UK HOtels When Bret Schundler took over as mayor of Jersey City in November 1992, he saidthe time was ripe for radical change in the postindustrial, fiscally troubled Democratic stronghold that in 1991 had issued bonds to fund the city's operating expenses. By radical change, the former Salomon Brothers Inc. bond salesman meant a neoconservative and very Republican reform based on school vouchers, privatizationof city services, and taxlien securitization. Now 35 years old and named recently by Time as one of America's "most promisingleaders age 40 and under," the freshfaced Harvard graduate continues to focus on cleaningup Jersey City even as his Democratic opponents in the City Council throw obstacles in his path. One plan of Schundler's that has undeniably worked is the use of securitized propertytax liens to rejuvenate the city's finances. Taking a page from the Wall Street book on mortgagebacked securities, Schundler created a new market by bundling the city's delinquenttax liens and successfully selling them to institutional investors. With Jersey City's tax collection rate now up to 94%, and the local property tax cut by$7 million, other cities, including New York City and Waterbury, Conn., have taken noticeand done their own taxlien securitizations. Recently, in a wideranging conversation that touched on Rousseau's notion of a blissfulstate of nature and Hobbes' reflections on man's fallen nature, the mayor, who once thoughtof becoming a Presbyterian minister, spoke to staff reporter Joyce Hanson about how hetapped the market to save Jersey City.
Q: Was it through your experience on Wall Street that you got the idea for the Jersey Citytaxlien financing?
A: Sure. I was at Salomon when they effectively initiated the mortgage bond market.Before that time most mortgages were actually held by the original lender, and the secondarymarket didn't really take off until the early 1980s. First they developed mortgagebacked securities, then you saw things like auto loan receivable securities. They even packagedthings like mobile homes. I would argue that Salomon was the pioneer in assetbacked securities. When I came to Jersey City as mayor, [liens were] just another receivable, andyou can certainly make them into an institutional investment. The problem we had was wecouldn't get banks to buy liens because each lien was so small. It may be a $3,000 or $4,000lien. So by putting $44 million liens together, we got a sizable pool which was worth doingsome due diligence on.
Q: How did you explain the financing to Jersey City taxpayers?
A: Well, if you send out a bill and someone doesn't pay their taxes, you're going tohave to charge taxpayers more so that they will pay for the person who is not paying. A lienis created for the taxes owed by a taxpayer, and that is effectively like a mortgage. So if youcan get somebody else to invest in that mortgage, you can get from an investor the money you need to run your operations and you don't have to increase the tax rates. Now the problemwith that is when you have a lot of liens created, you end up having more liens than there areindividuals buying them. So when you began to have more liens than you had individuals, you had a market that wasn't clearing. What happens when a market doesn't clear? You haveall these taxes that are owed and not being paid with nobody investing in them. What then ends up happening is you have to increase the tax rate on everybody else to get the moneyyou need to run your operation. So we said to ourselves, this is going to become a vicious cycle.
Q: So what did you do?
A: We figured out a way to effectively clear our inventory of liens, and that was bycreating one big pool that we'd sell into a trust account that we created.. With $44 million of liens in that trust account ...the city decides okay, and we'll accept $25 million in cash and $19 million in a [subordinated] note for the $44 million of liens that we're selling. Now wheredoes the trust account get the cash? The trust account sells a senior note to outside investors for$25 million, the trust gets that cash, and it passes it through to Jersey City. The trust account also issues a subordinated note for $19 million and they give that to the city. T he outside investor who bought the senior note, he's got a senior note which has $25 million in face value,collaterized by $44 million worth of lien. Now that you have an investment which has got aface value of $25 million, it's worth investing in for institutional investors. So you'vegot a whole new entrant into the market, and any time you expand your buyers you are able tolower the yield you have to provide.
Q: And now you have a much better collection rate on your delinquent taxes.
A: Right.
Q: Will you be able to securitize the liens in the future?
