Playing in the Private Sector: New Mexico’s Experience as an Investor and Financier of the State’s Economy

Under the administration of Governor Bill Richardson, state government has become a player in the private sector to an extent unprecedented in New Mexico’s history.  Little known to taxpayers, under the Richardson administration the State has purchased stock in 52 New Mexico companies ranging from computer software designers to dental clinics to a fish monger.  New Mexico also lends hundreds of millions of dollars money for film and television productions.

The State’s experience has been mixed.  Several companies in which the State purchased stock have folded. With the impending collapse of Eclipse Aviation, the State’s largest equity acquisition, the benefit to taxpayers of buying into private companies is becoming more questionable.  The returns to taxpayers from serving as a creditor to the film industry are also worth questioning.  It is difficult to measure the direct returns to taxpayers from providing financing to movie and television studios.  New Mexico is essentially loaning hundreds of millions of dollars interest free in exchange for temporary economic stimulus that can easily fall below expectations.  For instance, New Mexico has now become a major creditor of Lions Gate Entertainment, at the same time that studio is reneging on promises to invest in New Mexico and create jobs here.

This is the first in a series of reports for the Rio Grande Foundation to shed light on what state government has been doing as a player in New Mexico’s private economy.  Future reports will address the state’s specific equity holdings and the performance of its movie and television production financing.

This report addresses a threshold question that should have been addressed by the Richardson administration and the Legislature before the first dollar was spent to acquire stock in a privately held company or to finance a movie:  Is any of this constitutional?

A.  Incursions by the State Government into New Mexico’s Private Sector

1. Private Equity

Purchases in private New Mexico companies are made through the New Mexico Private Equity Invest Program (NMPEIP).  That program invests money from the Severance Tax Permanent Fund, which stood at $4.7 billion by the end of 2007.  Under a law passed in 2003 at Richardson’s urging, up to 9% of the Severance Tax Fund may be used in New Mexico private equity acquisitions.  At the end of 2007, the SIC had $141.5 million in private equity investments in New Mexico corporations and partnerships.

Private equity purchases are made by the State Investment Officer, Gary Bland, with the approval of the State Investment Council (SIC).  That body includes the Governor, State Treasurer, State Land Commissioner and individuals appointed by the Governor.  Private equity purchases must also receive approval from the Private Equity Investment Advisory Committee (PEIAC), which is composed of the State Investment Officer and a four private citizens appointed by the Governor.  Two members of the PEIAC also sit on the SIC.

According to Charles Wollman, the SIC’s public information officer, New Mexico state government currently holds ownership stakes in 52 New Mexico companies.  Those stakes have been acquired by either direct purchase of stock in the company or through the New Mexico Co-Investment Partnership, a New Mexico private equity fund managed by Santa Fe-based Sun Mountain Capital. The State of New Mexico currently owns stakes in the aforementioned fish monger, dental clinics and software designers, as well as several aviation and aerospace firms, a cleaning products company, a gas field services provider, water purification businesses, computer hardware firms, an on-line gift certificate vendor, a supplier of electronic librettos for opera houses, a solar power equipment manufacturer, and a banking security expert.

The performance of these investments—in terms of the actual dollar payout —is difficult to pin down.  These companies are not publicly traded, so there is no market establishing a value for their stock. Nor do they pay dividends. Because most of these companies are start-ups they are not expected to make money for many years, if ever.  Many of them, perhaps even the majority, are expected to fail.  The hope is that one or more blockbusters will at some future date move the performance of the private equity portfolio from red to black.

The SIC generally reports the success of its private equity investments in terms of economic development measures rather than traditional investment returns.  The SIC 2007 annual report claims that the 45 New Mexico firms in which the state had equity positions at that time employed more than 2,300 New Mexicans with average salaries of $60,380.  Payroll and other spending for these companies reportedly topped $178 million annually.

Sometimes these jobs come at enormous expense to taxpayers.  One of New Mexico’s earliest private equity purchases was in TCI Medical, a company that had promised to build a nuclear medical plant in Carlsbad. New Mexico made a $7 million equity investment in the company.  This company planned to apply advances in nuclear isotope technology to the healing arts. But General Electric entered the same field and destroyed TCI Medical’s business prospects.  Instead of generating 100 promised jobs, TCI Medical only managed to create six jobs, at a cost to New Mexico taxpayers of $1.17 million each. TCI closed its doors in 2006 and New Mexico lost its investment.

The SIC in 2003 extended about $2 million in a “mortgage participation re-bid” to help Millennium Transit Services of Roswell acquire land for a bus manufacturing and refitting operation.  In August 2008, Millennium Transit filed for bankruptcy.  According to Wollman, the state “may” be able to recoup most of its loan by selling off inventory and equipment.  But other creditors will be pursuing the same assets, and the final decision of the bankruptcy court is uncertain.  Millennium has stopped payments on its loan from the State.

