From the San Francisco Chronicle:
School bonds are a Wall Street scam
Nanci E. Nishimura
Updated 8:05 pm, Friday, September 6, 2013
Our children and grandchildren are the unwitting hostages of massive future debt from an exotic bond scheme promoted by Wall Street as a way to build schools that is really a financial scam.
These "capital appreciation bonds" will have a devastating impact on our children's financial future. They were part of AB1388, signed by then-Gov. Arnold Schwarzenegger in 2009, giving banks the green light to lure California school boards into issuing bonds to raise quick money to build schools.
Unlike conventional bonds that have to be paid off on a regular basis, the bonds approved in AB1388 relaxed regulatory safeguards and allowed them to be paid back 25 to 40 years in the future. The problem is that from the time the bonds are issued until payment is due, interest accrues and compounds at exorbitant rates, requiring a balloon payment in the millions of dollars. According to state Treasurer Bill Lockyer, these bonds represent "debt for the next generation."
This kind of bond has been outlawed by a number of states, including Michigan and Ohio, but California was identified by Wall Street banks as a source of potential profits in the millions. Several grand jury investigations warned school officials against these scams.
According to a recent San Mateo County grand jury report, the bonds have been issued in California to raise more than $500 billion - but the estimated future repayment of that debt will total more than $2 trillion.
School and community college districts issued 98 percent of all capital appreciation bonds. For example, San Mateo Union High School District raised $190 million, which will result in approximately $1 billion in debt. In San Diego County, Poway Unified School District raised $105 million which will result in approximately $1 billion in debt.
The Los Angeles Times reported that more that 200 California school and community college districts issuing these bonds will end up paying 10 to 20 times more than they borrowed.
Worse, because 70 percent of the bonds have terms of 30 to 40 years, payment will not be due until after the useful life of the school facilities built with the bond funds. Moreover, the property taxes that will be needed to pay off the debt is based on wild assumptions that property values will increase exponentially.
According to many reports, property owners who never voted for these bonds will have to pay for them.
The legality of this kind of bond was questioned in January 2009, when Attorney General (now Gov.) Jerry Brown declared that financing methods that result in taxpayers being charged higher interest rates than the actual market rate for the financing method, such as bonds, violates state law.
Brown was referring to the cash-out refunding method, similar to this bond scheme, used to raise construction funds beyond the amount approved by voters. In May 2011, relying on the attorney general's opinion, the Los Angeles city treasurer warned Los Angeles County school districts against these Wall Street scams. By January 2012, Lockyer and state schools chief Tom Torlakson had warned school districts and called for a moratorium on using the bonds.
In May of this year, a San Diego County grand jury found that by using the bonds, the Poway School District was "not acting consistent with statutory law, and incurring debt beyond what the voters authorized in violation of the California Constitution."
Many California school administrators were not even aware they approved these bonds, nor did they know the cost. California Watch quoted Lockyer noting incredulously that when school administrators authorized the original issuance of the bonds, "there were blanks where the interest rate amount was to be determined someday."
Wall Street exploited the school boards' lack of business acumen and proposed the bonds as blank checks written against taxpayers' pocketbooks. One school administrator described a Wall Street meeting to discuss the system as like "swimming with the big sharks."
Wall Street has preyed on these school boards because of the millions of dollars in commissions. Banks, financial advisers and credit rating firms have billed California public entities almost $400 million since 2007. Lockyer described this as "part of the 'new' Wall Street," which "has done this kind of thing on the private investor side for years, then the housing market and now its public entities."
State records show that Piper Jaffray has brokered 165 of such bonds since 2008, earning $31.4 million, and that Goldman Sachs earned $1.6 million on a single deal with the San Diego Unified School District. Lockyer told the Los Angeles Times that "the only people these deals benefit are the financial advisers, who have collected millions of dollars helping school districts sell capital appreciation bonds."
In response to the crisis created by these bonds, Sacramento is seeking to limit their abuse with bills to cap the debt service ratio at 4-1; to allow school districts to begin paying down the principal after 10 years; to notify the public and analyze the proposed bond; and to limit the length of repayment at 25 years. The lobbying by Wall Street against these regulations is very aggressive.
Holding our children and grandchildren hostage to mountains of debt to offset present financial needs is irresponsible and reprehensible. Sacramento has to enact laws to stop school administrators from falling prey to Wall Street. Elected officials must show up, stand up and stop the perpetuation of financial scams. If not, our children will be looking at bankrupt cities like Detroit in every county in California.
Nanci Nishimura is a partner at Cotchett, Pitre & McCarthy law firm in San Mateo. She specializes in public financial frauds. Stewart Pollock provided research and assistance.
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