Thursday, January 06, 2011

Government-Owned Broadband Networks Make a Bad Budget Worse

As highlighted by a recent 60 Minutes segment, several state governments and countless local governments are facing the specter of financial ruin. The Great Recession and its impact on state and local tax revenues have brought to light years of runaway spending and crafty accounting to paper over growing structural deficits. The 60 Minutes segment also pointed out that since many local governments are heavily reliant upon their own state governments for funding sources, many cities and towns could face some of the severest financial shortfalls in the year ahead.

However daunting these financial challenges may be for local governments, one thing responsible cities and towns should do in the year ahead is keep from making their financial problems worse by engaging in expensive and risky new ventures. Unfortunately, the situation could already be worse than it should have been for some local governments that have made heavy investments on money-losing municipal broadband projects. Municipal broadband operations funded and operated by a couple of towns in North Carolina, for instance, are putting growing strains on local budgets. The tale of these two cities ought to be a cautionary warning to other municipalities considering getting into the broadband business.

The towns of Mooresville and Davidson face looming multi-million dollar debts thanks to their joint purchase and operation of MI-Connection Communications System. Acquired by the towns from the bankrupt Adelphia Communications cable systems in December 2007, MI-Connection provides cable, voice, and broadband Internet services to businesses and residences. Purchase of the system required a massive start-up investment of approximately $80 million by Mooresville and Davidson. And the towns poured an additional $12.5 million into the system in 2008 to provide system upgrades.

Although public officials in Mooresville and Davidson who voted to establish MI- Connection maintained that user subscriptions would pay for the system, MI- Connections' long-term debts and yearly expenses are now straining the towns' budgets. In early 2010 the Mooresville and Davidson city councils both voted to loan MI- Connection nearly $580,000 to cover the system's debts. The towns were also asked to provide additional assistance to make up for MI-Connection's financial shortfalls. According to a Davidsonnews.Net report, "[t]his year's system budget calls for Davidson and Mooresville to kick in a total of $6.46 million to help pay this year's costs -- $4.44 million from Mooresville and $2.02 million from Davidson."

To put these multi-million dollar municipal broadband debts into perspective, the Town of Mooresville has a fiscal year 2010-2011 budget of approximately $83.5 million, while the Town of Davidson has a fiscal year 2010-2011 budget of almost $8.5 million. The $4.4 million MI-Connection received from Mooresville was paid in part by a $3.6 million withdrawal from the town's savings. And according to a Lake Norman Citizen report, "[i]n Davidson, one-fourth of the town's operating budget for this year is going to prop up the cable company, as is a new trash pickup fee of more than $200 per home."

MI-Connections and its supporters boast that the system's cash flow has improved and that it now has a clean audit. (MI-Connection's earlier audit for the prior fiscal year ending June 30, 2009, set off alarm bells at the North Carolina Treasury Department, prompting a Department letter to MI-Connection's governing board, insisting that "[t]he System has serious financial problems which the System's governing board must address immediately." MI-Connection lost $6.4 million that fiscal year.) But that doesn't speak to the fact that the system lost more than $6 million during its most recent fiscal year. MI-Connection still faces massive debts that will require significantly more user subscriptions and returns per customer in the face of competition from direct broadcast satellite (DBS), cable and telco providers if it is to quit losing money.

And the picture doesn't get any rosier when considering that MI-Connection's debt obligations are now increasing. Although MI-Connection previously paid only interest on its bonds, beginning September 1, 2010, principal payments became due. MI-Connection's debt payment schedule contained in a fiscal year 2009-2010 audit calls for annual debts payments of over $7 million for each of the next five fiscal years, starting 2011.

Although Mooresville and Davidson financed MI-Connection through the sale of municipal bonds, the towns' treasuries must ultimately be tapped should MI-Connection default. The towns' budgets would be further squeezed should they have to inject additional dollars into MI-Connection to keep the system operating. And ultimately the towns' taxpayers would bear the burden.

So for local governments already experiencing budget woes due to overspending, unfunded liabilities, and steep declines in local tax revenues brought on by the economic downturn, the MI-Connection saga offers some important lessons. Bankrolling municipal broadband projects deep in the red will almost certainly bring greater budgetary strains in the short run. And given the enormous start-up costs for municipal broadband projects, bailouts for struggling or failing projects can devastate town treasuries in the long run.

Of course, economic circumstances may already be precluding future municipal bond issues by towns eager to jump into the cable, voice and Internet business. In the 60 Minutes segment, Wall Street financial analyst Meredith Whitney predicts many local governments will be unable to meet their financial obligations, resulting in municipal bond defaults that could disrupt the entire market. While Whitney's focus was on major metropolitan cities, a recent New York Times story (reposted at shows that many small cities are also in dire financial straits, facing significant unfunded pension liability problems. Cash-strapped towns facing massive unfunded pension and retiree health care burdens are highly unlikely to obtain favorable future financing of municipal broadband projects.

As local governments enter 2011 facing hard choices about how to balance their budgets, they should recognize that undertaking municipal broadband projects will almost certainly make their money problems worse. There is good reason to be skeptical of the ability of local governments to operate broadband networks at a profit. Local governments do not typically possess the resources to oversee the design, operational, and marketing decisions that are crucial to driving innovation and to competing successfully against private sector providers in a market characterized by rapidly advancing technology. Ultimately, money-losing municipal broadband projects strain the financial ability of local governments to provide traditional, core public services such as police, fire, and sanitation.

By contrast, private sector investors — and not local taxpaying residents — bear the financial risks if private systems falter. For cities and towns now looking to dig themselves out of financial holes, buying and propping up municipal broadband networks will likely only make the holes deeper.