Doing borrowed time: The high cost of back-door prison finance

In the face of tight budgets and growing public opposition to new prison spending, officials in many states have employed a variety of "back-door" schemes to finance new prison construction. The mechanisms vary but the consequences are the same: rapid prison expansion that takes place with little public involvement or oversight.

A review of recent prison, jail and detention expansion initiatives shows that such back-door financing mechanisms are becoming more common at the federal, state and local level. Behind this trend is a cottage industry of investment bankers, architects, building contractors and consultants who have made enormous profits by encouraging local and state governments to borrow tens and hundreds of millions of dollars to build prisons and detention centers that the public does not want and cannot afford.
The U.S. prison population doubled during the 1980s and nearly doubled again in the following decade. By the end of the 1990s the nation's prisons held more than 1.3 million prisoners while the total incarcerated population - including jails and detention centers - fell just short of two million.

Prison population growth has continued since the turn of the century but at a much slower pace. Average annual growth rates fell from nearly seven percent during the 1990s to just under two percent in the past half-decade.

Elected officials in a large majority of states responded by introducing reforms designed to cut costs and improve criminal justice outcomes. Some canceled or postponed plans for new prison construction while others cut costs by closing housing units or entire prisons. Yet despite tight budgets and growing public opposition to new prison spending, lawmakers in several states - including Arizona, California, Colorado, Florida, Oregon, North Carolina, and Washington - continue to pursue plans for thousands of new prison beds.

Voters would almost certainly have rejected these costly expansion plans if policymakers put the question on the ballot in the form of a prison bond referendum. Instead, officials in many states have employed a variety of "back-door" schemes to finance new prison construction. The mechanisms vary, from establishing non-profit shell corporations that issue bonds and "lease" prisons back to the state, to handing the whole enterprise over to private prison companies. But the consequences are the same: rapid prison expansion that takes place with little public involvement or oversight.

A review of recent prison, jail and detention expansion initiatives shows that such back-door financing mechanisms are becoming more common at the federal, state and local level. Behind this trend is a cottage industry of investment bankers, architects, building contractors and consultants who have made enormous profits by encouraging local and state governments to borrow tens and hundreds of millions of dollars to build prisons and detention centers that the public does not want and cannot afford.

Paying for prisons- Corrections takes the "public" out of public finance

Until the mid-1980s, prisons were generally built in one of two ways. State officials either took the "pay-as-you-go" approach by funding new construction out of general revenues; or they sought voter approval to borrow money through the sale of "general obligation bonds."

Revenue bonds - debt that is backed by project income rather than the full faith and credit of the government - and other back-door financing schemes became more popular during the 1990s when state officials found themselves squeezed by mounting corrections costs and a growing anti-tax chorus. The website PublicBonds.org reports that, by 1996, more than half of new prison debt was being issued in the form of certificates of participation, a variant of the lease-revenue bond.

No state has built a new prison with general obligation bonds since the turn of the century and few have put the question to voters. Instead, states pursuing a prison expansion agenda have done so through increasingly complex, and costly, back-door finance schemes. North Carolina, for example, has financed construction of five prisons since 2001 by engaging a private consortium to float bonds, build facilities and sell them to a state bonding authority.

Elsewhere lawmakers have tried to turn prison finance over to the private sector. During the last few years, Arizona has found itself caught between a rapidly growing prison population and budget deficits which were among the nation's largest. The legislature authorized the Department of Corrections to contract with private companies to design, build and operate two new facilities - a 1,400-bed prison for drunk drivers and a 3,200-bed private "superprison" for women.

While pushing up costs, back-door schemes do have benefits for policymakers in North Carolina, Arizona and other states where they have been employed. They can keep prison debt "off the books," avoiding constitutional caps, and concealing major long-term obligations from normal budget scrutiny. Decisions about prison expansion remain beyond the reach of the voters who will bear the costs of operating them. Finally, back-door finance schemes generate large transaction fees for investment bankers and others with deep pockets and close ties to state officials.

Federal, local and private sector join the back-door borrowing frenzy

Aside from its role in surreptitiously growing state prison systems, back-door financing is playing an increasingly important role in prison and jail expansion at the federal and local level, as well as in the private sector. Officials in Shelby County, which includes the city of Memphis, Tennessee, were recently courted by the nation's leading private prison companies with offers to build a massive new jail. A plan advanced by The Geo Group (formerly Wackenhut Corrections) would have established a nonprofit bonding authority to issue revenue bonds, while Corrections Corporation of America offered to build the facility using its own credit line in exchange for a 50-year lease agreement. In 2005, CCA made a similar proposal to the leaders of Richmond, Virginia. Meanwhile, many smaller counties are being approached with proposals to finance larger jails that "pay for themselves" by renting beds to local, state and federal clients.

Even private prison companies, which can serve as vehicles for back-door prison financing, are themselves seeking ways to keep prison debt off their books and push risk back onto the public sector. Meanwhile, the explosion in the number of beds housing U.S. Marshals Service and Bureau of Immigrations and Customs Enforcements detainees has been financed almost entirely by counties and private prison companies.

A large majority of the more than 600 facilities housing federal detainees do so under Inter-Governmental Agreements, which allow the agencies to circumvent procedural safeguards such as public bidding. Inter-Governmental Agreements are much easier to procure than contracts but they offer few guarantees, making expansion plans that hinge on such agreements extremely risky. The promise of profitable federal detention business has spurred counties in Texas and elsewhere to "super-size" their jails and build facilities solely intended to serve the federal detention market.

Cost #1- Policymakers binge on easy prison credit

The proliferation of back-door finance has important policy implications. Easy access to investment capital permits policymakers to commit to thousands of new prison beds that will cost billions of dollars to operate over the coming decades while putting, as they say in the car commercials, "nothing down." The lucrative nature of back-door prison finance deals also brings together set of powerful financial interests which have a large stake in pushing the deals through.

