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Joel Thurtell Shames Poway, CA Financing

Posted by Larry Doyle on August 10, 2012 7:56 AM |

Do not discount the lengths to which some will go to satisfy a perceived current need while screwing future generations with an exorbitant — dare I say usurious — bill.

Just another day atop Capitol Hill, you think? No, for this scandalous behavior let’s navigate to Poway, California where town leaders recently utilized a capital appreciation bond to finance selected school operations.

How do capital appreciation bonds work? Well if you wanted any evidence as to the ignorance of the American public and the willingness of local pols to go to any lengths to feed the pigs then this story truly takes the cake. 

MAJOR credit to Michigan-based blogger Joel Thurtell for breaking this next iteration of Ponzi-style financing a few months back. Thurtell wrote, Disaster Shadows Poway,

I thought Michigan was bad.

Back in 1993, when I was writing about Michigan school debt, I was astonished to find school districts taking on debt with interest costs at two, three and in one case almost six times the amount of principal they borrowed.

But California always does us one better.

Think 575 percent interest is bad?

How about 1000 percent?

The power of compound interest — 2200+ percent interest in 2051!

Slimy as it was, nothing in Michigan approached the level of depravity achieved by the Poway Unified School District in San Diego when it borrowed last year to pay for building renovations, computers, fences, security equipment and other purchases deemed necessary to create an educational showplace.

The vehicle for this enormous debt was an innocuous-sounding financial instrument known as the Capital Appreciation Bond.

In August 2011, Poway issued $105 million of Capital Appreciation Bonds.

For 21 years, no payment is due.

Then, in 2033, the first property taxes will be levied to pay $30.5 million due that year. In 2034, $47 million will come due.

So it goes, with interest approaching and then exceeding $50 million a year until the final payment is due in 2051. By that year, principal will be down to $2.2 million.

The interest due on that small remaining principal, however, will be $55 million.

Total cost of paying off $105 million in CABs?

$981,562,328. (There is ambiguity, though. Another, figure is possible: $1,075,645,000.)

Let’s just round it to a billion smackers.

That is not a misprint: A billion dollars in interest to pay off roughly a hundred million in principal.

Ah, the beauties of compound interest!

It gets even better for investors and underwriters.

And worse for taxpayers.

The last two series of CABs, due to be paid in 2046 and 2051, have interest rates of 1279 percent and 2200 percent.

2200 percent!

It is a wonderful thing for the investors and for the people who perpetrate these financial Frankensteins.

But for the taxpayers of Poway who haven’t dumped their houses and skedaddled, the payback on debt between 2033 and 2051 is a financial time bomb.

School officials assured voters who approved the bonds in 2008 there would be no increase in taxes.

They had their fingers crossed.

The devils who designed this looming disaster are banking on property values in Poway increasing 300 percent by 2033, 350 percent by 2034 and 400 percent by 2051 in order to generate the tax revenue needed to repay the bonds.

Apparently, these geniuses didn’t read about the nationwide dropoff in real estate values.

Why is increasing value so vital to this scheme?

Under California law, the maximum tax rate that can be charged to a piece of property is $60 per $100,000 of assessed valuation. With the rate of taxation capped, the only way the bonds can be repaid is by hoping for huge leaps in property value.

What if values don’t increase by hundreds of percent?

Taxes will go up, after all.

What if homeowners can’t afford to pay?

Or, what if they WON’T pay?

If taxpayers cannot or will not pay those new taxes, there is an option.

It is called default.

MAJOR props to Thurtell for exposing this financing and the shameless behaviors of those in Poway and the underwriters who pushed through this financing.

Poway is not alone in resorting to paying usury to finance current operations. As Will Carless at the Voice of San Diego points out in a commentary run by Pomerado News,

. . .  deals elsewhere in the county mirror Poway’s deal in other ways, too.

The three bond measures, passed in 2008, all made the same promise to voters: Tax rates would stay the same.

San Diego Unified — Borrowed: $164 Million. On the Hook For: $1.25 Billion

Just like Poway, San Diego unified won’t start paying back those bonds for 20 years. The first payment is due in 2030. By the time the loan is fully paid back, in 2050, San Diego taxpayers will have paid back $1.25 billion, or about 7.6 times what the district borrowed in the first place.

Oceanside Unified — Borrowed: $30 Million. On the Hook For: $280 Million

Further north, in Oceanside, the payback ratio for taxpayers is even bigger, though the district’s loan is significantly smaller.

Oceanside Unified borrowed $30 million in 2008. By 2049, the district’s taxpayers will have paid back almost $280 million. That’s more than nine times what they originally borrowed.

Escondido Union — Borrowed: $27 Million. On the Hook For: $247 Million

Escondido Union School District has a similar deal.

The district borrowed almost $27 million in 2009 using capital appreciation bonds. Taxpayers in the district will pay back almost $247 million by the time that debt is paid. Again, that’s more than nine times the initial debt.

I am not often left short for words but what has this country come to when situations such as these occur.

Great job by Thurtell and Carless for bringing real light into this dark corner of municipal finance.

Perhaps somebody from the SEC may care to pay a visit to the folks at Government Financial Strategies  who were involved in the underwriting of the CAB utilized by El Dorado County, CA.

Look for Joel on The Road on the Sense on Cents blogroll.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.


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