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Dear Docket Clerk:

On behalf of the more than 1,500 member organizations of the American Public Transportation Association (APTA), I write to provide comments pertaining to the Department’s Notice and request for comments concerning Development of a Guarantee Program for Troubled Assets (the Program), published October 16, 2008 at 73 FR 61452.

About APTA

APTA is a non-profit international trade association of more than 1,500 public and private member organizations, including transit systems; planning, design, construction and finance firms; product and service providers; academic institutions; and state associations and departments of transportation. More than ninety percent of Americans who use public transportation are served by APTA member transit systems.

Relief for Public Transportation Agencies

It is both appropriate and imperative that the Program be constructed in a manner that provides relief to public transportation agencies at risk of default under Lease In/Lease Out and Sale In/Lease Out (LILO/SILO) transactions.

The Emergency Economic Security Act of 2008 (EESA) clearly contemplates that either the purchase of troubled assets or the insurance of troubled assets under the Program is available for these transactions. Specifically, Section 103(f) requires the Secretary to exercise the authorities under the EESA taking into consideration the need to ensure stability for public instrumentalities that have suffered significant increased costs or losses in the current market turmoil. Public transportation agencies find themselves in just such an unstable situation, even though the underlying securities guaranteeing the agencies' payments under the LILO/SILO transactions are absolutely sound. In other words, at the present time the agencies' risk of payment default is small. However, without timely relief to stabilize the environment for these financial instruments, there is a significant risk of a cascading effect that will substantially further increase costs or losses that will exacerbate, rather than stabilize, the current market turmoil.

This significant risk is driven by impending technical defaults under the terms of the transactions. As indicated in more detail below, public transportation agencies funded all or nearly all of their payment obligations through the purchase of U.S. Treasury, which provided investors unassailable security for the agencies' payment. In addition, certain private financial entities, such as AIG and others, provided an additional overlay of security for investors by acting as a debt payment undertaker, surety or equity payment undertaker, according to the terms of the transactions. Each such financial entity is, in effect, a private guarantor or insurer of the payment obligations. These private guarantors were required to maintain minimum credit ratings, typically a AAA rating. The credit rating downgrades experienced by AIG and other similar entities resulted in a series of technical defaults that threaten the financial future of most of the nation’s largest transit agencies, as well as the financial futures of the state and local governments that fund them.

In addition, certain private financial entities, such as AIG and others, provided an additional overlay of security for investors by acting as a debt payment undertaker, surety or equity payment undertaker, according to the terms of the transactions. Each such financial entity is entrusted to an equity payment undertaker, such as AIG and others. Each equity payment undertaker is, in effect, a private guarantor or insurer of the payment obligations. These private guarantors were required to maintain minimum credit ratings, typically an AAA rating. The credit rating downgrades experienced by AIG and other similar entities resulted in a series of technical defaults that threaten the financial future of most of the nation’s largest transit agencies, as well as the financial futures of the state and local governments that fund them.

Public Transportation Agencies

Public transportation agencies are public instrumentalities created by state and local governments. Funding for these agencies combine resources provided by the Federal Transit Administration of the U.S. Department of Transportation (FTA), farebox revenue paid by transit riders, and state and local government funding. They provide bus, subway, commuter rail, and other transit services.

LILO/SILO Transactions

At the urging of FTA and facing intense pressure to provide services without increasing passenger fares or state and local subsidies, transit agencies throughout the U.S. explored various innovative financing techniques. One of the most effective and efficient techniques was the LILO/SILO transaction. A typical such transaction involved an investor purchasing assets (rail cars, buses, or facilities) from the transit agency funded by a combination of debt and equity investment. The transit agency contracted with entities such as AIG to act as private guarantors. An aspect of the agreements required the private guarantors to maintain minimum credit ratings of their own, notwithstanding the fact that the Treasury securities were unassailable. With the recent turmoil in the financial markets, many transit agencies are required to replace AIG as the private guarantor for their transactions. This has proved practically impossible to accomplish since the private guarantor must typically maintain a AAA rating, and there are virtually no AAA-rated private guarantors available to step in.

