“This is way worse than loan sharking. And Poway is the poster child. What they have done is absolutely insane.”

-Michael Turnipseed, executive director of the Kern County Taxpayers Association



Once again, a group of rubes got rolled by The Street.

The latest suckers to get taken by three card monte? The Poway Unified School District, which despite a good credit rating, will pay tax-exempt interest of 6.8% through a complex Wall Street originated exotic loan offering — no payments for 20 years!

Had the district done a straight up school bond offering, it would have paid 4.1%.  That interest rate differential is enormous over the 40 years or so the $105 million borrowing covers: About $300 million for the normal bond offering versus a billion for the exotic version.

Even worse, the motivation for this absurdity seems to be the district’s desire to avoid tax increases. It is yet another attempt at a free lunch. The district thought that the Street would help them come up with “creative financing” to resolve their budget woes. Another attempt at lead into gold!

Below are the bullet points of my rules that are should be basic guidelines for dealing with Wall Street. Poway seems to have violated about half of them:

1. Reward is ALWAYS relative to Risk
2. Overly Optimistic Assumptions
3. Legal Docs protect the preparer (and its firm), not you
4. Asymmetrical Information
5. Motivation
6. Performance
7. Shareholder obligation
8. Other People’s Money (OPM)
9. Zero Sum Game
10. Keep it Simple, Stupid (KISS)
11. Counter-Parties
12. Reputational Risk
13. New Products & Services
14. Lawyer Up
15. There is no free lunch

Full details are here.



15 Inviolable Rules for Dealing with Wall Street (October 25th, 2010)

 See also:
Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools (Voice of San Diego)

Schools Pass Debt to the Next Generation (NYT)

A Cautionary Tale for our Times


Category: Fixed Income/Interest Rates, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

23 Responses to “When Will They Learn, Version 47”

  1. [...] Barry: No such thing as a free lunch, school bond edition.  (TBP) [...]

  2. bgad says:

    The real blame for this lies with those in control in Poway. 20 years from now, the only people who will live in this district will either be too ignorant to find about the liability that they are buying into or too poor to worry about it.
    Secondarily, the Junk Muni funds, who can be the only consumers for this issue, should share in the blame. They will buy these bonds in order to juice the “return” in their funds all the while realizing that the bonds are unlikely to ever be refunded. The Funds assume that they probably won’t even be in existence in 20 years. The Suckers who buy into the Fund for it’s high “return” will never know that these bonds are buried somewhere within it!

  3. NoKidding says:

    IBGYBG for both parties that signed the paperwork. THe town will go bankrupt.

  4. Dima says:

    When will who learn? The parties that signed and agreed to this have already learned that the best way to make a killing is to fleece the institutions. They knew exactly what they were doing and made a handsome profit while doing it.

    The only people who have not learned are the taxpayers and bond fund investors who do not understand that you can never trust a government official or Wall Street Financier. There’s a sucker born every day. They eventually get wise, but only after being fleeced.

  5. Orange14 says:

    LOL. I grew up in San Diego and remember when Poway was just a bunch of scrub brush on some hills. FWIW, my late father’s architectural firm designed the first high school in the Poway school district along with a number of elementary and a couple of junior high schools! The origin of this problem goes back a lot of years to the 1960s when voters began to routinely vote down school bond issues. It became more acute with the passage of Proposition 13 in 1978 which put a cap on local property taxes from which school systems derive their funding (as do a lot of other local services). This forced the school districts to be more ‘creative’ in seeking funding for projects or to do more with less money (e.g., increase class size, skimp on maintenance, etc.). Even if the school district ‘wanted’ to increase taxes, they cannot. I agree that from a lot of perspectives this is just a very dangerous bond issue and the piper will be paid.

  6. rpseawright says:

    Thanks for both the link and the analysis, Barry. Orange14′s point is a good one. The repairs were badly needed but no bond measure would pass if it increased taxes (prior such measures failed). That doesn’t excuse the duplicity and bad judgment, of course. I suspect that the current school board will decide to spend more time with their families when they come up for reelection (now that the damage is done).

  7. franklin411 says:

    Conservative formula for governance:

    1. Borrow tons of money to finance low taxes w/o denying your kids public services
    2. The bill comes due 20 years later, but by then you and yours will have moved to a new area. The new residents will probably be non-whites
    3. Blame “lazy welfare rat” non-whites for “running up a huge tab,” claim they don’t deserve a public education, and form Tea Party hate groups to defeat any attempt to fix the problem

    At least, that’s how it has worked in California since 1980.

  8. [...] (8.27.12): Barry Ritholtz (The Big Picture) added some additional, excellent commentary here. Share this:TwitterFacebookLike this:LikeBe the first to like [...]

  9. NoKidding says:

    Yes franklin, clearly the central issue in this story is race.

  10. AnnaLee says:

    Since I have this mental picture of Americans always thinking there is a free lunch, I cannot help wondering – Does the average American see bankruptcy of their governments more palatable than taxes? If so, do they see nothing that they, themselves lose? Perhaps the American people would like for all the country, including institutions, to default and start over at zero owed, zero collected, full employment, free services, etc. I have an idea, why not free breakfast and dinner too?

