Sunday, March 17, 2013

California Schools Finance Upgrades by Making the Next Generation Pay -

California Schools Finance Upgrades by Making the Next Generation Pay -

This past week I was at a conference where one of the presentations was on these Capital Appreciation Bonds.  Essentially while these look like zero coupon bonds to investors, they take advantage of accounting loopholes that allow the price appreciation to be catergorized at deferred interest. And hence only the loan amount is reported on financial statements not tHE total amount (debt and interest) is due.

Moreover, these are non callable and at rates which are generally higher than current market rates would suggest. 

 From NY Times:

Since 2007, hundreds of school districts and community colleges across California have used capital appreciation bonds to raise nearly $7 billion for various construction projects, according to data from the state treasurer’s office. The bonds have allowed school districts that are short on cash to finance classroom renovations and new athletic facilities while delaying payment for years, or even decades.

and later:

" And in the most expensive case yet, the Poway Unified School District borrowed $105 million to finish modernizing older school buildings, which local property owners will be paying off until four decades from now at an eventual cost of nearly $1 billion. Because payments on the bond do not start for 20 years, current school board members faced little risk of resistance from property owners."

A few comments:
  1. The PV of these is not as outrageous as the articles lead you to believe.  Yes the borrower has to pay back 10-20 times the amount borrowed, but paying back in future dollars.  This is a cardinal mistake (dollar today does not equal a dollar tomorrow!). 
  2. Genius move to say that the interest accumulates and hence keep it off the balance sheet.  Shaking my head at this one.  Also gets around rules that attempt to limit borrowing as a percentage of assessed valuation etc.  I don't like it as it keeps taxpayers uninformed as to the true amount of their liabilities, but none-the-less I must recognize the creativity and genius to get around the stated rules. 
  3. The accounting rule has to be amended.
  4. It is a near perfect example of future generations having to pay off our debts.   
  5. As general obligation bonds, the school district is not allowed to default.  In the event of a default their will be a special assessment (think tax) that will be used to pay off the loan.  (at the conference the speaker cited examples from the 1930s (Great Depression) where cities closed down and were foreclosed as a result failure to pay off general obligation muni debt.
  6. Look for a more on this coming soon!  (Several large media outlets reportedly doing pieces on this from across the US.)
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