Municipal Bankruptcy Watch: Poway, California

There’s been quite a ferment of commentary about the financing deal cut by the small city just outside San Diego of Poway, California:

New school, new library, new technology – just a few examples of the renovations and repairs made to Poway Unified School District’s 24 aging schools starting in 2001 under Proposition U.

To finish the job, Poway taxpayers passed Proposition C in 2008. Last year, as part of that bond, the district borrowed $105 million.

It won’t begin paying it back until 20 years from now.

With interest, that $105 million loan will end up costing taxpayers almost $1 billion over 40 years, according to our media partner, Voice of San Diego, who broke the story.

According to Poway’s 2007 financial statements the city had less than $80 million in revenues for that year. I suspect that, if anything, its revenues have declined since then. It had another, roughly $50 million in assets. It was running at a deficit.

The consensus view appears to be what were they thinking? That’s easy. They were thinking “I’ll be gone; you’ll be gone; it’ll be somebody else’s mess to clean up.” Poway is primarily dependent on property taxes. Even if Poway were to increase its property taxes beyond anything that can be reasonably imagined it would be hard-pressed to pay back what it’s borrowed and, given California state law, the increase would only take effect slowly, over time.

I think there are several questions raised by Poway’s case. It’s obviously a disaster in the making. Don’t the lenders bear some culpability in the fiasco? In what drug-induced hallucination did they believe Poway would be able to pay back what it’s borrowed?

And who at the state level oversees this stuff? California is a sovereign state. Cities and towns don’t get to do whatever they want. That’s under state control and oversight. Isn’t there some level of fiscal malpractice that’s just too far for California to tolerate?

Update

In the body of the post I have incorrectly given the impression that the city of Poway has the debt rather than the school district. However, the balance of my point remains: that the debt that has been incurred is too great for the district to repay, that the lenders should never have encouraged it, and that, regardless of the voters’ complicity, they should not be allowed to get themselves into such a mess.

31 comments… add one
  • In what drug-induced hallucination did they believe Poway would be able to pay back what it’s borrowed?

    Good question. My immediate thought is that the people who approved the loan get paid up-front, so if the loan fails years down the line, they’ll be long-gone.

  • steve Link

    “California is a sovereign state. Cities and towns don’t get to do whatever they want. ”

    Is that really true? How much ability/right does the state have to intrude into local affairs? Anyway, couple of thoughts.

    1) This makes a great case for the federalists. Local government is always better.

    2) Who financed this? At first glance, everyone seems to agree this does not get paid back, so why would anyone finance this? Could it be because those who wrote the deal get paid up front and will make money off of this and damn the risks to the company? Shouldnt we realize that the incentives of those working for banks are different than those of the banks? Will we ever learn this? Or, is it the CRA we should be blaming here?

    Steve

  • Is that really true? How much ability/right does the state have to intrude into local affairs?

    Yes, it’s true. Ask any lawyer. If a state were to write its constitution that way, in theory counties, cities, and towns could be administered centrally at the state level. The only real requirement is that the state itself have a republican form of government.

    Here in Illinois, for example, the state has imposed limits on how local governments can raise revenues. Nothing the local governments can do about it. In California, famously, there’s Prop. 13. Nothing the local governments can do about it.

    Under the U. S. system, states really run the show. Over the last 75 years state have abrogated a lot of their power to the federal government but that doesn’t change the basic formula.

    Whether the voters of the state would go along with it is another story.

  • PD Shaw Link

    Cities are “municipal corporations,” organized by the states with all of the powers and limitations established by the state. Generally speaking, a municipal corporation that doesn’t pay its debts can have its property seized or its revenue garnished just like a private corporation. Except that in most states, state laws limit the ability of creditors to seize municipal property to the extent it would impair public services, but such laws may not impair foreclosing on that vacant lot the city is keeping on the edge of town to build a school on some day. Creditors in some states may also seek a writ of mandamus from a court to order taxes to be raised. Even in states like California that permit bankruptcy, the creditor may feel the protection of being able to receive a substantial return.

    Which is a long way of saying, what the creditors should be thinking is what types of collection outcomes are available against the city if it can’t pay its installments.

  • Drew Link

    Heh.

    “It won’t begin paying it back until 20 years from now.”

    In my daughters best texting style: LOL

    “With interest, that $105 million loan will end up costing taxpayers almost $1 billion over 40 years”

    And OMG

    “The consensus view appears to be what were they thinking? That’s easy. They were thinking “I’ll be gone; you’ll be gone; it’ll be somebody else’s mess to clean up.”

    Absolutely. In my profession I’d be sued to high heaven for this, and rightfully so. In government, it’s lawlessness.

    “Don’t the lenders bear some culpability in the fiasco?”

    You bet they do, but this is a point I’ve been making for four years running. The government sets up a pig trough, oh, say, CRA, and the capitalists come in and feast, as they are wont to do. The politicians who set up the pig trough scream “greed” knowing full well they can obfuscate in the political realm even though they put the whole thing into motion, and to their personal benefit. Taxpayers? Hosed.

    “Isn’t there some level of fiscal malpractice that’s just too far for California to tolerate?”

    Not when political affiliation trumps common sense. Like I said, id get sued to the nines if I did something like this. Not politicians. People get blinded by party affiliation. Democrats goooooooood. Republicans baaaaaaaad. We ain’t in Kansas anymore.

