It’s rarely a good thing when one’s local school district and its finances — in this case the district which has graduated my three children, which employs my wonderful wife as a teacher and which generally has remarkable common purpose — is covered in The New York Times. As the Times reports (in a story broken by a local blog), the Poway Unified School District borrowed money at 6.8 percent tax-exempt despite its Aa2/AA- ratings last year via a bond which provided for no debt service payments for more than two decades. These so-called “capital appreciation bonds,” which raised $105 million in 2011 for needed improvements to district facilities, will require $877 million in interest payments between 2033 and 2051. To make matters worse, the bonds are non-callable; to add call provisions would have added about $100 million in costs due to the higher coupon the bond would be required to offer.
No one should be surprised that the local community is not happy with this turn of events.
In a statement attempting to justify the deal, the district noted that the bond issue was the fifth part of a plan to modernize the 24 oldest schools in the district and argued that while this particular bond “has a total repayment ratio of 9.3 times the principal amount,” the overall borrowing program has a repayment ratio of 4.2 (for every dollar borrowed, $3.20 in interest will be paid). In that context it doesn’t sound so bad overall until one recalls that a typical 30-year mortgage at the same 6.8 percent interest rate would require $1.35 in lifetime interest payments for each dollar borrowed, or a repayment ratio of 2.35 and that a more normal tax-exempt bond deal would have required barely 4 percent in interest payments. Moreover, the district’s statement (and a subsequent presentation at a School Board meeting) skirts the issue of why this particular (and particularly rich) bond was deemed necessary and appropriate. “Our job is to educate these children, to make sure they have a future,” said District Superintendent John Collins, as if that settled the matter.
In California, unlike most of the rest of the country, schools are largely financed at the state level, with only certain construction costs among the things funded locally. What this bond measure means is that someone living in a home with an assessed value (the median market value is closer to $500,000) of $300,000, who currently pays about $165 per year in SFID (School Facility Improvement District)property taxes, will see those taxes rise to $710 per year by 2033 and $842 by 2051. That’s a huge increase.
So what happened? The district seems to have made a Faustian bargain by following the letter of the law (but not the spirit) to achieve what was deemed necessary but unavailable otherwise.
In 2008, voters gave the district permission to borrow more money to finish a modernization plan that had been begun earlier but which was under-funded because (surprise!) it took longer and cost more than expected. It was the “planning fallacy” on full display. But that approval came with a major promise and commitment from the duly elected school board: no tax increases. It was clear at the time that no matter how badly the work was needed (and many of the schools were dreadfully run-down and in desperate need of repair), the electorate would not fix the problems if it meant higher taxes (prior such bond measures were repeatedly voted down). If you think that sounds like our state-wide and federal situation — demands for no tax increases and even tax cuts but no reduction or even an increase in services — you’re onto something, Captain Obvious.
By the time the last of the financings needed to complete the project in 2011 was on tap, it became clear that without increasing taxes, the district couldn’t afford to borrow money conventionally. The creative solution invoked involved these capital appreciation bonds with no clear statement to the voters of what was going on. This bond structure — no payments for over 20 years — means that no new taxes were needed (we’ll see about 2033, when other bonds are paid off but the extremely high debt service on the new bonds goes on-line). The full 2,200-word ballot statement from 2008 makes no mention of capital appreciation bonds and provides little detail about the nature of the financing. The bond measure even received an endorsement from the San Diego County Taxpayers Association, which now regrets having done so and says it was misled.
What we have here is a cautionary tale for these difficult times. The lack of planning that underlies the whole situation is typical but unacceptable. The lack of transparency as well as the lack of full and clear disclosure is shady and disappointing. The willingness to “kick the can down the road” and foist our problems onto future generations is disgusting. But in a political environment where more and more is demanded from government but where tax increases are not permitted, the district’s actions are perfectly understandable while, at the same time, being utterly deplorable.
As I noted earlier today in another context, we need more responsible government at every level. We need a responsible citizenry just as badly. Tragically, neither seems to exist, especially in this instance.
UPDATE (8.27.12): Barry Ritholtz (The Big Picture) added some additional, excellent commentary here.
Above the Market 
This deal makes the subprime mortgage securities issued in the mid-2000’s look stellar. To assume the average assessed value of homes in Poway increase five-fold in 40 years is optimistic at best. I’d like to see the Offering Memorandum to see how much this cost the PUSD in underwriter commissions and costs.
It looks like a terrible deal today, but let’s see how it plays out. It may be that the rubes played it accidentally brilliantly. If we have a period of relatively high and sustained inflation, then real property prices should rise accordingly, and the District will be paying principal and interest in devalued dollars (I didn’t read the offering docs, but I assume the interest rate is fixed). Something like 4-5% inflation could bring the effective interest rate down to a reasonable cost to the District and a more market-oriented yield to the bondholders.
And, of course, the District has the option of not raising taxes in 2033, and making partial or no payments on the bonds (default).
The most interesting piece of information would be the price that those bonds are trading at today — it would give insight into what the market really expects will be paid on the bonds.
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