The right way, the wrong way, and the Poway of school bond financing

Aug. 8, 2012

By Wayne Lusvardi

Imagine you can get in a time machine and fast-forward to the year 2032 in the Poway Unified School District, the third largest school district in San Diego County.  In that year, $981 million in deferred interest on a $105 million bond for school facility improvements will become due and payable.  That is nearly 10 times what the school district borrowed in 2012.

Imagine paying a $1 million mortgage for your one-bedroom tract home worth only $100,000 in 2012. (Typically, bonds only have to pay double what was borrowed, just like your home mortgage — not 10 times.)

By 2032, nobody can sell their home in the Poway area due to the huge property tax liens on every property.  And the large proportion of over-mortgaged homes — also called “underwater mortgages” — is still depressing home values in 2032 in the Poway area.  The $105 million borrowed in 2012 to improve school buildings stimulated the local economy.  But, by 2032, the Poway economy is now stagnant.  The largest industry is financial-disaster tourism, like in Detroit today.

Poway cannot attract new teachers because their pension plan is broke.  Local churches have had to take over the school system so that the education of a future generation is not lost.  The school board now leases the former renovated school buildings to churches for a dollar a year in rent.

No bond investors will loan funds for any public improvement project in the area, such as repaving roads or repairing broken water pipes. The burden of bond debt is too high for any more debt to be added.

Poway is a local example of present-day Detroit. Detroit still thinks that every Starbucks is an economic jobs multiplier worth $1 million and that corporate bonds for the unionized auto industry will be paid back by some federal bailout.  Poway’s unionized school district is the equivalent of Detroit’s unionized auto industry.

‘Capital appreciation bond’

The mechanism in this future economic disaster is something called a “capital appreciation bond.”  It is the bond equivalent of a “negative amortizing home loan” where the interest owed is just added to the loan principal for 20 years.  A capital appreciation bond is worse than an interest-only loan where the repayment of the principal amount borrowed is deferred to the future in a so-called balloon loan.

In a “capital appreciation bond,” the interest just keeps growing, and both the principal and the interest become due in 20 years. By then, the $105 million originally borrowed by the Poway School District has become $981 million by 2032.  And it won’t be paid off until 2052.

The official statement of Poway’s School Improvement Bond makes no mention that it is a capital appreciation bond and does not disclose the terms and conditions of payment of the bonds.

Capital appreciation bonds are the 2012 equivalent of what “sub-prime loans” were to low-income borrowers and “collateralized mortgage bonds” were to lenders during the Housing Bubble of the last decade. Capital appreciation bonds are highly risky debt instruments for local governments only with tax-exempt bond financing.

The Poway Unified School District has become the local government equivalent to Lehman Bros. or Countrywide Financial.  The bond houses that may fund such debt will become the new Fannie Mae and Freddie Mac.  The California State Debt Advisory Commission has become the new Standard and Poors bond rating firm.  Mark Saladino, the Treasurer-Tax Collector of Los Angeles County, has prepared on open letter warning about capital appreciation bonds.

Poway 2032

In 2032, Poway will have become a public joke.  Hedge funds were the rich man’s way to make money in risky investment markets during the Housing Bubble from 2003 to 2008.  Sub-prime home equity loans were the poor man’s way to make money during the Bubble.

Now, capital appreciation bonds are the “poor community’s” way to borrow its way out of insolvency in the aftermath of that Housing Bubble.  Hence the term: “the right way, the wrong way, and the Poway” or poor way.

In 2012, the Poway school district is betting that future population growth, housing development, and increases in property values will bail out what appears to be an un-payable debt.   The state of Michigan has had to ban school districts from issuing such “capital appreciation bonds” for areas like Detroit ,where the old auto industry economic base collapsed.  But apparently, in the economic disaster zone of California, for local government and public schools there is no such restriction.

What is worse, by 2032 the cancer of capital appreciation bonds may have spread to the gigantic Los Angeles Unified School District.  Seeing what little Poway was able to do, Los Angeles may be tempted to swallow such a poison pill in the hope of curing its financial cancer.

Some 63.9 percent of voters in the Poway area approved a second school improvement bond for $179 million in 2008.  This would not have passed had the two-thirds supermajority vote requirement for taxes under Proposition 13 been in effect. But that was overturned by voters and replaced with a lower 55 percent voter threshold for bond financing of school building improvements.

Ironically, Prop 13 could have prevented the future disaster that the Poway school district is headed for.  But in 2012, teacher’s unions and the Democratic Party erroneously claimed that the money problem that public schools faced was due to Prop 13.

In California circa 2012, there is the right way, the wrong way, and the Poway to bail out debt-laden communities.  Foreclosures, short sales, reformed public pension and health plans, cutbacks of “categorical” jobs and political earmarks, and budget austerity rather than bailouts would be the right way.  The wrong way would have been to continue with the status quo.  But the Poway was to pile more debt on top of existing debt in the hope of a magical self-bailout that can only end in disaster.


