Sandy Recovery: The Case For Disaster Bonds

Super Storm Sandy wrought havoc across the East Coast, leaving behind an estimated $10 to $20 billion dollars worth of physical damage and inflicting another $30-$50 billion in economic losses. With such a huge price tag, homeowners, private companies, insurers, and governments at all levels are struggling to figure out their financial responsibility for cleaning up the mess.

One possible solution is for the federal government to authorize the release of Sandy Disaster Bonds.

Much like private activity bonds, disaster bonds are tax-exempt debt instruments that direct private sector money into communities recovering from hurricanes, floods, or other calamities. Over the last decade, Congress authorized nearly $40 billion worth of disaster bonds for 13 states through standalone disaster relief packages as well as making program allocations in larger pieces of financial legislation. Overall, disaster bonds have a proven record of success in places like Louisiana and New York City, where they stimulated large investments in damaged communities.

Establishing a program today is likely to be challenging given the need for Congressional action. Fortunately, the process is straightforward:

First, Congress must designate an area where the bonds may be used. For example, after 9/11 Congress determined that the entire area south of Canal Street in Manhattan would be eligible for a variety of special tax and bond programs.  This “Liberty Zone” became the epicenter of the federal government’s recovery program. Next, Congress needs to set a cap on the total value of the bonds issued. In most cases, this is determined by using an estimate of the damages divided by the population affected.  In the aftermath of Hurricane Ike in 2008, this amounted to $2,000 per resident living in the disaster area resulting in over $1.8 billion of available bonds in Texas alone. Then Congress must determine what taxes they want to waive to encourage private investment. Much like tax-exempt municipal and private activity bonds, federal taxes on interest are waived for disaster bonds. After 9/11 and Hurricane Katrina, the Alternative Minimum Tax was waived as well.

The authority to issue bonds is then passed to states and/or localities, although both private firms and local governmental units are eligible for funds. The state serves as a conduit for the debt, which passes on all the tax advantages of the disaster bond to investors, while handing over all the repayment responsibility to the recipient organization. Typical bond applicants include utility companies, hospitals, real estate firms, manufacturers, and companies in the hospitality industry.

While the general mechanics of disaster bonds are relatively constant, the specific application varies.

The most recently implemented disaster bond programs were released in quick succession after the damage caused by Hurricane Ike and the storms that swept through the Midwest in the fall of 2008. Taken together, these two programs are the largest ever approved by Congress, both in their geographic scope and in their total value. Overall, tax-exempt bonds were made available in nine states with a total value of over $16 billion. After Hurricane Katrina, $15 billion worth of Gulf Opportunity Zone Private Activity Bonds supported a range of projects from $1 billion to rebuild a Marathon Oil Company refinery facility, to a $460,000 bond to finance the construction of a commercial office building issued by the Calcasieu Parish Public Trust.

Unlike GO Zone Bonds, Liberty Bonds issued after 9/11 included a more rigorous set of targeted sectors and a more complicated management structure for the $8 billion allocation. Congress evenly split the issuing authority for the bonds between the governor and the mayor. Furthermore, different pots of money were set up to encourage different types of projects, including retail, residential, and utility projects in areas directly impacted by the terrorist attack.

Questions remain about the fairness and overall execution of disaster bond programs. Criticisms include lack of transparency, limited public involvement, questionable project selections, and the burden they can place on already stressed bureaucracies.

In the wake of Super Storm Sandy, any new disaster bond program needs to avoid these shortcomings. Sandy Disaster Bonds should be targeted, to aim the funds towards the geographic areas and industries that are face the largest challenges; flexible to adapt their funding criteria to match communities evolving needs by engaging with city governments, local businesses, and non-profits; and transparent to ensure the taxpayer subsidies are appropriately allocated.

Disaster bonds are not a panacea for damaged communities. Sound governance, public involvement, long term infrastructure planning, and emergency response teams are all important to ensuring the recovery of our damaged communities. Nevertheless, innovative financing techniques, like disaster bonds, are an important part of America’s policy toolkit that can help the public and private sectors share the costs and responsibilities of rebuilding.