  11. BITFU Search Engine says:

    A little context brought to you by BITFU, the best political search engine on the planet. [Yeah, I’m biased. Plus it helps that we’re the only political search engine.]

    The Voice of San Diego is credited with breaking the story here: http://bit.ly/TiSFp4

    Here’s a story by the same publication back in May (before the story broke) highlighting the “new spirit of cooperation between the Poway Teachers’ Union and the School District”. It borders on pornography as it trumpets the intercourse between two competing interests, fleecing the taxpayers in the name of “working together”. http://bit.ly/PjK4WC [Freaking hilarious. I'm surprised that the Voice of San Diego still links to this May article, as it's kind of embarrassing, but very revealing nonetheless.]

    Most of the commentary on the actual bond rip-off (as opposed to straight reporting) comes mainly from Right of center sites. The returns of the search “Poway Unified School District” on Left-oriented sites are sparse. They aren’t interested, or they don’t want to criticize a union and the School District (which is run by Dems, even though the City is largely Repub). [In fact, most of the coverage of Poway deals with the fact that the Colorado shooter went to school in the Poway District.]

    But here’s an under-reported aspect of the story sure to put a damper on the Union-Loathing Right: As the Voice of San Diego notes in the most recent coverage: “This time, Poway Unified didn’t try to push a tax increase. Instead, it came up with a different way to pay for its new bond program, Proposition C.”

    Now, do a little investigating of Proposition C in San Diego and you get this gem contributed by a reader of the San Diego Reader lamenting Proposition C….back in 2010 http://bit.ly/NRwTvM

    Proposition C wasn’t some Union-bloated monstrosity. Rather, it was an initiative for Developers who pushed hard for this, because Prop C meant they could accelerate all sorts of development projects. Here’s the kicker quote:

    So now “the people” and by people I mean the developers are whining that the infrastructure wont be in place for another 10 years so no new homes can be built until then.

    They are throwing the “elementary school” and “library” word out there to get you hooked. Everyone likes elementary schools and libraries and the developers are going to build them out of the kindness of their hearts with their money.

    Don’t be fooled. This Proposition is nothing but a greenlight for developers to develop this area into oblivion

    Obviously, nothing here invalidates anything Barry has written on the subject…and I apologize for the length. I’ve added it as a comment because it’s fascinating (and disgusting) to actually witness the process of crony capitalism, as opposed to just the result.

  12. socaljoe says:

    California has some of the most expensive real estate and highest real estate taxes in the country. Tax revenue should be a problem. Maybe more of the revenue should be spent on actually providing education, including facilities, instead of early and lucrative retirement.


    BR: California has not kept pace with tax revenue relative to their spending
    (I don’t know what “early and lucrative retirement” means in the context of this post)

  13. VennData says:

    The legacy of Prop 13 strikes again. …and at the Federal level half of the electorate is still of the belief in the Reagan free lunch of supply side tax cuts bringing in more revenue.

  14. howardoark says:

    Whether it was smart or dumb really depends on inflation and the rate of conversion of debt in old dollars into debt in new dollars. Given that government at all levels is living way past its means, cash in circulation will probably be converted at some small fraction (X old dollars for every new dollar). I suspect that debt owed to public pension funds may be exchanged at a much lower rate (say .01X old dollars of debt for every new dollar of debt – as a matter of public policy to keep the retired public servants living in a manner they’re accustomed to). Private bond holders will change at the X:1 rate. So, if Potway sold the bonds to Calpers, they might be screwed, but if they sold it to Goldman Sachs or your 401(k) they may do ok.

    Or we could have 3% deflation for 40 years in which case they’re probably screwed so bad it won’t matter. But they’re not betting that way.


    BR: So you think its appropriate for a school district to roll the dice on future inflation rates, rather than take the sure thing of lower bond costs . . . ?

  15. donna says:

    I’ve lived in Poway for over 25 years. We moved here in part because of the reputation of the school district. Having gone through the incredibly difficult challenge of getting school bonds passed in Poway, I do understand the board’s frustration, but — yeah, this was ridiculous. It took us about seven years to get the last school bond passed, though. Funny that our housing prices are so high because of the great school district, but people never wanted to pay for them. And now the quality of the education is declining as well. I’m really glad my kids are already through the schools here.

    A lot of the problem is the city of Poway itself and the school district do not coincide — the school district includes Poway, unincorporated areas of the county, and areas of the city of San Diego. Both the city and the district have their problems. We have a large number of people who live here who do not have kids in the schools and so do not support the schools. But they have benefitted from the schools in higher housing prices, and yet don’t want to contribute to something that has held up their home prices even through the housing crisis. It’s sad, really. I’m glad my kids did get to benefit from their education here, but very ready to move on from the area since the politics have become so bad here.

  16. hard to eradicate says:

    Long time reader (several years)….first time poster (so forgive the spelling and grammar).

    Like Donna, I actually live in Poway (the city)….my children go to school in the aforementioned Poway school district (which actually covers Poway and a pretty big piece of the north side of the city of San Diego). The Poway School district is noted in the area for being a pretty decent set of schools. In fact, when we moved to the San Diego area back in 2000, the school district was one of the major reasons we chose to live in Poway.

