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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

ISN’T IT TIME to subscribe to all my work via e-mail, an RSS feed, on Twitter or Facebook?

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.


  • fred


    Beyond the absurdity, how does this deal get done?
    Property taxes are capped and histortic LT residential real estate appreciation is 4-6%. The math doesn’t add up!
    Who would buy these bonds and why?

    As far as the current residents of the town, shame on them.
    The current homeowners must be counting on selling their homes after their children are educated to unsuspecting new buyers. Doesn’t current RE law only require disclosure of property taxes due in the year of the sale?

    Maybe a lien should be attached to the property in the amount of the time value of the bond outstanding?

    LD, please tell me there’s no way the liability can become an American taxpayer liability or find its way onto the Feds balance sheet.

    I am also very concerned that some of the CA (among other), creative state budget “funding choices” may lead to more “prisoner dilemas” with the rest of us states/citizens acting as “unsuspecting mules”.

    This situation doesn’t even come close to passing the SOS truth, transparency and integrity smell test!

  • LD


    In reviewing some red herrings on these deals I saw that the bonds had $5,000 denominations. What does that tell us? The bonds were marketed to Mom and Pop. A scam truly on both ends.

    Yes, a lien should be placed on the properties so future homeowners are fully aware as to what they are facing.

    Do not doubt that the socialist state that is the left coast of our country now may/will make its way eastward if/when certain politicos sell their souls for the votes of those playing these scams.

    Better to call for California to establish its own sovereignty than the rest of us getting stuck picking up these tabs.

  • Bill

    What is the annual ROI on these things? I bet the bonds were approved in a special election.

  • David

    Is not there some standard of “reasonableness” that should be in place here, such as a reasonable expectation that the loan can be paid back without “pie in the sky” projections for property values in place (e.g., CalPers anticipated returns for the State of California’s, now unfunded pension liabilities).

    I know that after the meltdown there was much talk about the concept of reasonableness in mortgage lending. This seems pretty egregious and another example of so many people being asleep at the wheel.

  • Jeff Brown

    This is moronic on its face, if not approaching criminal negligence. However, I’m a bit confused on the real estate tax rate quoted. The now famous Prop 13, which back in 1978 established (as a state constitutional amendment) that with stated exceptions, the tax rate was not to exceed 1% of assessed valuation. That would put the taxes, expressed in dollars, at $1,000 per $100,000 of value assessed.

    Furthermore, as any San Diego homeowner will attest, the typical tax rate on their home’s value runs around 1.1-1.5% or so.

    What am I missing here? Much thanks for the post.

  • Gamma

    Thanks Larry.

    I need more facts on this one.

    Issuing a 40 year zero-coupon bond with a face of 1 billion for ten points is not in isolation a usurious deal – the effective annual rate is less than 6% I think.

    The wrinkle of a few interim payments and the math on just the final year in isolation make it seem odd, but I think the real question is what policies the issuer has in place to discipline itself to sock away money during those 40 years.

    A municipality operating reasonably to take 10 million or so per year of tax revenue and put it away in treasuries or other prerefunding vehicles earning a bit more than 4% would be able to pay this off easily in this example.

    I have not read the offering docs, but if the issuer truly is not putting away anything until the day of reckoning then there is indeed a problem. It does sound like they misrepresented things if they told folks that taxes would not be increased ever – at some point if you borrow you need to come up with money to pay it back.

    Borrowing more will increase taxes by definition (unless you put the money into something yielding more, and you don’t get clipped on yield curve or other basis risks), so investors in these bonds and the public should not be misled.

    I would like to see more investigative reporting about how muni treasurers get their jobs, put deals up for bid, and track bond payment streams versus incoming tax revenue. I am sure that where there is smoke there is fire (Jefferson county, Alabama, etc.), it’s just that I just can’t see through the smoke right now on this particular example and need more facts besides the math. 🙂

    Thanks as always.

  • fred


    You can’t go wrong by suggesting a closer inspection of the terms and conditions but I am not as willing to extend “the benefit of the doubt”.

    1. I don’t argue with your math but long term Treasuries are now yielding 2.5%, one of the rating agencies would have to slap a triple A rating on junk (securitized CABs anyone?) to make it investment grade and achieve your target return; so even if you assume adequate funding of reserves (how many public pensions are fully funded now?), necessary returns will probably lag.

    2. The majority of the proceeds are being invested in capital items with a useful life under 20 years whereas the bond matures in 40+ years, substantial further investment will be required just to “maintain the value of the asset”.
    Where will this money come from?

    Housing affordability, a necessary component of price appreciation, requires a) rising household income and b) declining interest rates. Given the current condition of the economy and ZIRP, future housing appreciation will probably lag necessary return projections as well.

    I don’t know Gamma, this seems to be just another example of town administrators “kicking the can down the road” to avoid making the tough decisions.

    Caveat Emptor!

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