The largest single equity investment made by the SIC in a New Mexico company is in Eclipse Aviation of Albuquerque.  New Mexico has invested just under $20 million in Eclipse, not including millions in employee training tax credits, property tax breaks and other financial benefits.  At one time, the State owned 5% of Eclipse.  Due to engineering disappointments, market conditions, manufacturing glitches, and strong competition, as of the date of this report Eclipse Aviation is facing the same fate as TCI Medical.  New Mexico stands to lose its entire investment.

The collapse of Eclipse Aviation could spell broader consequences for the SIC’s New Mexico private equity program.  Glowing valuations of Eclipse Aviation have been a major factor in the SIC’s ability to claim positive returns on its New Mexico private equity investment portfolio.

2.  Film and Television Financing

As explained by the SIC’s website, “The State Investment Officer may make investments in New Mexico film projects of up to 6% of the market value of the Severance Tax Permanent Fund. These investments, capped at $15 million per project, currently take the form of a guaranteed, no-interest loan up to 100% of the production budget. Investments require a negotiated participation in the film project’s post-break even revenues.”

The loan is usually guaranteed by a letter of credit from a bank.  It may also be guaranteed by another corporate entity with a credit-worthy rating.

New Mexico offers other production incentives, including a 25% tax rebate, exemption from sales taxes, and 50% reimbursement for on-the-job training for New Mexico residents.

New Mexico has loaned about $229 million to 23 film productions.  Not all of those loans have been repaid or have produced a profit for the State.  The State Film Office claims that these 23 film productions have created 4,140 jobs, and generated total expenditures of about $202.5 million in the state. No analysis has been done as to how many jobs other small and growing businesses could have created if that money had not been used otherwise, such as to facilitate lower taxes.  Most New Mexico businesses don’t have highly paid lobbyists or movie stars to boost the self-esteem of politicians and enchant them with visions of dabbling in Hollywood’s glitter.


B. Statutory Authority for State Investments In Private New Mexico Corporations and Partnerships

At the urging of Governor Richardson, in 2003 the Legislature enacted NMSA Section 7-27-5.15.  Under this law, up to nine percent of the market value of the severance tax permanent fund may be invested in New Mexico private equity funds or New Mexico businesses.  These investments must “enhance the economic development objectives of the state.”  The State Investment Officer is authorized to make investments directly in New Mexico businesses “to create job opportunities and to support new, emerging or expanding businesses in a manner consistent with the constitution of New Mexico.”  Its stake may represent up to 51% of the total investment capital in a business, and may exceed that amount in certain exceptional circumstances.

The State Investment Officer may also invest three-fourths of a percent of the market value of the severance tax permanent fund “to create new job opportunities by providing capital for land, buildings, or infrastructure for facilities to support new or expanding businesses in a manner consistent with the constitution of the State of New Mexico.”
C.  The Unanswered Constitutional Question:  The Anti-Donation Clause

Do the SIC’s investments in private New Mexico companies and loans to film producers violate the New Mexico state constitution’s anti-donation clause?

In response to disastrous losses of public funds invested to support railroads in the 19th century, New Mexico’s constitution adopted what has come to be known as the anti-donation clause.  Article 9, Section 14 of the New Mexico State Constitution provides: “Neither the state nor any county, school district or municipality…shall directly or indirectly lend or pledge its credit or make any donation to or in aid of any person, association or public or private corporation….”

In the 19th century, Western states had allowed their funds to be used in speculative ventures to aid the extension of railroads.  “The railroad was not just a curiosity, or a rich man’s toy, or an incomprehensible abstraction,” writes Albuquerque attorney Alan Hall in “Understanding the Anti-Donation Clause:  A Historical Perspective.”  “Rather, it was something that everyone instantly understood would improve their individual lives.  It would raise prices received by producers, and simultaneously cut prices paid by consumers.  It would increase wages and profits, open huge new markets, and tie the country together like never before.  The railroad was like a new god, beneficent and all-powerful, or better yet, a new lover:  ardent, beautiful—rich.”

But the railroad proved to be a costly lover.  States approved the issuance of staggering amounts of railroad aid bonds.  Some counties and towns made outright gifts of land, money or government securities to attract railroads.  Other governments made loans.  The most common means of supporting economic development was acquiring stock in railroads themselves.

Each time the economy turned down, governments that had invested in railroads took a hit.  During the Panic of 1837 many states defaulted.  The post-Civil War deflation wiped out many investments in railroad stocks.  Railroad debt crushed taxpayers.

“In their optimism,” Hall explains, “city fathers and county commissioners failed to carefully investigate the feasibility of the projected lines or the experience of the railroad entrepreneurs, and compounded this incaution by neglecting to insist on any safeguards on how the public monies that they so readily offered up were spent.  Large sums were typically handed over for no security other than the naked promises of railway officials.  Fraud and mismanagement consumed significant amounts of the contributions, resulting in many publicly-funded lines never being built, while others were hopelessly uneconomic from the day of their opening.”

In response to this experience, New Mexico joined other states by writing into their constitutions clauses prohibiting the use of their treasuries to aid private enterprises.

New Mexico’s anti-donation clause has been amended over the years to allow certain student loans and veterans’ scholarships.  The anti-donation clause was specifically amended to permit state and local governments to create “new job opportunities” by providing land, buildings, or infrastructure, for new or expanding businesses.  Governments may also donate or pay a portion of the costs of land for the construction of affordable housing without violating the anti-donation clause.  A similar amendment, however, was not made contemporaneously with statutory authorization of direct investments in New Mexico companies.  Nor is there any amendment permitting the pledging of the state’s credit or lending money for film productions.

 D.  Has the Richardson Administration Been Violating the Anti-Donation Clause?

1.  Lending to Film Producers

The question as to whether the State’s use of its credit to finance film production implicated the anti-donation clause was raised in a September 19, 2005, SIC meeting.  State Land Commissioner Patrick Lyons had asked that the Attorney General address this issue.  The minutes record a promise by the Attorney General’s representative to issue an advisory letter on the applicability of the anti-donation clause to the state’s film industry loans.  The Attorney General’s data base of advisory opinions and letters, however, does not show that the promised advisory letter was ever issued.

A search of all New Mexico Attorney General opinions since 2003 when the New Mexico private equity acquisitions were authorized by statute fails to show that the applicability of the anti-donation clause to the Richardson administration’s conduct with respect to private equity and film financing has been addressed in any manner.  Nor was the Attorney General’s Office and the SIC able to identify any such letter or opinion when requested to do so.

The State seems to clearly be violating the anti-donation clause by lending money to film productions.  The anti-donation clause prohibits the state from “directly or indirectly lend[ing] or pledg[ing] its credit” in aid of any private enterprise.  Yet this is precisely what the Richardson administration has done to the tune of hundreds of millions of dollars.

2.  Private Equity Investments

The applicability of the anti-donation clause to private equity investments is less clear, but raises enough questions that it should be addressed by the Attorney General and the Legislature, if not the courts.

Strictly interpreted, a “purchase” of stock may not be a donation because the state is acquiring something in exchange for its investment.  The SIC’s Wollman says “we view these as investments, not donations.”  But saying doesn’t make it so.

What happens when that investment becomes worthless, as in the case of TCI Medical and the looming Eclipse Aviation failure?  The state in those circumstances has, in fact, donated its multi-million investment to the failed company.  Indeed, until the state gets its money back, with a market rate of return, it is effectively donating—or lending—its money to these closely-held corporations while they attempt to get off the ground.

And what of investments in risky start-ups where the SIC had little, if any expectation of ever getting its money back, let alone a market rate of return on its investment?

In the 2006 case of Office of the State Engineer v. Lewis, the New Mexico Court of Appeals held that an expenditure of state resources must be examined “in substance and effect” to determine if it is a prohibited donation.  The court looked beyond the label attached to a transaction. It intimated that an acquisition acquired for a price above its real market value, or an expenditure of public funds for something with  no true market value, could be considered a donation in aid of private enterprise prohibited by the constitution.

The New Mexico corporations and partnerships receiving money from the SIC have no market value because their shares are not publicly traded—there is no market for them.  Further, many of these start-ups are never expected to pay a return on the state’s investment.  It is difficult to reconcile these kinds of investments with the central purpose of the anti-donation clause:  curbing the use of public money in speculative ventures.

The constitutional difficulties with the State’s private equity program are further compounded because the 2003 authorization of investments directly into private New Mexico corporations does not require that the investments be made with any expectation they will ever produce a positive return, or even be paid back. The State Investment Officer is authorized to make investments in New Mexico businesses “to create new job opportunities” and “to support new, emerging or expanding businesses.”   Without requiring even an expectation that its principle will be returned, the money given by the SIC to a New Mexico company looks more  like a donation to aid private enterprise than it does a prudent investment, and thus more and more likely to be a violation of the state constitution’s anti-donation clause.
E.  What Should Be Done?

This massive expenditure of public funds has generated a political constituency unlikely to welcome a reevaluation or cessation of these investments and loans, regardless of their legality.  But as the public learns about more of its investments going sour or coming up short in producing promised jobs, political leaders should step forward to scrutinize these programs more closely.  The looming collapse of Eclipse Aviation, and with it the loss of nearly $20 million, provides a promising opportunity for the Legislature to halt the expenditure of funds on speculative investments and to bring the State Investment Council’s operations into compliance with New Mexico’s constitutional prohibition against donating or lending public money to aid private enterprise.