March 30, 1992 - From the March, 1992 issue

“Dirt Bond” Reforms: Treasurer Kathleen Brown’s Perspective

Mello-Roos bonds are land-backed financings that are appropriately titled "dirt bonds." These bonds have been critical to pay for parks, libraries, and other public uses. As a result of California's stagnant economy, investors and taxpayers have become critical of Mello-Roos bonds. Kathleen Brown, Treasurer for the State of California, comes to its defense.

To the investment world, California’s Mello-Roos bonds are sometimes referred to as “dirt bonds.” But forget the earthy moniker: These land-backed financings have been like manna from heaven for cash-starved local governments and developers. 

In just the last decade, $3.6 billion worth of these bonds have been sold to pay for parks and roads, fire stations and libraries, curbs and classrooms — all staples for scores of new California communities. 

But that was then, and this is now — a time when California’s economy is being rocked by recession and plummeting real-estate prices. Now these so-called “dirt bonds” are being looked at more warily by investors and taxpayers alike.

Their concerns range from credit worthiness and tax inequities to allegations of possible mismanagement. The fear is that taxpayers could end up paying and bondholders could end up losing millions of dollars for bond deals gone awry. 

Reexamining Mello-Roos

As the Mello-Roos Communities Facilities Act of 1982 marks its one decade anniversary, it’s an appropriate time for reexamination. That is why the California Debt Advisory Commission, which I chair as state Treasurer, recently convened a special hearing on Mello-Roos bonds to hear testimony from over two dozen tax­payers, local officials, municipal finance experts, and legal experts from around the state. 

What became clear from the day’s testimony is that the lion’s share of all Mello-Roos bonds issued over the last decade remain success stories for taxpayers, investors, and local governments. 

Without them, dozens of California communities, complete with schools, roads, sewers and water systems, would not be in existence today. Mello-Roos bonds have been and in most cases continue to be an effective tool in financing our state’s growth-induced infrastructure needs. 

But for all the benefits of Mello­-Roos bonds, there also is potential for abuse. The problems that have recently come to light may in fact represent a kind of “early-warning system.” 

With the aftershocks of the S&L scandal still being felt, it is not a time for closing our eyes or our minds to the possibility that reforms may be in order — both to protect California taxpayers and to preserve these bonds as an effective financing tool for another decade.

The Need for Mello-Roos 

California needs Mello-Roos bonds — and for all the same reasons the act was originally adopted a decade ago. Then, as now, local government officials with the responsibility for building infrastructure lacked the financial resources to pay for it. And while Proposition 13 and reductions in federal funding have imposed limits on revenues, no such limits have been imposed on California’s growth, which during the period since the state’s tax revolt has grown 25 percent — enough to build six new cities the size of San Francisco. 

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For that reason, repeal of the act is as unwise as it is unwarranted. To do so would require finding new forms of revenue to pay for water, sewers, schools and roads — or face further gridlock on our highways, more children in our already crowded classrooms, more pollution and a greater loss of business, jobs and economic development. 

Reforming the System

But there are reforms we can be looking at. Among the state’s objectives should be to find ways to lessen our reliance on Mello-Roos bonds — perhaps through passage of a constitutional amendment repealing the two-thirds vote requirement for local infrastructure. The way to create tax equity may be to allow a return to “majority rule” when it comes to passage of local general obligation bonds. 

Or we may need to look at new state and local regulations. These might include the imposition of guidelines for stricter standards for issuance, including minimum land value requirements. Or governments may need to step in to limit tax rates or to ensure tax fairness, so that taxes paid reflect the benefits received. And Mello-Roos financings should by all means be integrated into overall local government growth management strategies. 

We also need to explore how to best ensure sufficient opportunities for democratic expression. Mello­-Roos homeowners may “vote with their feet” in deciding to purchase homes in Mello-Roos districts, but that should not mean they forfeit the right to influence tax and spending policies affecting their communities.

Finally, there is a clear need for stricter disclosure measures. State law should be changed to alert people to the extra costs they face when buying homes in areas serviced by Mello-Roos municipal districts. This should be done prior to the close of escrow, so that homebuyers or secondary buyers are put on notice as to what their taxes will be, how much they can be increased, and over what period of time. 

Greater disclosure should also be required of bond issuers so that investors buying the bonds can better discern between poorly-structured Mello-Roos projects and ones that are more viable. 

Conclusions 

Mello-Roos bonds have proved an effective financing tool over the last decade. But no tool is appropriate for all tasks, and sometimes even the best instruments eventually grow dull from overuse, misuse or abuse. 

It is time to take a fresh look at Mello-Roos bonds, and to decide just how we can sharpen them as tools so they can be better used for the growth and infrastructure tasks that await California in the decade ahead.

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© 2022 The Planning Report | David Abel, Publisher, ABL, Inc.