A: Oh, anytime we want, if we need to. And what happens here is [the outside investor is] only taking 8% interest on that , but the liens themselves are accruing interest at [a statestatutory interest rate of ] 18%. So what happens is you end up getting surplus interest accumulating in the trust account beyond what has to be paid to senior noteholders, and all ofthat will come back to the city. We also have a private collection firm now which is workingon collecting the $44 million worth of outstanding debt plus the interest that accumulates inthe future. So through a combination of lowering your tax rates and improving your collectionoperation through privatization, you now have the necessary combo for increasing your ongoingcollection rate.
Q: So where do you see this program going as the collection rate improves?
A: Well, this program will be used repeatedly whenever you begin to see the collectionrate fall. Anytime that collection rate falls and a city builds up an inventory of liens, they'llsecuritize the liens and that will give them a chance to immediately get caught up.
Q: So essentially, a new market has been created .
A: Right. There's a market in the securities, but there's also more of a seller's market inthe liens. There's always been a market in individual liens, but we drew a lot of attention to thelien market through the securitization of them. We created new classes of buyers and investors.So by increasing the number of buyers and actually decreasing the supply of lien products, itmakes it a lot easier to sell the conventional ones.
Q: What are the sort of governments that would be most likely to benefit?
A: Anybody who has seen collection rates fall would want to do this because this is a wayto immediately get caught up ... Now you don't want your collection rate to fall. But if a city allows its collection rate to fall through whatever set of circumstances, once you're into this vicious cycle of falling collections resulting in rising tax rates resulting in increased defaults andfalling collections how do you get out of it? Well, the way you get out of it is by taking thewhole bundle of inventory liens and securitizing them and getting a massive revenue infusion. Dropyour tax rate and then privatize the collection effort so you keep people up to date. That's howyou get out of it. It's the equivalent of that electric shock machine for heart attack patients. You can get cities back into health.
Q: What happens at the auctions?
A: As a delinquent taxpayer, if you don't pay your taxes, the state requires that the city charge you 18%. You go to this original auction and you hold up an individual lien on a person'shouse, and say this person owes $3,000. Will anybody buy this lien? Will anybody pay off whatthey owe to the city? If so, you can become entitled to have them pay you the money that's owed, plus 18%. Now someone will say okay, I'll do it. Well, someone else might say, listen,I'll pay off that person's taxes and take their mortgage, or lien, and I'll do it for 17%. Another person says, I'll do it for 16%. If you have a very active market, with lots of buyers and not alot of liens, not only will you clear your inventory of liens, but the taxpayer will get a breakbecause the bidding will be heavy. Instead of having to pay 18%, the rate will be bid down to amuch more affordable rate. You can conceive of it getting bid down to approximately themortgage rate. You don't imagine it would ever go below that because, if you were an investor, you would rather invest in a bank mortgagebacked security at 8% than an individual lien.
Q: So have you thought of any other ways to make Wall Street financing ideas work forJersey City?
A: That's the only thing in terms of securitization that we've done. But I would like information on what various market participants are interested in. If you get good information onwhat buyers will pay for, that gives you an incentive to go down to the state and ask for a waiverto be able to, if you will, satisfy the more aggressive appetites of a given market. The first ruleof sales is know your customer. If we have good information on what investors want, that canallow us as an issuer or a borrower to provide what the buyer really wants and get a higher price.
Q: Both you and New Jersey Gov. Christine Todd Whitman are reformminded Republicans, but do you have conflicting goals about how much state aid Jersey City should get?
cheap hotel in MontpellierA: We don't have conflicting goals. Our goals are 100% synonymous. The governor'sgoal is to cut state taxes and she is doing that, and her goal is to cut state spending and I wouldlike to see that happen. That hasn't happened yet, but that's vitally important because what hasto happen is you want the state to maintain its municipal aid. Its municipal aid should continue to grow at the rate of inflation. Thus far she's frozen municipal aid and she is not cutting statespending, so what happens is it becomes tougher for the cities. To accommodateher tax cuts, she's making life difficult for mayors by cutting real state aid to municipalities.
Q: Do you have any political aspirations beyond being mayor of Jersey City?
A: My focus right now is being here. I've never in my life said to myself "this is where I'm going to be in so many years." What I have said is that this is the kind of system I believe in, let me see what I can do to try to advance that. So right now, I think being mayor of Jersey City allows me to do a lot in terms of piloting new programs. I'm where I'm supposed to be.