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Say you’re a school district in California and you want to spruce up your buildings and facilities. You know voters won’t go for new taxes, so how about this: I loan you $100 million now, and you don’t have to start paying me back for 20 years. Not bad, right? But what if you’ll have to pay me $1 billion in interest during the following 20 years. By 2052, that works out to the equivalent of a tenfold markup.
That’s exactly what a handful of California school districts have done as they scramble for ways to overcome the hit to tax revenue caused by falling home values. In the process, they’re saddling a future generation (or two) with massive bills. Since May 2011, 11 California school districts have issued bonds that mature in 40 years, the maximum allowed under state law, according to an analysis by James Nash of Bloomberg News.
To understand how this type of municipal debt works, let’s zero in on the Poway Unified School District, whose $105 million issue was exposed in an Aug. 9 investigation by the Voice of San Diego, a nonprofit news organization. As writer Will Carless reports:
In 20 years, the school district will be on the hook for its first payment towards last year’s loan. That payment will be a little more than $30 million, $24 million of which is interest. The following year, the payment will balloon to almost $47 million. And, for the next 18 years after that, until 2051, district taxpayers will have to pay about $50 million every year towards the debt—essentially paying off their initial loan every two years for the next two decades.
The district says it had to borrow to uphold a 2008 pledge that it wouldn’t increase taxes to pay for construction cost overruns. It says depressed property taxes wouldn’t be enough to fund a regular bond, which traditionally have lower rates and shorter terms. (Carless reports that with regular bonds, schools typically pay back two or three times as much as they borrow.)
The State of Michigan in 1994 outlawed the type of bonds Poway issued because of their high cost. Dodd-Frank financial reforms in 2010 were supposed to provide new protections to help municipalities from getting into rotten deals. In particular, the law said the advisers hired by cities should have a “fiduciary duty” to put taxpayer interests ahead of their own. But it’s been two years since Dodd-Frank passed, and the reforms are languishing amid pushback by the industry.
This November, California voters will have to choose between property tax increases or $5.5 billion in education cuts—a vote University of California President Mark Yudof calls a “defining moment” for the state. With even deeper cuts, more creative and risky deals like Poway could be even more in demand.