Taxpayer Going Down With Ship Project


Taxpayers stand to lose more than $200 million from the recent collapse of a luxury cruise ship company controlled by one of the country’s wealthiest men but heavily supported by the federal government.

American Classic Voyages Co. and its supporters in the U.S. Senate blame the aftermath of Sept. 11 for forcing it into Chapter 11 bankruptcy. But there is evidence that American Classic, the largest U.S.-flagged cruise ship line, was in trouble well before the terror attacks sent the travel industry into a tailspin.

Thanks to hundreds of millions of dollars in government-backed loans, the bulk of its debt is now the responsibility of the U.S. government rather than the company, its billionaire chairman, Samuel Zell, or the banks that loaned the money.


The U.S. Maritime Administration guaranteed a total of $367 million in loans to help the company build two 1,900-berth cruise liners and several other ships. The luxury liners would have been the first U.S.-built cruise ships in a half century. The company’s bankruptcy petition states that it owes at least $221.5 million on those loans--the likely price to the taxpayers, if rescue attempts fail.

The company dubbed this ambitious effort Project America, and American Classic’s president originally described it as a visionary, “win-win situation for the nation.” It would jump-start the country’s dormant commercial shipbuilding industry, bolster national security and break a near-monopoly of foreign-flagged cruise ships in North America, he said.

The project was launched under a law sponsored by Sen. Daniel K. Inouye (D-Hawaii). The two large cruise ships would be based in Hawaii and financed through a loan-guarantee program backed by Republican Sen. Trent Lott of Mississippi, where the ships would be built.

Today, the money is gone. Neither cruise ship has come in. The company has laid off 2,150 workers. The entire deal is under investigation by the Transportation Department’s inspector general. And critics say it is a case study in pork, politics and public policy gone awry.

“This is a tragedy for our employees, for our passengers,” said Phil Calian, American Classic’s president and chief executive, who is attempting to reorganize the company while operating only its famed Delta Queen Mississippi River cruises. “We truly believed in what we were building.”

The Oct. 19 bankruptcy filing cited the attacks a month earlier as the catalyst: “The tragic events of Sept. 11 dealt a devastating blow to our business that has made it impossible to continue our full operations.”

Indeed, bankruptcies are running at a record-breaking rate this year, according to federal court figures released Tuesday by the American Bankruptcy Institute. Already in the first nine months of the year, 1,437,354 bankruptcies had been filed, a pace that certainly will shatter the previous one-year record of 1,442,549 in 1998.

But analysts blame most of those bankruptcies on America’s overall economic downturn rather than the Sept. 11 attacks, and those familiar with the American Classic case say there were other forces at work.

“American Classic Voyages is an example of a company that was in dire financial condition in the first place,” said Jack Williams, resident scholar at the American Bankruptcy Institute and an expert on admiralty issues and terrorism. “They’re so over-leveraged and so undercapitalized that they’re vulnerable to such catastrophic events.”

Project Finds Senate Sponsor in Inouye

On July 15, 1997, the Senate passed a $247-billion defense spending bill on a 94-4 vote. Buried inside that bill was a provision crafted by Inouye earmarking $250,000 for something called the U.S.-Flag Cruise Ship Pilot Project.

The provision stated that it was seed money “to assist with a pilot project that will facilitate the transfer of commercial-ship shipbuilding technology and expertise to United States yards . . . and enable the operation of a foreign-built cruise ship and two newly constructed cruise ships” between and among the Hawaiian Islands.

The company named to run the pilot project would also win exclusive rights to inter-coastal Hawaiian cruising. The company would have to sign a contract for the new ships within 18 months, take delivery of the first ship by Jan. 1, 2005, and the second by Jan. 1, 2008. The provision also required that the company already be operating an inter-island cruise ship in Hawaii.

Sen. John McCain (R-Ariz.) called it an “egregious example of pork-barrel spending” and introduced an amendment to torpedo it.

After reading key sections aloud, McCain said: “I understand there is only one cruise ship operator in Hawaii that can meet this criteria. Only one. And that operator is being handed a 30-year to 40-year monopoly for his existing business.

“How many times has the U.S. Senate so blatantly set up a monopoly set-aside for any individual or business?”

