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Towns Defaulting on Prison and Jail Bonds

by Matt Clarke

Municipal bonds have long been considered a safe investment. However, recent defaults on bonds used to pay for the construction of privately-run prisons and jails have investors worried about losing their capital, and towns worried about their ability to raise money through future bond issues.

As far back as 2005, bonds used to finance the West Alabama Youth Services detention facility went into default. Those bonds, which were originally issued at par and yielded a 7.25% return, are currently trading at 9 cents on the dollar.

However, such defaults were rare until recent years. Driving the current wave of bond defaults are unscrupulous businesses that sold small towns on the idea of building privately-operated jails while overstating the need for jail bed space and the potential revenue stream. Some of these private detention facilities were able to buck the recent trend of reductions in state prisoner populations by switching to immigration detention.
However, a speedier deportation process and more stringent standards for immigration facilities have resulted in complications.

For example, the Baker County Development Corporation was created to finance a jail and immigration detention center in north Florida. In 2008, $105 million worth of bonds were issued to finance the facility. The county technically defaulted in August 2010 by using reserves to pay the interest; the bonds dropped to 71.25 cents on the dollar with a yield of 20.73%.

According to Matt Fabian, director of research for Municipal Market Advisors, Baker County as well as Central Falls, Rhode Island and Hardin, Montana have debt troubles due to jail construction that didn’t work out as planned.

In 2005, $99 million in bonds was issued at par with a 7.25% yield to pay for the Central Falls Detention Facility. After the bonds entered technical default in 2009, they were trading at 85.3 cents on the dollar and yielding 8.63%.

The Two Rivers Detention Center in Hardin defaulted on $27 million in revenue bonds in May 2008 after the city could not find prisoners to fill its vacant prison. [See: PLN, Dec. 2009, p.1].

Further, in April 2010, the Texas panhandle town of Littlefield had to dip into its reserves to cover interest on $1.2 million in debt used to finance the Bill Clayton Detention Center. Following the technical default, Fitch Ratings dropped the town’s bond rating from BB to BBB – essentially junk bond status.

According to Littlefield city manager Danny Davis, the city had to cut fire and police services and may raise property taxes in an effort to avoid completely defaulting on its $780,000 annual bond service payments. The city is also exploring selling the jail or having the state take it over. The latter option seems unlikely, as Texas is faced with a huge budget deficit and has cut the state prison system’s budget by 5% in FY 2010 with another 10% cut announced for FY 2011.

Littlefield’s problems originated in August 2008 when Idaho prisoner Randall McCullough committed suicide at the Bill Clayton Detention Center, which focused attention on deplorable conditions at the GEO Group-run facility. [See: PLN, June 2009, p.1]. GEO lost its contract to house out-of-state prisoners and terminated its operating agreement with the city in 2009, leaving Littlefield with a prison empty of everything except debt. The city is now hoping to contract with Avalon Correctional Services to operate the detention center as an Intermediate Sanction Facility.

Bob Libal, the Texas coordinator of Grassroots Leadership, a non-profit advocacy organization that opposes private prisons, said many small towns agreed to use risky debt to fund “speculative prisons” managed by private companies.

“They go after a lot of towns without a lot of sophistication and resources to do the due diligence,” said Libal. “If they let the bonds go under, it is very difficult for them to issue any more debt.”

This problem will continue so long as towns look at private prisons as a way to generate revenue and jobs – but perhaps they are simply getting what they deserve for trying to profit off of other people’s incarceration and misery.

PLN previously ran a comprehensive article on back-door prison finance through the use of municipal revenue bonds and other types of government securities. [See: PLN, Nov. 2008, p.1]. The impact on state and county governments’ ability to raise money to build government-run prisons and jails by selling bonds remains unclear since those bonds are backed by the taxing authority of the government. For the past several years there has been a large, ongoing, federal investigation into corruption in the state and municipal bond markets but no indictments have been issued yet.

Sources: SmartMoney, Lubbock Avalanche-Journal

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