Monday, February 1, 2010

New Jersey Autobahn

The Turnpike Bonds can fix Pension Under Funding (or Maybe there is a better way to “Monetize the NJ Turnpike Authority”)

1 - A Fairytale Story of Financial Stupidity.

Once upon a time, in a fairytale land which was bounded by a great river and even greater ocean, their lived a group of happy people. The people were happy because they received more benefits from their government, than they were obliged to pay in taxes. Whenever the responsible politicians of this happy land tried to reduce the level of government service or increase the taxes associated thereof, the happy people voted the responsible politicians out of office. So the very smart politicians (who remained in office) continued to keep the taxes low, the level of State provided benefits high, and pushed any “fiscal responsibility” into the future. And the people remained very happy.

Then one day when the government workers, who have been providing the people with all of their benefits and service, decided to retire and discovered – to their collective horror – that although a pension benefit had been promised to each of them, no money had been contributed to fund the Pension Obligation of the Happy Land. The retiring fairytale land workers then sued the Government, and the Court found that because the promise of a pension was a “contract right”, the Government would be REQUIRED TO PAY all of the promised pensions, to all of the retiring workers. And so the workers were very happy, too.

However, in order to pay all of these benefits, taxes were increased many-fold. The people of the fairytale land were no longer happy, because they were now required to pay higher taxes in order to pay for the worker’s retirement benefits. Many of the people soon left the fairytale land so that they didn’t have to pay the new higher taxes; this meant that the taxes on the people who remained became much higher. AN NO ONE LIVED HAPPILY EVER AFTER. THE END

2 - An Alternative Ending to the Story.

Governor Chris Christie could, upon taking office, immediately declare a FISCAL EMERGENCY and accordingly:
  1. Cut government services
  2. Evaluate Governmental Operations in terms of improving their efficiency and effectiveness
  3. Increase tax rates and / or the tax base and / or Fees in order to generate additional revenues.
  4. Or any combination of these three

In my view, monetizing the potential value of NJ Turnpike Authority (hereafter the “NJTA”) would clearly fall under the topic of “improving their efficiency and effectiveness” as well as generating additional revenues. Governor Corzine may be a nice guy, but he was never an effective “communicator” with respect to his plan to restore “fiscal responsibly” to the operations of the State of New Jersey. I feel that since the NJ Turnpike Authority holds a valuable asset, it SHOULD BE monetized for the greater good of all of the citizens of New Jersey. The problem with the Corzine Initiative was: (a) the proposed plan wasn’t very well “focused” and seemed to allow the State to continue with its irresponsible fiscal polities, and (b) the average voter didn’t see any benefit to the proposal (i.e., compare and contrast “my life in New Jersey” now, with the Plan and without the Plan).


Issue Participatory Revenue Bonds from the NJTA to the New Jersey State Pension Trust Fund (hereafter NJSPTF) in order to provide short term “bridge” solution, which would allow the State Government to readjust its priorities and install a longer term solution. Sound crazy, right? Read on and learn more.


The NJ Turnpike has raised tolls ONLY 6 times in 57 years or an average of once every 9.5 years! DO YOU KNOW of any product or service that has raised its rates so infrequently? In 1951, the Wholesale Price Index was 30.4; by 2007 it was 172.6 or an increase of 467% or about 8% / year.

Based of these “back of the envelope” calculations – Do you think the Turnpike is a Bargain or a Subsidy to its drivers? Do you think that the only reason that the NJTA doesn’t seem to have needed to raise tolls more frequently (to keep up with the cost of inflation, additional maintenance and repairs) is the simple fact than more than 50% of the Turnpike traffic is interstate, i.e., non New Jersey drivers help to defray the costs of operation? That is to say – if the NJTA had raised tolls in accordance with inflation, they would have generated enough money to pave over the entire State of New Jersey!



Require that the State Legislature, pass comprehensive Pension Reform with respect to : (a) defining eligibility requirement, (b) benefit rates and vesting levels, and (c) annual funding allocations and PAYMENTS which would require a 2/3rds vote of the New Jersey Legislature to amend or suspend. SPECIAL NOTE: State Worker Union Contracts should also include “enforcement” language in any future labor contracts.

IMPORTANT NOTE: We have to “hold their (the State) feet to the fire”, so the following plan would become contingent and effective ONLY after this enabling legislation was enacted.


A) The New Jersey Turnpike Authority would initiate a toll increase which is designed to reflect the true economic value of the roadways to all drivers (NJ and non-NJ). Based on the anticipated of this additional revenue, the NJTA would then issue a special series of Participatory Revenue Bonds (see * below) to the New Jersey State Pension Trust Fund. This is a requirement so as not to interfere with the guarantee agreements of all of the existing bond issues. Since the Participatory Revenue Bonds are a “restricted issue”, these bonds could be issued in “memorandum form” and as such they which not subject to public trading requirements.

[It this point - most readers would say, “What good are municipal bonds as an investment in a tax-exempt pension entity?” PLEASE READ ON – it gets better, I promise.]

B) The New Jersey State Pension Board (i.e., the Pension Fund Trustees) would then crease a separate asset Trust known as the PARTICIPATORY BOND TRUST, and immediately transfer the Participatory Revenue Bonds into this trust.
[So far so good]

C) The Participatory Bond Trustee would immediately create a Single Member LLC (SMLLC) which would be known as “Participatory Bond Holding LLC”, and immediately transfer the Participatory Revenue Bonds from the trust into this LLC.
[It starts to looks like musical chairs, doesn’t it? Keep reading.]

