Does Uncle Sam Own Your Sewage?

Swimming pools and libraries are closing, theaters have to merge -- the financial crisis in German cities is going from bad to worse. With funds desperately short, municipalities either have to save, or find ways to increase their income. That's where cross-border leasing comes in.

Cross border leasing refers to a two-way leasing contract between U.S. investors and German towns or cities, offering a significant tax advantage to both parties.

Leaser and lessee in one

For example, the city of Leipzig rents out its water towers, water storage and water mains for 99 years to a U.S. investor and immedately leases it all back -- for a term of 29 years. Under the terms of the contract, the city is thus both the letter and the lessee.

The trick: because of the long life of the contract, the deal counts as an international development investment in the United States. The American investor can therefore write off the investment and save a bundle on taxes. He keeps the lion's share of the money saved for himself, and kicks a part back to the municipality. In the case of Leipzig's drinking water system, the kick-back is €18 million ($20 million).

Leipzig isn't alone. With ever more debt-ridden municipalities paying their employees with loans from private banks, the scheme is winning more and more adherents. Munich, Cologne and Frankfurt are among the German cities that have leased trade-fair grounds, sewage-treatment plants, and even entire underground transportation systems to U.S. companies -- and getting paid for it.

Win-win?

But is it the win-win situation it appears to be? The dangers of the deal -- real or imagined -- have recently sparked opposition from some of the cities whose assets were up for consideration.

The objections are many. First of all, critics say, if a deal goes sour, the municipality pays. The German city of Aachen recently had to pick up €19 million in legal and consulting fees after cross-border leasing negotiations tanked.

Another oft-cited problem is that under the terms of such leases, the city remains the owner of the property -- with all the rights and responsibilities that entails. In other words, the city must keep the property in good condition for the life of the contract. Yet no one knows for sure how long a sewage-treatment plant or trade-fair hall will be needed, for example.

"The city of Cologne has leased out its trade-fair hall under a long-term cross-border leasing arrangement," notes Thomas Hartmann-Wendels, a professor of banking and banking law at the University of Cologne. "But it is possible that in 10, 15 or 20 years, we no longer have trade fairs, we don't need them any more. What do you do then with the trade fair buildings? Just keeping them because there is an existing contract would be very expensive."

All in the plans

Supporters of the contracts say no treasurer plans to really keep such a deal going until the contract expires. In reality, when the the re-leasing arrangment runs out after 25 or 30 years, the city can exercise a so-called termination option -- in other words, they can cancel the main leasing agreeement.

Hartmann-Wendels fears the worst -- that cities would not be able to exercise their termination options. Then the foreign investor would not only have a leasing contract that runs for 100 years, but also the right to operate the leased property -- a German public utility -- on the free market.

Manfred Busch, treasurer of the city of Wesel, near the Dutch border, says such fears are unfounded. A city will always be able to exercise its termination option, he says, since they will have planned for it financially all along.

"No one can be that dumb," Busch says. "Of course, the whole contract and in the whole deal is developed so that not only the leasing fees will be paid out over the 25 years, but also the value of the termination option as well."

A question of puddles

Busch asserts that opposition to such transactions isn't based on any real dangers, but rather on the fear that people have of their public works being owned by Americans. "I bet if these deals were made with England -- that is to say, over the small puddle and not the big one -- no one would worry about it," he says.

The argument that the municipality remains responsible for the upkeep of a property during the life of the contract is also not a problem, he says. In the end, the city has to keep up its infrastructure with or without a cross-border leasing contract.

Yet Busch does admit to one dangerous aspect to the deal. It could be very costly to do business with the wrong bank. Under the terms of the arrangements, the city gets the entire amount of the 99-year rent at one time. It gives this money, minus its part of the tax advantage (which goes straight into city coffers), to a bank. The bank sees to it that the rent makes it to the U.S. investor each year. if the bank starts to stumble, then the city will have problems meeting its payments.

Says Busch, "If I wake up and see that Deustche Bank is broke, and I've parked €400 million somewhere in Deutsche Bank, that would be a disaster."