IRS Actions

Under normal circumstances, investors would be likely to waive replacement of the private guarantor, given their security interest in the underlying Treasuries. However, in recent years, the IRS has acted against the investors, determining the investors took insufficient risk and that the transactions lacked economic substance. As a result, investors have seen an erosion of their benefits from the transactions.

The typical LILO/SILO transaction contained provisions that would require the transit agency to make the investor whole should the transit agency default on its obligations. The private guarantor arrangements were designed to foreclose any practical possibility of payment default, and the FTA reviewed each transaction involving federally-assisted assets to ensure the assets were safe – that the transit agencies demonstrated “satisfactory continuing control” of the assets.

The erosion of investor benefits is not an event of default under the transactions. Nonetheless, the combination of IRS actions and the disruption of financial markets has presented investors an opportunity to recoup the profits lost to the IRS actions by declaring transit agencies in technical default, solely because alternative private guarantors are not available to replace AIG, even though the underlying securities are absolutely sound.

Results

Allowing investors to proceed to default in these transactions would invite financial disaster for state and local public instrumentalities and further disruption of their ability to obtain credit. As you will see in separate submissions by several of our member public transportation agencies, this purely technical default will cost state and local public instrumentalities hundreds of millions of dollars; IRS enforcement efforts will be set aside in favor of windfall profits to investors; public transit services will necessarily be cut in America’s largest urban areas; and state and local instrumentalities, having only technically defaulted in these transactions, will face higher costs or even unavailable credit as they struggle to recover from the crisis in our financial markets.

Treasury Use of the Guarantee Program

These consequences can be avoided without significant cost or risk to taxpayers under the Program. We believe Treasury should use its authority under the Program to guarantee the obligations of AIG and other private guarantors. The stability and soundness of the assets, (i.e., U.S. Treasury obligations) that secure the payment obligations ensure all payments will be made. The fact that the payment obligations are fully funded or overfunded and that the investors maintain a security interest in the underlying U.S. Treasury obligations ensures there will be no shortfall or diversion of the assets. Treasury would merely act to meet the technical contractual obligation that the private guarantor maintains financial stability, as usually demonstrated through its credit rating. While this is not a perfect solution, it is a solution that may forestall disaster.

Specific Issues

Question 1

One key issue Treasury must consider in establishing the guarantee program is its breadth. As noted above, not all troubled assets are mortgages or credit default swaps. Accordingly, the Program must be flexible enough to guarantee assets that present unique circumstances with substantial, far reaching consequences.

Question 1.2

In our view, it would be reasonable to structure and implement the Program in a manner that takes into consideration different classes of troubled assets as well as the degree to which an asset is troubled. In particular, we believe there is an important distinction between financial instruments that are based on sound underlying assets and financial instruments based on underlying assets that are not sound. In both cases, the negative effects on financial market stability may be significant. However, when the underlying assets are sound a guarantee will promote financial market stability in a quick, efficient and virtually no-cost manner.

Question 1.2.4

In guaranteeing non-mortgage troubled assets, Treasury must fully analyze the foreseeable negative implications of not acting. Such implications include significant consequences to the obligations of the public instrumentalities' transactions on which a financial instrument is based. In the case of LILO/SILO transactions, Treasury must be particularly cognizant of the value added by avoiding additional market upheaval, which is important to promote financial market stability.

As indicated above, we believe that financial instruments based on sound underlying assets represent a unique set of circumstances for which a tailored implementation of the Program is appropriate. In the case of LILO/SILO transactions, the financial instruments became "troubled" because the market turmoil created a technical default, not because of any deterioration in the underlying assets. These technical defaults in turn have a negative effect on financial market stability. Consequently, there is an opportunity to promote financial market stability by issuing a guarantee to cure such technical defaults in a quick and cost-effective manner.