That business was a subsidiary of American Classic Voyages, a Chicago-based holding company.

The company, with real estate magnate Zell at its helm, had expanded in recent years into the Hawaiian cruise market, buying up a bankrupt cruise line there and making it profitable.

Calian said the company sought Inouye’s help in getting the legislation, which gave it exclusive rights to inter-coastal Hawaiian cruises. That in turn gave it the marketing advantage it needed to attract financing for the new ships through the federal loan-guarantee program for shipbuilding.

American Classic also created a political action committee in 1993 that, through the 1990s, contributed a total of $114,282 to Inouye, Lott and a dozen or so other key House and Senate supporters of the Pilot Project Statute and other pro-ship legislation, Federal Election Commission records show.

In late 1996 and early 1997, the company went to Washington and built “a very strong, cohesive coalition” of political and industrial support for a project American Classic argued would help the company restore a vital American industry, Calian recalled.

“We sat down with leaders of the shipyards, labor and Congress and told them that this was what we wanted,” Calian said. “We explained that it did need the support of the government. Otherwise, it never would have happened.”

The defense spending bill was signed into law by President Clinton in October 1997.

No one paid much attention to McCain’s pessimistic prediction that it was “the beginning of what could turn into a multimillion dollar bailout for a cruise ship line and ships to be constructed by a certain shipyard.”

CEO Pleads His Case on Capitol Hill

On April 29, 1998, American Classic president Calian was back on the Hill, testifying at a hearing on a proposal backed by California’s tourism industry that would permit limited, interport U.S. cruise traffic by foreign-flagged ships.

Under an 1886 law, only U.S.-flagged cruise ships can travel between U.S. ports without an interim stop in a foreign port. And only U.S.-built ships can fly U.S. flags. A change in the law would have been a boon to the California tourist industry, several witnesses testified. To pro-shipbuilding witnesses, that change would hurt U.S. shipyards still further.

To Calian, it meant competition. American Classic owned the only U.S.-built cruise ship still plying the high seas: the S.S. Independence, built by Bethlehem Steel in 1951. And he testified that his company was taking on a great financial risk in Project America, which would use private capital to produce the two U.S.-built cruise ships and prove American industry was up to the task of building its own vessels for the North American cruise market.

Project America “will preserve our shipbuilding industrial base necessary for our national security,” he testified.

“We’re taking business risks attached to this venture. And it will require about a billion dollars of business risk before we find out whether it is profitable and whether there’s a potential to truly get a return on our investment.”

The proposal to waive the 1886 law never became law. And, as it turned out, the biggest risk-takers in Project America would be the U.S. taxpayers.

The Maritime Administration approved the loan guarantees for Project America under a program resurrected by Congress in 1993 to stimulate American commercial shipbuilding. The goal was to create jobs and protect national security. One of the program’s strongest backers has been Lott of Mississippi, the site of Northrop Grumman Corp.’s Ingalls shipyard.

The program promised banks and other institutions that loaned the money to prospective U.S. shipowners and shipbuilders that the government would make good in the event of a default.

The agency already had guaranteed about $4 billion worth of loans for shipbuilding or refurbishing--with only a 3% default rate--before signing on to Project America in March 1999. But the American Classic-Northrop Grumman project was, by far, the biggest ever.

In a series of appropriations approved by Congress in the ensuing years, the administration authorized a total of $1.1 billion in loan guarantees for Project America--87.5% of the ships’ total cost. That was the maximum allowed under the Maritime Guaranteed Loan Program. Also, American Classic raised at least $150 million from private investors through two public stock offerings.

Documents filed recently in federal bankruptcy court in Delaware show that the Maritime Administration also:

* Guaranteed 87.5% of the cost of two river boats American Classic had contracted from a shipyard in Jacksonville, Fla., at $45 million apiece. One of those boats, the Cape May Light, was launched last May. The second, the nearly complete Cape Cod Light, is languishing at a cost of $58,000 a month in maintenance fees at the shipyard.

* Approved at least $24 million in loan guarantees for American Classic to renovate the Independence.

However, the company’s subsidiaries were heading into rough waters.

