Wednesday, August 8, 2012

Ponzi financing in California

I don't have a lot to add to Mish Shedlock's take on this situationthis post of mine basically covered the issues at hand—but suffice it to say that by now, just about every government in California is bankrupt and desperate. Given my previous post, though, I thought I had to pass this item along. From Mish (italics are quotes from this article, bolding is mine):
Poway California, population 47,811 as of 2010, has placed an enormous bet on rising home prices and tax revenues. Poway borrowed $105 million but will not start to pay that amount back until 2033 at which time they will owe $877 million in interest. 
Clearly this would be fiscal insanity anywhere, but it is especially true in California given Proposition 13 that caps property taxes... 
Last year the Poway Unified School District made a deal: It borrowed $105 million from investors to fund a final push in its decade-long effort to revamp aging schools. 
Without increasing taxes, the district couldn’t afford to borrow money in the conventional way. So, instead of borrowing from investors over 20 or 30 years and paying the debt down each year, like a mortgage, the district got creative. 
With advice from an Orange County financial consultant, the district borrowed the money over 40 years in a controversial loan called a capital appreciation bond. The key point for the district: It won’t make any payments on the debt for 20 years. 
And that means the district’s debt will keep getting bigger and bigger as interest on the loan piles up... 
As well as being expensive, 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. In 1994, the state of Michigan banned school districts from issuing bonds like this, deeming them too toxic to taxpayers. 
Nevertheless, California’s ever-strapped districts have increasingly looked to capital appreciation bonds to raise money for improvements without increasing taxes on current residents. Across the state, districts have borrowed billions this way, using exotic financing to shift the burden for paying for today’s school construction to future generations of Californians. 
"This is way worse than loan sharking," said Michael Turnipseed, executive director of the Kern County Taxpayers Association in central California, which has lobbied the state Legislature to tighten laws on school district borrowing. "And Poway is the poster child. What they have done is absolutely insane." 
Think growth will bail out Poway? Think again. 
From Poway City Data the population of Poway shrank by .5% between 2000 and 2010. 
The current upfront cost of this $1 billion proposal would be $2196 per every man, woman, and child. 
By the time Poway starts paying the bill, the cost will be $20,916 per every man, woman, and child. 
Given the average household size is 2.9, the cost per household when the debt is due will be $60,656... 
This scheme is not insane, it's well beyond insane. Unfortunately, I cannot come up with a stronger word to describe it. 
Bear in mind that 20 years from now it is highly likely the school district will need still more money for school maintenance.  What then? Will property taxes rise 10-fold to pay back this loan?
Mish's last point is right on. The problem with taking on massive amounts of debt—thus shifting the burden of current expenditures onto future generations, with interest—is that future generations will still have to find a way to finance the expenses that come up in their time, in addition to paying off the previous generations' bills.

For an analogy, imagine trying to pay down a mortgage on your own house while also still paying down your parents' mortgage on a house that you no longer live in but that has been accumulating interest for decades without a single principal payment—yeah, doesn't sound too feasible, does it?

Sooner or later, the debt writedowns (defaults) will come, because they must. If you can't find the money now, you can't just wave your hands and assume that your kids will have it in 20 years' time. They won't. They'll be too busy paying down their own student loans, not to mention fixing the crumbling infrastructure that you left for them.

But hey, that's not your problem, right? Hey, somebody give J.G. Wentworth a call... we've got some bridges that need some fixing.

[Mish Shedlock]

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