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May 10, 2010




High Speed Rail: A Jobs Program For Some Other Country?
By Cynthia Ward | 05/12/10

CommentsThis piece was written by a gentleman named William Grindley, a brilliant man with a passion for community service, who has granted permission to use his work. William's views here provide a possible-and plausible-scenario that answers many of the questions we have all been asking. Namely,who is paying for this thing, and how? William also manages to answer the "why" and it is that answer that gives me the most concern. His piece is posted here in its entirety. Enjoy.

Heads They Win – Tails California Loses – Twice
Why $42.6B Is Considered ‘Chump Change’ By Sovereigns
California’s high-speed rail promises are in trouble. The Authority’s funding isn’t as deep as they need, and pesky questions keep getting asked about why the Authority needs an illegal subsidy, albeit disguised as a ‘revenue guarantee’.

But wait. There’s a one-two punch way out of the Authority’s financial Armageddon. And while brought to you by the same folks who brought you the 2008 financial industry meltdown, it’s safe (for them), it’s legal, and it was used ad nauseam prior to 2009. It’s called a Collateralized Debt Obligation (CDO) backed by a Credit Default Swap (CDS). And not only that, using this approach gives them a Double Dip -- they lock you up on patents and technology for the next 100 years.

Here’s how it could go, especially for a sovereign like China or France. China has $2.4 Trillion (12 zeros) of foreign currency reserves, mostly in US dollars.[i] Financing $42.6B of high-speed rail in California would take only 2.2% of that, even if they paid everything up-front.[ii] But spread out over the eight years of constructing the first phase ($5.3B/yr) the annual dip into China’s reserves would amount to less than one-quarter of one percent.

So it sounds feasible, but why would China or France risk never making a RMB or a € ? The answer is a CDO backed by a CDS. Watch. First, China forms a ‘private’ corporation to own and operate the system, with their government lending the corporation the $42.6B in eight tranches to build the first stage. Whatever revenues come in they collect, plus at least the 16% after tax return the Authority says private companies will need to join in financing the train.[iii]

The operating company then puts all the high-speed rail’s assets, its collateral, into an investment instrument called a Collateralize Debt Obligation (CDO). To make sure they don’t lose money, they take out a Credit Default Swap (CDS), an insurance policy theoretically used to protect investors. But that CDS could be for $50B, or $100B or any amount. At mid-2010 premium rates of 4% on a risky CDS, they would have to pay annual premiums of $200M or $400M. While that sounds like a lot, it’s chump change in the bigger game of global finance. And the Authority forecasts their operating surplus (profits) for their first full year of operations will be $370M.[iv] With that forecast surplus the operator could can buy CDS coverage worth over $90B. It’s a win-win for the operator.

If everything goes even half as well as the Authority predicts, the operator will earn enough to pay most of the CDS premiums. But, that doesn’t matter, because as the operator, they can make the system fail. Remember, railroads coined the term ‘feather bedding’ to designate over staffing and make-work jobs. Suppose that in our example, the system goes bankrupt, and the operator defaults on its CDS premiums. Then the operator collects their insurance policy’s value -- $50B, if not probably more. First example of Heads They Win, Tails California Loses since the state is now stuck with a huge piece of infrastructure it has to figure out how to operate using its own money.

So why would a sovereign government want to default and walk away from a project just if it just breaks even or loses money on its CDO-CDS charade ? Seemingly they gain nothing.

But wait. The REAL benefit to the operating sovereign’s “private entity” is called a ‘Technology Lock-In’. It means that once a system is built, every bit of its future technology has to be sourced from the original supplier. That’s every locomotive and rail car, every signaling system, every electrification tower, every safety appliance, every line of software code, etc, etc. And if this were to be China or France, they get to sell California 45 train sets even before operations begin. Those initial train sets, would reap their so-called ‘private’ companies $2.275B.[v] And the system is scheduled to need at least another 55 train sets – plus replacement parts – by its fifteenth year of operations. That’s just a start, since any technology that comes out of the originating software or processes used in ‘their’ high-speed rail solution would belong to the operator. That means the Chinese or French operators would have to be paid royalties for use of any of the inventions that the California taxpayers will have to pay for if the system ‘goes broke’.

There it is. A Double Dip on the chorus’ refrain of – Heads They Win, Tails California Loses. They collect their CDS with or without making billions, and lock California into generations of their technology.

Understand now why the Chinese and French are so interested in building California’s high-speed rail system ?

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