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  1. Wayne Lusvardi
    Wayne Lusvardi 8 August, 2012, 14:20

    I should have added that such a financing scheme is ripe for a future declaration of bankruptcy and sticking bondholders with the loss. But what if the bondholders end up owning all those school facilities and the land?

    Reply this comment
  2. Rex The Wonder Dog!
    Rex The Wonder Dog! 8 August, 2012, 14:30

    In a Chpt 9 muni BK there is no selling off of assets. Real property never gets liquidated-it is exempt. Bondholders will get nothing

    Reply this comment
  3. Steve Rider
    Steve Rider 8 August, 2012, 16:44

    A classic example of politicians kicking the problem down the road. By the time the payments start kicking in, the elected officials that setup this deal will be long gone. Literally passing debt to our children. Unfortunately this is all too common.

    Reply this comment
  4. Rex The Wonder Dog!
    Rex The Wonder Dog! 8 August, 2012, 18:32

    The stoopidity of this deal is just mind boggling, even for idiots who work in gov.

    A $105 million deal with $1 billion in interest…..the school board should be recalled, and IMO charged with fraud.

    Reply this comment
  5. Vince Peterson
    Vince Peterson 8 August, 2012, 22:25

    I live in Poway.

    Excellent coverage of this disaster. But I wish in all the coverage reporters would start naming the school board trustees who foisted this debacle on residents.

    The measure was approved by the trustees in November 2007 to be placed on the ballot in Feb 2008. The trustees at that time were: President – Jeff Mangum, trustees Linda Vanderveen, Penny Rantfle, Andy Patapow and Todd Gutschow.

    It is worth noting Jeff Mangum is now running for poway city council. Vanderveen and Patapow are running for reelection to the school board. The only running any of them should be doing is to avoid being tarred and feathered.

    Reply this comment
  6. Mike
    Mike 9 August, 2012, 09:48

    I am a poway resident. I have a two year old! This bill will definitely hit home. I am sure these board members made this deal because they are such real estate experts. They figured poway will definitely grow and absorb these costs… Poway will double in value!!! …. Well I got news for you.. Poway is out of land!! And developing anything is very difficult… Let alone in the high fire zones that they probably see future expansion..And with 30% of poway still underwater on there mortgage I foresee forclosures hold values down for at least another 7 years.. It seems to me chapter 9 needs to happen now!!! Before this high intrest rate spirals out of control and we will be negotiating a intrest rate on 1 billion instead of 150 million…

    Reply this comment
  7. Wayne Lusvardi
    Wayne Lusvardi 9 August, 2012, 12:17

    The boundaries of the Poway School District and the City of Poway are not the same.

    Poway School district has 33,000 students but City of Poway only has about 48,000 population.

    Poway School District serves many surrounding cities and unincorporated areas. Those areas may have more land for future growth and development.

    But this economic recession – it is really a “managed depression – is probably going to last a long while — maybe as long as 2032 for real estate. California’s anti-urban sprawl law – SB 375 – also will divert new development into “blue” coastal cities not inland areas like Poway. So Poway could be stranded with debt.

    Reply this comment
  8. Wayne Lusvardi
    Wayne Lusvardi 9 August, 2012, 12:17

    From Fox Business News:

    The San Diego Unified School district borrowed $164 million up front, but will owe a whopping $1.3 billion at the end of its long-term bond. Oceanside Unified sold a $30 million bond, but will owe nearly ten times as much decades later, $280 million total. And Escondido Union School District likewise borrowed $27 million and will owe $247 million total. The bonds are a “kick the can” move to avoid dinging taxpayers now with higher property taxes. Oh, and the bonds are not callable — they can’t be paid off early or refinanced.

    Reply this comment
  9. Rex The Wonder Dog!
    Rex The Wonder Dog! 9 August, 2012, 14:43

    Lou Dobbs had it on FBC yesterday. Kept calling Pow-way, Poe-way 🙂

    Reply this comment
  10. Chris Cruse
    Chris Cruse 23 August, 2012, 11:13

    Wayne, the people who voted for and have to pay for the bonds are in a SFID (school facilities improvement district). The SFID includes all of the city of Poway and the older housing areas in nearby communities that are not in a Mello-Roos district. These areas are already developed. Poway leaders have repeatedly proclaimed that the city is nearly built out. Census data shows that the City of Poway lost population from 2000-2010. Nevertheless, PUSD projected 5-8% growth in assessed valuation in the SFID for the first seven years after the bond was passed. San Diego County Taxpayers Assoc endorsed the bond measure, even with the wild growth in assessed valuation projections.

    In 2006, before the housing meltdown, Poway had already issued a CAB bond under Prop U. The $3 million bond was due in 2031 and could not be refinanced. Folks in the PSID will have to pay back around $19 million for that. That is more than 6-to-1.
    So PUSD was already doing CAB bonds BEFORE they went back to the voters and asked them to approve the second school bond, Prop C. But they never mentioned the possibility of having to pay back Prop C with CAB bonds to the voter, although now they are saying they told SDCTA that is what they planned to do.

    Reply this comment

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