Michigan killed CABs; California can do it, too!

The story that killed CABs in Michigan. Even before Michigan lawmakers enacted a ban on Capital Appreciation Bonds, they were dead from exposure to light. Reprinted with permission of Detroit Free Press.

 

 

 

 

 

By Joel Thurtell

Note: The Michigan Legislature banned CABs in 1994, not 1993.

California public schools and the taxpayers who support them are facing a financial disaster that could force some — maybe many — school districts into default.

Since 2000, California public schools have sold more than $22 billion of an obscure-sounding loan known as zero coupon or Capital Appreciation Bonds. CABs are dangerous because they require no immediate repayment but, with interest compounding, they are guaranteed to suck huge cash payments from districts in the distant future.

The $22 billion is principal only for some 1,200 of these ugly bonds. Nobody has calculated exactly the interest that will be owing on these debts, due to mature in mid-century. One estimate puts interest on CABs at more than $70 billion.

By that time, when California schools are scraping to pay skyrocketing debt service, the school officials who approved these outrageous financial creations will be long gone.

Meanwhile, the bond underwriters, bond attorneys and “independent” financial advisers who urged school boards to approve financial doomsday machines will have enriched themselves by billions of dollars.

What is happening in California today played in a similar way in Michigan in the late 1980s and early 1990s. In 1993, when the carnival of bond profiteering was exposed — in a set of articles reported and written by me and published in the Detroit Free Press — the plunder came to an abrupt halt. A school board member from northern Michigan told me his district was poised to sell high-interest CABs when my stories broke on April 5, 1993. Finally aware of the CAB monster, electors were furious and made school board members aware that CABs were poison.

Michigan Sen. Jim Berryman was outraged when he read my Free Press stories. That same day, he assigned senate aides to draft a bill banning CABs for Michigan schools.

“I requested it the day I read your article,” Berryman told me. “I read it and I just couldn’t believe it. It floored me that we put that type of temptation in front of school boards. It’s truly irresponsible — they’re like junk bonds.”

The Michigan Legislature in 1993 enacted Senate Bill 856 prohibiting CABs and replacing backroom bargaining over bond sales with a requirement that municipal bonds be competitively bid.

California’s taxpayers might want to take a look at what Michigan did. On May 9, the California Senate’s Government and Finance Committee will consider Senate Bill 1205, which is modeled after Michigan’s CAB ban.

While the interest on $22 billion of California CABs could amount to $70 billion by 2051, it would be chump change compared to the amount districts will owe if this gravy train for a select few underwriters, bond attorneys and financial advisers is not stopped.

In Michigan, school debt was declining slightly in the 1980s until 1988, when the first CABs were issued. By 1992, school indebtedness had more than doubled to over $4 billion.

It was so foolish.

CABs allowed more than 80 school districts to spend lavishly — constructing new buildings, buying buses, even computers — while pushing payments to a distant future when many of the purchases would long have been buried in landfills.

No interest or principal was to be paid for at least 10 years. But, make no mistake, interest was being calculated on principal all along, with interest payments of 200, 300 — even 575 percent in Michigan.

How about interest TEN TIMES PRINCIPAL?

Incredible as it may sound, California has gone Michigan one better. Poway schools near San Diego will actually pay interest of 1,000 percent!

CAB deals were always negotiated, meaning the business was conducted privately, without competitive bidding. My research found that competitive bidding is always cheaper for the district than the wheeler-dealer bond sales.

Taxpayers in Michigan were told the bonds meant no new taxes. Nobody mentioned that the promise was based on property values increasing without interruption.

Otherwise — ha-ha! joke’s on you — taxes will indeed go up!

Now, we have history as our guide — look what happened to property values in the last few years.

Yet in California, bond salesmen still have the nerve to sell school officials with slick calculations using wildly optimistic “present value” estimates of future growth in a district’s taxable property value. These fantasy tours of the future ignore the fact that real estate values can go down, not up, whereas interest compounds in one direction only. Districts that bet on constant increases in property value may be faced with defaulting on bonds if their tax bases don’t grow enough for them to pay the hyper-interest they owe.

If California’s school districts continue to issue CABs, they will add untold billions to what is already a tremendous load of school debt.

Does this sound crazy? It is. Yet, it’s fact.

There is a remedy: California could do what Michigan did 19 years ago:

Ban CABs, and order competitive bidding on municipal bond sales.

Over the next days I’ll be re-posting my 1993 Free Press CAB articles along with new reporting on how this migrant has been soaking California citizens until now unaware of the CAB danger.

Drop me a line at joelthurtell(at)gmail.com

 

 

This entry was posted in CAB scams, Muni bonds and tagged , , , . Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *