Asset: property owned by a person or company, regarded as having value and available to meet debts, commitments or legacies.
One of the sillier moments I experienced at a council meeting involved a council member known for his bluster, subversive command of the room and deep skepticism of his colleagues and their free spending ways. While, in theory, we could have found some common ground on the third characteristic, the first two kept me from having much professional respect for him. He acted like a spoiled man-child and, as a result, was almost completely ineffective as a councilor. In all my years, he is one of my least favorite.
That may be why this incident sticks in my memory. A group of property owners were petitioning the city to take over the maintenance of their private roadway. The dead-end road provided access to their properties, the majority of which were lake homes, and they were tired with having to coordinate the maintenance responsibilities among themselves. As part of the deal, they were offering to pay to have the road improved to city standards, a fact that immediately gained the support of the influential city engineer (who, not coincidentally, would be paid to facilitate this transaction.) It was at this point that Councilor Bluster made his memorable statement.
“So the city is getting a free road.”
There is some basis for this thinking beyond simple cultural dogma. Roads, streets, sewer and water systems and other infrastructure are generally considered to be assets. When cities account for their assets and liabilities in their audits, infrastructure is counted in the former and debt in the latter. When we invest in infrastructure we are building an asset for the community. Always the positive side of the ledger.
Is a street really an asset, though?
When I go to the bank for a loan, I am required to secure that debt by pledging an asset as collateral. This asset is something that not only has a value greater than the debt I am taking on but it needs to be something that the bank can secure and get rid of if they need to. For example, a house is logical collateral for a mortgage, particularly when the homeowner has 20% equity or more. If the property owner defaults on the mortgage, the bank can foreclose, sell the house and then pay off the debt. My heart and lungs, while they might have great value to me and might even fetch a lot if there were a market for such things, is not something that can be easily secured and then sold and so they would not make for very good collateral.
When a city issues a bond, when it takes on debt, they don't secure it with infrastructure. When Detroit or San Bernardino failed to make good on their debt payments, the bond holders didn't go out and dig up the old road to sell it off. They can't seize the water pipe and sell it to a different city. Even if they could, these things don't have any significant value when you pull them out of the ground. So infrastructure is not collateral, it is not an asset. The asset is the good faith and credit of the municipality. In other words, the tax base that is supported by the infrastructure.
When the property owners in the example I gave petitioned the city to bring their road into the municipal inventory, they weren't asking the city to take over an asset. They were asking the city to assume a liability. The city already had the asset, which was the tax base of the homes and the revenue stream they provide. The liability is the obligation to service and maintain the roadway indefinitely. That financial burden shifts from the property owners to the city, the former of which were willing to pay a one-time transaction charge (via the city engineer and his improvements) to make the deal happen.
Here is where the incoherence of municipal accounting comes into play. The new road actually shows up on the city's balance sheet as an asset. Municipal accounting assumes that the road itself has value. Cities that do more than a cursory accounting of infrastructure in their financial statements (an extremely small list) will depreciate that asset over the course of its useful life until, at some point, it has a value of zero. This is the accountant's way of saying that the value is gone.
The problem is, the city doesn't get to simply walk away from this now fully depreciated asset. The city has a commitment -- an obligation -- to maintain that asset. They have to fix the road. In accounting terms, they have accrued a liability, the same as a debt. While the city will not experience a hard default for reneging on this obligation, they certainly experience a soft default. Experience enough soft defaults and the city's true asset -- its tax base -- will be negatively impacted.
Current accounting practices do not bear any relation to the future cash flow or the actual financial health of the city. When cities take on obligations, they should be properly accounted for as liabilities, not assets. When the city uses debt to build new infrastructure, it is taking on the double liability of both the current debts payments and the future maintenance obligation. The tax base associated with these obligations needs to also be accounted for as a cash asset (think of it like an annuity) discounted over the useful life of the infrastructure. Then we would have an accurate account of the obligations (liabilities) of the community and how that compared to the tax base (assets) that needed to support them. In short, a true account.
And if you have even a vague sense of what these numbers would look like accurately represented, then you have an understanding of why I panic when I ponder the future financial health of our cities, states and country.