A guy walks into his bank looking for a home improvement loan of $100,000.  That’s no big thing most of the time.  And it’s not an unreasonable amount. 

He sits down with a loan officer.  They discuss his plan.  They discuss his credit worthiness.  And the loan officer tells him that there’s only one way to finance the project.  It will be a loan on which he pays nothing for the first 20 years and then he must pay the principal and interest over a second 20 years.  It’s a total of 40 years.  Oh and by the way, the total of principal and interest payments will be $1,000,000 with no ability to pre-pay.

Should he do it?  Would you do it?  Is this a good deal? 

Well yeah, it’s a good deal for the bank.  And that’s one of the things that is going on these days in some school districts as they look for ways to finance construction projects with school bonds.  Scary.

The Poway, California Unified School District revealed recently (actually, the media got hold of an article written by a Michigan author on the Poway bond and spilled it over onto local newspapers and TV stations) that it is using a bond called “Capital Appreciation Bonds” to complete the renovation of several schools in its district.

Poway’s bond issue will be for $105 million.  The total amount of principal and interest will be $982 million.  When the district starts to repay the bonds in 20 years it will cost nearly $50 million per year in principal and interest to pay off bonds that are 20 years old when the first payment is made.  Think some of those renovated schools will need additional renovation by then?

 source: Voice of San Diego

According to an article in “The Voice of San Diego”, “capital appreciation bonds work by tapping future growth in property values to pay today’s debts, a concept considered by many in the school bond business to be both risky and inequitable.”

When this came to light recently, there were quite a few people in Poway who were understandably upset.

To start making this long story short, the State of California is now looking at an outright ban on CABs and the County Treasurer of Los Angeles County just sent an open letter to school officials in California warning against the use of these bonds.

But Poway is going to have to live with it for 40 years.  School officials in that city have tried to rationalize their use of the CAB as doing what the voters wanted.  However, it is now being revealed that when the bond issue authorization was approved by voters that there was never a mention of the repayment period or the nature of the bonds.  Did the School Board and top administrators mislead the voting public? 

What should these people have done?  How about an honest, straightforward public hearing/meeting/forum in which all the cards were laid face-up on the table?  It seems to me that the school district did a miserable job of communicating with the people who are going to have to pick up the tab.

This is a woeful example of pretty much what is wrong with government at all levels.  Nobody seems to understand that 1) government finance (including bonds) are provided by the taxpayers, 2) government projects are designed to serve and benefit the taxpayers, 3) not informing taxpayers of the true cost of something is the worst form of malfeasance.

In other words these officials forgot whose money they were spending and on whose behalf.  All they had to do was ask them again—tell the public that there were some problems, develop some alternatives and ask for guidance.  That’s not so hard.  Now some elected officials will pay for it by getting tossed out of office by voters, some administrators will probably be leaving soon to “pursue other interests” and the voters will still be left to pick up the tab. 

Seems like everybody loses.  Oops, no the bank and bond holders win.