    This story broke here in Poway a couple of weeks ago. It’s truly remarkable to see this play out before our very eyes. The district (and the property owners in the district) are going to pay ~$900M in interest to borrow ~$100M. Unfortunately that is not a typo. Let it sink in for a minute.

    Apparently several other districts in the area (including the San Diego school district as well as two neighboring districts in Escondido and Oceanside) have done the same type of bond issue recently. I suspect there is a group of financial advisors/consultants that have been dragging this type of proposal around to all of the SoCal area school districts trying to profit off of the fears/uncertainties/doubts that many districts are having with their future budgets and the current CA state budget woes…..and they got a few to bite.

    While Barry points out the truly egregious interest rates that we will be paying (well at least the property owners still remaining in the district 20 years from now …. fortunately our children will be done here in a few years so “we” may just move out of the district) those rates are only the start. The real kicker is we can’t even pay off the bonds early. Somehow our district and their representation agreed to issue non-callable / non-refinanceable (sp?) bonds. Something that is nearly standard in most home mortgages, they agreed to forego. It makes me wonder if the board is buying some of the bonds themselves? It’s such an unbelievably good deal….nearly 7% annual return with the muni-bond tax shelter. I certainly wish they would have offered me some of these bonds. I’d even have given them a little hometown discount for since they doing me the service of educating my kids (although I may send them somewhere else to learn personal finance).

    While I appreciate Barry’s list for dealing with Wall St….I personally think our board wasn’t suckered….they suckered the property owners. I suspect that they were worried that if they did a straight up bond offering that required them to raise taxes in the near future, they would have been voted out. Maybe we should have a list of bullet points for public servants with fiduciary duties? I’d start with bullet number 8 and repeat it 14 times….number 15 is a good one to keep too.

  17. bgad says:

    To Hard to Eradicate—- Why in the world would you buy these bonds? Yes, they theoretically will pay 6% interest in the future but not for 20 years! And why do you think that they will ever pay a penny? Both you and Donna before you, have said that you will probably move out of the district because of the tax rates that you know will be necessary to pay off these bonds. Don’t you think that most of the other residents will do the same especially when you and other start to move? I doubt that anyone new will voluntarily move into this district if they find out about this time bomb. It seems to me that there is virtually NO chance that these bonds will ever pay a penny.

  18. [...] Ritholtz of The Big Picture wrote a nice follow-up this morning linking my post and emphasizing that, once again, “a group of rubes got rolled [...]

  19. hard to eradicate says:

    bgad…i agree that the numbers are sort of stunning, but i think these bonds will get paid. i’m no financial whiz on the fixed income side, but from my scratching, and some estimates that i’ve seen …to service the interest payments it looks like it will end up being an extra couple hundred dollars per $100K of valuation for the property owners. i’m sure there is a lot of other math involved…i haven’t read the prospectus….. but if those numbers are sort of accurate, then i think they are doable and they would generate a great return. that plus they are general obligation bonds so i don’t think there is a lot of risk here (i thought i saw a quote from our county tax assessor saying he —- or whomever would be the assessor at that time —- would be legally obligated to make sure they were paid). i’m sure there is more to it than that with all of the CA tax laws, and i’m sure there are unforeseen risks (we are talking about 20 years until the first payments are made)…..but i don’t think we are talking about insolvency for the district. we are just paying a lot more than we probably needed to……just my $.02.

    that plus the inequity of forcing the property owners 20 years in the future to pony up for facilities that are already 20 years old…..i don’t get how this is a model of fiduciary responsibility. but all indications are that the horse has left the barn…..and we are left to argue about who left the door open.

  20. rpseawright says:

    hard to eradicate – For a home assessed at $300,000, the monthly contribution to the annual levy would go from $5.04 to $74.49 over the life of the bond. More at the link below.


  21. Marc P says:

    BR, I suggest not jumping to the conclusion that the politicians got “rolled.”

    Maybe they knew exactly what they were doing. They didn’t want payments to hit the budget on their cash-based accounting system so the politicians paid a premium to avoid that result.

    Maybe the problem is that government accounting is a joke. Local governments don’t report a full balance sheet and do their best to avoid clearly reporting the increase in debt each year. What happened in Poway is no different than underfunding pensions and getting some “expert” to opine that 8% is the expected portfolio return over the next 30 years. Or getting the firefighters union to accept a pay freeze by agreeing to pay retirement benefits of 80% of salary rather than 75%.

    Politicians make careers of manipulating the finances (and hiding them) for their short term goals while ignoring the problems they foist upon their children. If it waddles like a sociopath and quacks like a sociopath…

    Business would do the same things if they could, but it’s criminal. Who was the presidential candidate who said that if he ran his company the way Congress runs the government, he would be in jail?

    Let’s fix governmental accounting.


    BR: So they work hand in glove with the Street to hide liabilities from taxpayers? Sounds very Greek like

  22. Marc P says:

    BR: Yes. I hope that doesn’t surprise you.