Mission & Name
US Foreign Policy (Dr. El-Najjar's Articles)
Swimming With the Sharks:
School Districts, and Capital Appreciation Bonds
By Ellen Brown
Al-Jazeerah, CCUN, February
The fliers touted new ballfields,
science labs and modern classrooms. They didn't mention the
crushing debt or the investment bank that stood to make
Melody Peterson, Orange County Register, February 15, 2013
Remember when Goldman Sachs –
dubbed by Matt Taibbi the Vampire Squid –
sold derivatives to Greece so the government could conceal its debt,
then bet against that debt, driving it up? It seems that the ubiquitous
investment bank has also put the squeeze on California and its school
districts. Not that Goldman was alone in this; but the unscrupulous
practices of the bank once called the
of the municipal bond business epitomize the culture of greed that has
ensnared students and future generations in unrepayable debt.
after collecting millions of dollars in fees to help California sell its
bonds, Goldman urged its bigger clients to place investment bets against
those bonds, in order to profit from a financial crisis that was sparked in
the first place by irresponsible Wall Street speculation. Alarmed California
officials warned that these short sales would jeopardize the state’s bond
rating and drive up interest rates. But that result also served Goldman,
which had sold credit default swaps on the bonds, since the price of the
swaps rose along with the risk of default.
In 2009, the lenders’
lobbying group than proposed and promoted AB1388, a California bill
eliminating the debt ceiling requirement on long-term debt for school
districts. After it passed,
bankers traveled all over the state pushing something called “capital
appreciation bonds” (CABs) as a tool to vault over legal debt limits. (Think
Greece again.) Also called payday loans for school districts, CABs have now
been issued by
more than 400 California districts, some with repayment obligations of
up to 20 times the principal advanced (or 2000%).
controversial bonds came under increased scrutiny in August 2012, following
a report that San Diego County’s Poway Unified would have to pay $982
million for a $105 million CAB it issued. Goldman Sachs made $1.6 million on
a single capital appreciation deal with the San Diego Unified School
Green Light to Exploit
In a September 2013 op-ed
in SFGate.com called “School
Bonds Are a Wall Street Scam,” attorney Nanci Nishimura wrote:
. . AB1388, signed by then-Gov. Arnold Schwarzenegger in 2009, [gave] 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. . . .
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. [State Treasurer] 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
Gullible school districts agreed to these
payday-like loans because they needed the facilities, the voters would not
agree to higher taxes, and state educational funding was exhausted. School
districts wound up sporting shiny new gymnasiums and auditoriums while they
were cutting back on teachers and increasing classroom sizes. (AB1388 covers
only long-term capital improvements, not daily operating expenses.) The
folly of the bonds was reminiscent of those boondoggles pushed on Third
World countries by the World Bank and IMF, trapping them under a mountain of
debt that continued to compound decades later.
The Federal Reserve
could have made virtually-interest-free loans available to local governments,
as it did for banks. But the Fed (whose twelve branches are 100% owned by
private banks) declined. As noted by
Cate Long on Reuters:
The Fed has said that it will not buy muni
bonds or lend directly to states or municipal issuers. But be sure if yields
rise high enough Merrill Lynch, Goldman Sachs and JP Morgan will be standing
ready to “save” these issuers. There is no “lender of last resort” for
Debt for the Next Generation
Among the hundreds of
California school districts signing up for CABs were
fifteen in Orange County. The Anaheim-based Savanna School District took
on the costliest of these bonds, issuing $239,721 in CABs in 2009 for which
it will have to repay $3.6 million by the final maturity date in 2034. That
works out to $15 for every $1 borrowed.
Santa Ana Unified issued $34.8
million in CABs in 2011. It will have to repay $305.5 million by the
maturity date in 2047, or $9.76 for every dollar borrowed.
Placentia-Yorba Linda Unified issued $22.1 million in capital appreciation
bonds in 2011. It will have to repay $281 million by the maturity date in
2049, or $12.73 for every dollar borrowed.
California finally passed a law limiting debt service on CABs to four
times principal, and limiting their maturity to a maximum of 25 years. But
the bill is not retroactive. In several decades, the 400 cities that have
been drawn into these shark-infested waters could be facing municipal
bankruptcy – for capital “improvements” that will by then be obsolete and
need to be replaced.
Then-State Treasurer Bill Lockyer
called the bonds "debt for the next generation.” But
some economists argue that it is a transfer of wealth, not between
generations, but between classes – from the poor to the rich. Capital
investments were once funded with property taxes, particularly those paid by
wealthy homeowners and corporations. But California’s property tax receipts
slashed by Proposition 13 and the housing crisis, forcing school costs
to be borne by middle-class households and the students themselves.
The same kind of funding shift has occurred in college education nationally.
Tuition at public universities and colleges was at one time free. But in
successive economic downturns, states have made up for shortfalls in
educational budgets by raising tuition. By 2012, tuition was covering 44% of
the operating expenses of public higher education. According to
a March 2014 report by Demos, 7 out of 10 college seniors now borrow,
and their average debt on graduation is over $29,000. The result
nationally is a student debt that has grown to $1.5 trillion.
State that Escaped: North Dakota
According to Demos, per-student
funding has been slashed since 2008 in every state but one – the indomitable
North Dakota. What is so different about that state? Some commentators
credit the oil boom, but other states with oil have not fared so well. And
did not actually hit in North Dakota until 2010. The budget of every
state but North Dakota had already slipped into the red by the spring of
One thing that does single the state out is that North Dakota
alone has its own depository bank. The state-owned Bank of North Dakota
(BND) was making 1% loans to school districts even in December 2014, when
global oil prices had dropped by half. That month,
the BND granted a $10 million construction loan to McKenzie County
Public School No. 1, at an interest rate of 1% payable over 20 years. Over
the life of the loan, that works out to $.20 in simple interest or $.22 in
compound interest for every $1 borrowed. Compare that to the $15 owed for
every dollar borrowed by Anaheim’s Savanna School District or the $10 owed
for every dollar borrowed by Santa Ana Unified.
How can the BND
afford to make these very low interest loans and still turn a profit? The
answer is that
its costs are very low. It has no exorbitantly-paid executives; pays no
bonuses, fees, or commissions; pays no dividends to private shareholders;
and has low borrowing costs. It does not need to advertise for depositors
(it has a captive deposit base in the state itself) or for borrowers (it is
a wholesale bank that partners with local banks, which find the borrowers).
The BND also has no losses from derivative trades gone wrong. It engages in
old-fashioned conservative banking and does not speculate in derivatives.
Unlike the vampire squids of Wall Street, it is not motivated to maximize
its bottom line in a predatory way. Its mandate is simply to serve the
North Dakota currently has a population of about
740,000, or the size of Santa Ana and Anaheim combined. If a coalition of
several such cities were to form a municipally-owned bank, they too could
have their own low-cost capital funding mechanism, allowing them to escape
the budget-sucking tentacles of Wall Street’s vampire squids.
Ellen Brown is an attorney, founder of the Public
Banking Institute, and author of twelve books including the
best-selling Web of Debt. Her latest
book, The Public Bank Solution,
explores successful public banking models historically and globally. Her
blog articles (nearly 300) are at EllenBrown.com.
Share this article with your facebook friends