The result is a powerful cocktail of political opportunity and private profit that can encourage overbuilding and have a corrosive effect on criminal justice policymaking. Prison expansion is rarely the only option on the table. In both Arizona and North Carolina, bipartisan groups of legislators were considering sentencing reform proposals that could have reduced or eliminated the need for prison expansion. Given the intense budget pressures each state faces and the lack of public support for further prison spending, reform seemed to be the obvious choice. But once the big-ticket expansion plans gathered momentum, advocates of sentencing reform had difficulty getting a serious hearing for their ideas.

Cost #2- Back-door finance locks in excess prison capacity

State policymakers know only too well that pressure from local communities and other interested parties makes prisons easier to open than to close. Reginald Wilkinson, who until recently ran Ohio's Department of Rehabilitation and Corrections, had to go all the way to the Ohio Supreme Court to vindicate the department's right to close prisons over the opposition of the union that represents the state's prison guards.

But closing a prison, jail or detention center can be doubly difficult if the facility was financed "off the books." Louisiana lawmakers discovered this unfortunate fact when they tried to shut down the nation's most notorious juvenile detention center.

States that pursue private financing for prison expansion in order to save money and maximize flexibility are likely to find the opposite - risky and costly schemes which shackle them more closely to leased prisons than to the ones they own. Louisiana's experience demonstrates that each privately financed prison can turn into a political landmine that is difficult, if not impossible, to defuse.

Cost #3- Immigrant "gold rush" creates speculative detention bubble

The emergence of prison and detention markets and easy access to investment capital have combined to create the conditions for speculative expansion, especially at the local level. No state has seen more speculative prison growth - or more fallout from speculation - than Texas. The state made headlines in the early 1990s when a detention scheme promoted by a group of investment bankers and developers collapsed resulting in one of the largest-ever bond fraud and conspiracy cases.

A decade later, Texas' speculative detention market is hotter than ever thanks to a federal detention "gold rush." One group of investment bankers has played a particularly active role - helping to inflate the detention bubble by setting up a string of questionable deals that span the state. Over a five-year period, a Connecticut bond house known for putting together "tough" deals and a Dallas firm with substantial experience financing private prisons sold nearly $200 million of revenue bonds for eight Texas counties and one small city with a combined resident population is just 111,000 (i.e. $1,800 of debt per person). The proceeds of the bond deals underwritten by Herbert J. Sims & Co. and Municipal Capital Markets Group were used by the sparsely-populated localities - which count just over 100,000 residents between them - to build, acquire or refinance for-profit jails and detention centers that derive the bulk of their income housing federal detainees or other states' prisoners.

The rapid growth of local detention finance schemes, most pronounced in Texas and elsewhere along the U.S.-Mexico border, is a recipe for disaster. As the Texas experience shows, the players driving the expansion have little stake in the financial stability of the projects, much less their social impact. A July 29, 2003 article in The Bond Buyer warned that experts believe "A wave of private jail construction designed to spur economic development in the rural Southwest poses a growing risk to bondholders and the counties that stand behind the projects".

Why the economics of prison expansion escape the bond markets

There is ample evidence that the current wave of prison expansion is financially unsound. On one hand, public enthusiasm for incarceration has waned and, while no one expects prison populations to return to 1970s levels any time soon, it is plausible that long-term demand for beds could fall below the current supply. Many state governments appear to have hit a ceiling in terms of the public's willingness to fund prison expansion. The federal appetite for new prison and detention beds continues unabated, but lawmakers have not yet shown a willingness to fund them at a level that would take up the slack in the much larger state market.

On the other hand, the supply of prison, jail and detention beds is growing, fueled by a myth of ever-rising demand and financing schemes that encourage state and local governments to build now and pay later. Lawmakers in states like Arizona, which can barely afford to run existing prisons, are bringing thousands of new beds online with no plans to fund the additional expense. Meanwhile counties are adding thousands of detention beds based on Inter-Governmental Agreements with the federal government that are not, for purposes of securing long-term debt, worth the paper they're written on.

The risks back-door prison finance poses to both investors and governments are not merely theoretical. A review by staff at Good Jobs First, a nonprofit economic development think-tank, found that prisons financed with certificates of participation accounted for a third of all lease-backed bond defaults in the 1990s. A decade ago, a $74 million speculative scheme to build 500-bed prisons in six Texas counties collapsed when five of the six were unable to attract prisoners. The fiasco gave rise to one of the largest ever bond fraud and conspiracy cases and resulted in a partial bailout by the state which acquired facilities that failed to meet basic detention standards at 50 cents on the dollar.

Build it and they will come (but not in time to pay the mortgage)

The belief that prison expansion is inevitable could become a self-fulfilling prophecy, at least in part. Once prisons, jails and detention centers are built, the political pressure to fill them is enormous. Back-door financing only heightens these pressures by aligning bond investors, insurers and rating agencies with the communities that see prisons as a source of jobs and economic development.

Fortunately, activist and advocates across the country have begun to get what the financial markets are missing. They have developed strategies to challenge back-door financing of prisons, jails and detention centers by putting the public back in public finance.

Ultimately, increased attention to the may persuade both policymakers and Wall Street that back-door prison finance is not in anyone's long-term interest. If not, we will all pay the price for many years to come.

"Doing borrowed time" was authored by Justice Strategies analyst Kevin Pranis. A longer version will appear in the forthcoming Prison Profiteers: Who Makes a Buck from Mass Incarceration (The New Press). The author would like to acknowledge Judy Greene, May Va Lor, Mafruza Khan and Phillip Mattera for their contributions to the growing body of prison finance knowledge.