional Corruption in Bond Finance” (Edmond J. Safra Working Papers, No. 42, The Lab @ Edmond J. Safra Center for Ethics, Harvard University, Cambridge, MA, 2014), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2428967.
 “About Us,” The Lab @ Edmond J. Safra Center for Ethics, accessed November 17, 2013, http://www.ethics.harvard.edu/lab/about-us.