Question 1.5

In general, an investor's ability to sell its interest in a LILO/SILO transaction is governed by the terms of the agreement for the transactions. We do not believe it appropriate or necessary to alter these agreements. Indeed, the underlying assets securing these transactions are sound, and a guarantee of these underlying assets is not required. Rather, the guarantee under the Program would replace or backstop the obligations of AIG and other private guarantors to cure the technical default caused by the downgraded credit ratings. In this regard, we believe that a private guarantor, such as AIG, that obtains a guarantee under the Program should be able to transfer its obligations to a qualified replacement, and that the guarantee should flow with the transfer.

Question 1.6

As both a methodological and a practical matter, Treasury should evaluate the soundness of the underlying assets to determine potential losses. For LILO/SILO payment undertaking agreements, Treasury should simply confirm that the structure of the underlying assets ensures that maturity dates and amounts are sufficient to support all required payments. The department must necessarily use different assessment methods for different classes of assets since, as demonstrated by LILO/SILO transactions, the risks involved are vastly different among asset classes.

Question 1.7

As discussed in more detail below, we believe that the key element in setting premiums should be the risk of loss (i.e., the credit risk) of a financial instrument's underlying assets. While it may seem conceptually inviting to set premiums for assets guaranteed under the Program to reflect the prices of similar assets purchased under TARP, such an approach should be pursued with caution. In the first instance, the determination of what assets are "similar" is critical. Any such determination should be based on an analysis of the financial instruments' underlying assets to ensure that the financial instruments purchased under TARP are as close to identical as possible to those that are guaranteed. Even if the underlying assets are identical, however, the purchase price of the financial instrument may not represent an accurate proxy for the credit risk of the underlying assets. For example, the holder of a financial instrument may be forced to sell the financial instrument due to the holder's particular financial situation or due to external factors. In such circumstances, the purchase price under TARP likely would be less than a price that accurately reflects the credit risk of the underlying assets. Accordingly, we have serious concerns about the feasibility and appropriateness of setting premiums to guarantee assets based on the prices of similar assets purchased under TARP.

Question 1.7.2

Just as it does in calculating possible losses, Treasury must consider the unique nature of widely different asset classes and set appropriate premiums and standards for each. We do not believe a one size- fits-all approach is either feasible or appropriate in developing the Program.

In setting premiums for the Program, Treasury should calculate the risk of loss (i.e., the credit risk) consistent with traditional insurance practices. This would be consistent with Treasury authority under Section 102(c)(2) of the EESA to base premiums on the credit risk associated with the asset. In these transactions, the guarantee of the credit risk – the surety and payment undertaking agreements – would effectively be at or near zero. The risk of loss is virtually non-existent, and should be reflected in a minimal premium.

Question 4.1

We do not believe Treasury would require any additional or specialized expertise to implement this facet of the Program. Evaluation of the assets underlying the payment undertaking agreements is well within the existing expertise within the department.

Question 6

Eligible assets should, as discussed above, be broadly defined to include LILO/SILO transactions with privately guaranteed surety or payment undertaking agreements, which involve a unique set of circumstances with far-reaching consequences. As such, we believe LILO/SILO transactions with privately guaranteed surety or payment undertaking agreements should be eligible under both the guarantee and asset purchase programs. Eligibility should flow from the soundness of the underlying assets and the substantial value added by avoiding further market upheaval. Treasury should purchase or guarantee any such troubled LILO/SILO transactions where a technical default is solely the result of the failure of the financial system to create a ready market for replacement private guarantors.

Finally, because the credit risk of the underlying assets in LILO/SILO transactions is virtually nonexistent, we believe the questions relating to payouts are largely academic in our unique circumstances. Similarly, we believe that the form that should be used to schedule payment of premiums is largely a ministerial question, so long as the premiums are based on traditional insurance practices as indicated above. Nonetheless, we stand ready to work with you on these issues as needed to address the unique circumstances of these transactions.

Thank you for the opportunity to comment on this vitally important aspect of economic recovery.

For additional information, please contact APTA’s Chief Counsel and Vice President – Corporate Affairs, James LaRusch at (202)496-4808 or jlarusch@apta.com.

Sincerely,

William W. Millar
President
American Public Transportation Association

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