* For the non-accounting readers: Normally, Bonds pay a fixed rate of interest based on their stated Par Value – example $1,000 Par Value XYZ Bond @ 5% will pay $50.00 / year until it matures (redeemed). A Participatory Bond is a special type of hybrid because the Bondholder gets the fixed rate of interest PLUS an additional interest amount (which is called bonus interest) based on certain events and conditions. A Participatory Bond is the simplest way to “soak up” the additional revenue which will be created by the implementation of a more realistic toll structure, while not negatively impacting the Bond Covenants Agreements (like a Mortgage Agreement) of all of the existing NJTA Bond Issues.

Now you might well say, “Why not just issue these Participatory Bonds directly to the general public, and cut out all of this “musical chairs” nonsense?”
[Please keep reading, because, like Hamlet, I do have “…much method in this madness…”]


A) One or more Financial Intermediaries will be required to form a Mutual Fund known as “AAA Bond Trust”, which shall be composed of “AAA Rated” taxable corporate bonds.

KEY POINT #1 - The amount of bonds held or placed into this trust shall have stated coupon income levels equal to the tax equivalent level (see below) of the income expected to be generated from the Participatory Bond Trust.

KEY POINT #2 - A provision of the Mutual Fund Agreement shall require that any security which is identified for a “downgrade” by its rating agency shall be immediately removed from the Trust and a suitable replacement Bond inserted in its place with a like a similar income stream (i.e., “auto re-swap and replace”); thus this Fund shall always contain only high grade securities.

B) The Mutual Fund Trustee would immediately create its own a Single Member LLC (SMLLC) which would be known as “AAA Bond Holding LLC”, and immediately transfer all of the Bonds from the trust into this LLC.

PART 4 – ... and now {Drum roll please} …. The “SWAP”

The Participatory Bonds Trustee and The Mutual Fund Trustee would then enter into a “swap agreement” (under IRS Reg. §1.446-3 etal - and additional Court citations) for a period of no more than 20 years whereby the Participatory Bonds Trustee would become the assigned owner of the AAA Bond Holding LLC and the Mutual Fund would become the assigned owner of the Participatory Bond Holding LLC.

Participatory Bonds Trustee ==> Participatory Bond Holding LLC
Mutual Fund ==> AAA Bond Holding LLC

Participatory Bonds Trustee ==> AAA Bond Holding LLC
Mutual Fund ==> Participatory Bond Holding LLC


1 – The NJTA Exempt Interest is redirected into the Mutual Fund Trust, while the actual increased cash income from the Mutual Fund AAA Bond Trust is applied to the New Jersey State Pension Trust Fund.

2 - The additional pension investment income will be invested and reinvested within the Pension Trust Fund for the benefit of the pension beneficiaries.

3 - Because the AAA Bond Holding LLC is not a “publicly traded” entity, the Participatory Bonds Trustee can legally value their swapped LLC asset based on its projected income stream (Income divided by Fair Market Yield of equivalent assets – see below). Naturally this valuation would be amortized over the available life of the underlying Swap Agreement, and become $0.00 in the final year of the Swap Agreement.

4 – The amortized valuation would the offset by the additional contributions which were part of the legislative agreement (see Part 1 above)

5 – When the Participatory Revenue Bonds mature, the proceeds are returned to the LLC, which is then returned to its original owner, and then liquidated into its trust owner. Each Trust is then dissolved and the net proceeds returned to the underlying Pension Trust and the Mutual Fund owners, respectfully.

6 – This temporarily increases the net asset value of the Pension Fund (for long term value for all pension beneficiaries) and additional income (for the payment of benefits for current retirees). It defers any immediate tax increase to pay unfunded pension liability, and gives the State time to standardize its pension obligates and enter into a payment plan for the unfunded liability.


1) Tax Equivalent Level Computation; effective income yield is based on an after tax rate of income. Consider this simplified example.

Description AAA Bond Holding LLC $ Participatory Bond Holding LLC $
Stated % 8.30% $83.00 4.50% $45.00
Effective Fed + NJ (assumed)combined tax rate =46% (38.00) exempt income is not taxable 0.00
Net After Tax % (which are equal) $45.00 $45.00
PAR Value at Income** $1,844.44 $1,000.00

** Taxable Income $83.00 / 4.5% Tax Exempt Rate = $1,844.44

2) IRS Reg. §1.446-3 actually REQUIRES that the UNDERLYING INCOME PRODUCING ASSET MUST BE “SWAPPED” (or assigned) in order for a “bona fide “ assignment of income to be recognized for tax purposes – this is fancy tax parlance which means that you can’t give away the milk and keep the cow. This requirement is easily fulfilled by placing the assets (Participatory Bonds and AAA Rated Bonds) into the separate LLC entities.


The AUTOBAHN Benefit:

Since Governor Corzine’s Turnpike Monetization Plan didn’t provide any direct benefit to the many NJ commuters, who use the Turnpike and Parkway (other than the elimination of any tax increases which would otherwise be required), I would propose an additional benefit to all NJ Turnpike and Parkway Drivers (as a way of softening the effects of the above proposed Toll Increases):

(1) Painting the inside lanes of the Turnpike and Parkway with orange “tiger” strips – orange is a color which is very reflective after sunset and in bad weather, and

(2) Allow unlimited traffic speed in “The Orange Autobahn Lane”. This is an reference to the attribute which is similar to the famous German Autobahn Roadway (a driving experience of which I was once personally privileged to enjoy, It's Better Than NASCAR – HOO-RAH!).

While all drivers will (obviously) be paying more for the use of the use of these roadways, they will be allowed to travel faster (if they so wish) by moving into the Autobahn Lane. It is strange that accident statistics show that the Autobahn is no more dangerous than other high speed and heavy trafficked roadway. This unusual paradox may result from each driver’s need for constant vigilance in such a high speed environment, and may actually force drivers into performing better.

COMMENTS? Happy Motoring ... und Auf Wiedersehen

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