The December 2000 launch of its newly acquired foreign-built ship, the reflagged Patriot, for a San Francisco to Hawaii cruise was a washout. Hundreds of travel agents were stranded when the ship failed a U.S. Coast Guard inspection in Los Angeles. Some steered their business elsewhere.

A Times travel writer who cruised on the Patriot in February praised the nine-deck vessel as “a great expectation” with a genuine Hawaiian feel when she boarded, but concluded that the cruise “doesn’t live up to its Hawaiian itinerary.”

And when the company canceled several scheduled winter cruises on its newly launched Cape May Light, Florida-based industry analyst Raymond James & Associates said, “Consumer demand for the new Delta Queen brand may be softer than anticipated.”

There were clear signs in the company’s filings with the U.S. Securities and Exchange Commission during the months before the Sept. 11 attacks that American Classic and Project America were in serious financial trouble.

As early as last December, American Classic reported, the company used new government-backed loans to pay other federally guaranteed loans that came due. In July, it had to refinance an additional $50 million in Maritime Administration-guaranteed loans. In August, the company reported an operating loss of $32.4 million for the first six months of this year, compared with $7.5 million in losses during the same period of 2000.

An Aug. 20 report on the company by the Raymond James research firm said the company was short on cash and was a “risky” investment.

Also looming was a prolonged dispute between American Classic and Northrop Grumman over delays and large cost overruns in the cruise ships’ construction.

Eight days after the Sept. 11 attacks, the Maritime Administration and the two companies signed a detailed, six-page agreement settling the conflict. The restructuring agreement extended Northrop Grumman’s delivery dates for the two ships until 2004 and 2005 and required Northrop Grumman and American Classic each to commit more than $40 million in additional capital to cover the cost overruns.

Under the original project agreement, Northrop was merely the contractor; it committed no equity to the ships. The Sept. 19 agreement required the shipyard to pay for part of its own cost overruns.

American Classic filed for bankruptcy on Oct. 19, listing assets of just $37.4 million and a total debt of $547.3 million.

Work on the ships has stopped while the agency and Northrop Grumman wrangle over how to salvage a half-built cruise ship and a billion-dollar project that now appears to have no takers.

“Unfortunately, to date the U.S. Maritime Administration has decided not to continue the guaranteed funding necessary for the construction of the ships. So it is with sincere regret and a deep feeling of disappointment that we discontinue work on this contract,” a Northrop Grumman statement said.

The agency countered that it “previously made a proposal to Northrop Grumman that would have allowed continued [loan-guarantee] funding. The Northrop Grumman Corporation has rejected this proposal.”

Neither side would provide further detail.

McCain Calls for Administration Probe

McCain weighed in again after the bankruptcy in an Oct. 26 letter to the Transportation Department’s inspector general, calling on him to review the Maritime Administration’s handling of the cruise ship project and “determine what immediate actions the Department of Transportation and [the agency] can take to safeguard” taxpayer dollars at risk.

The inspector general’s office recently announced that the probe is underway.

Citing Project America’s problems, McCain also urged the administration to scrap the loan-guarantee shipbuilding program. Mitchell E. Daniels Jr., director of the White House Office of Management and Budget, agreed. He called the program “an unwarranted corporate subsidy” and pledged a zero-budget request for it next year.

Yet the latest appropriation bill that emerged from the House-Senate conference committee in mid-November approved $30 million in shipbuilding loan guarantees in the year ahead.

And in a statement last Thursday, Inouye said he has no regrets over the cruise ship project, referring to it as “a law that I am proud to have championed. . . . Until the terrorist attacks hit American soil, Project America appeared to be working as planned.”

But the government hasn’t come away totally empty-handed.

The government was ordered to take possession of the Independence as the vessel’s secured creditor, under a ruling by U.S. Bankruptcy Judge Erwin I. Katz.

American Classic had asked the court to order the government to take possession of it, because the company still owes the government more than $24 million for the ship’s refurbishing, had no buyer for it and was paying costly maintenance fees.

“The only likely buyer would be for scrap value,” the company told the court. “As such, the debtors estimate the value of the S.S. Independence to be $1 million to $3 million.”


Samuel Zell is also referred to as Sam Zell.

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