  • Drew Link

    Oh, and by the way. Wonder what the banks, or whomever the lenders are, are thinking?

    They are thinking governments always find a way to pay. So…..

    Put out $100 million in metered money. Collect a billion over 40 years. Do the math on theback of an envelope. It’s a 20% loan.

    Love doing business with the government. EZ pickings.

  • Jimbino Link

    It’s about time we placed serious burdens on future generations. After all, it is costing us a fortune to try to educate them and clean up the air, conserve water and energy, protect the fish, birds and mammals–all to their benefit.

    Since, as it appears, we can’t tax the breeders directly, at least we can tax their brood. Maybe the breeders will even begin to consider the severe load they’re putting on the planet and show some restraint.

  • Drew Link

    Per annum

    You can’t make this shit up……..

  • TastyBits Link


    You bet they do, but this is a point I’ve been making for four years running. The government sets up a pig trough, oh, say, CRA, and the capitalists come in and feast, as they are wont to do. …

    Now the capitalists are victims. Unfucking believable.

  • TastyBits Link

    This trash was probably spun into gold, and it will sit in a pension, 401k, mutual, etc. fund for the next 20 years. This is not an excuse for the fund manager or anybody else, but this is how this crap happens.

    I am not sure if municipal bonds can go into CDO’s, but that could be one option. Another option is a CDS (insurance) to insure it will be repaid.

  • Drew Link

    Now the capitalists are victims

    ???????????

  • PD Shaw Link

    Thomas Jefferson believed that government could not authorize debts beyond that generation’s ability to pay them.

    I set out on this ground, which I suppose to be self evident, “that the earth belongs in usufruct to the living”: that the dead have neither powers nor rights over it. . . . Then no man can, by natural right, oblige the lands he occupied, or the persons who succeed him in that occupation, to the paiment of debts contracted by him. For if he could, he might, during his own life, eat up the usufruct of the lands for several generations to come, and then the lands would belong to the dead, and not to the living, which would be the reverse of our principle

    Thomas Jefferson to James Madison (6 Sept. 1789)

  • TastyBits Link

    @Drew

    Instead of the CRA, look at the GSE’s, Freddie & Fannie. You have government sponsorship (guarantees), government printing press (the Fed), government oversight, and ringmasters Frank & Dodd. What could go wrong?

    The Freddie & Fannie mortgage portfolio is/was enormous, and this contributed to the housing mess. The financial mess was caused by the CDS’s, and the Freddie & Fannie SIV’s were huge.

    After the collapse of housing and finance, Frank & Dodd were ready with legislation to cleanup this mess & to prevent another one. I suspect that Son of Frank/Dodd is going to be a blockbuster.

  • steve Link

    Reading over Proposition C, it looks like a GO bond, which would be unsecured debt. However, even a revenue bond does not allow creditors to take unused property by what I am reading. It does allow the municipality to renegotiate almost everything, even pensions, but it looks as though creditors do not have as much leverage as I had thought. Sovereignty is upheld and the judge is not able to affect municipality spending, taxing or even future borrowing.

    To be sure, it kills the municipality credit rating. It creates mountains of legal bills (which would also be true for creditors). So, this does not look like risk free lending for a creditor. As Bond Girl noted.

    “As far as recoveries are concerned, Moody’s found that the average historical 30-day post-default trading price for municipal debt was $59.91 (par $100), versus $37.50 for corporate senior unsecured debt over the same period.”

    https://self-evident.org/?p=877

    So, I cannot see why anyone would take out such a loan or why they would lend it if they were representing the taxpayers or the shareholders. The Masters of the Universe, aka the financiers, are presumed to have a better understanding of finance. I assume they get their money up front.

    Steve

  • Drew Link

    Steve

    Please, as I’ve noted before, stick to medicine.

    You make a loan, you get maybe 2% in upfront “origination” fees. On the $100 million offering cited that’s $2 million. That would not be atypical.

    You risk $100 million for $2 million? I don’t think so. What the lender really thinks is that this is an annuity. Because its an incompetant and corrupt government and a comatose and ignorant electorate, like you. As I noted before, if you think you will get paid by the municipality the stated amount, that’s $22 million a year in interest. Do the math. If you get basically 5 payments, you cover principal. This is called stealing. A succeSsful venture capital investment might return 5-8x the investment. I’m to understand that a municipal bond is going to return 10x? Absurd. Just absurd.

    I love you Steve. You are a great asset on this site. But please leave the finance to others. You make a fool of yourself when you venture into things you know nothing about. I don’t tell you how to treat a gunshot wound to the chest. Please afford the same respect to others.

  • steve Link

    Drew- Who gets the origination fees? Who risks losing the $100 million? If these are different people, then I think I understand why they would do this.

    Steve

  • PD Shaw Link

    I think this backgrounder on municipal bonds is helpful:

    “[D]efaulted municipal bonds have a fairly high recovery rate of 68.33 percent based on the number of defaults. Recovery can be made in a couple of ways. The borrower may get out of the default situation by making full debt service payments or collateral securing the bonds may be liquidated. Most issuers, particularly providers of essential services such as water and sewer, resume paying debt service. These types of securities are backed by physical assets that are public property. Thus they are never pledged to bondholders. In such cases, bondholders maintain a lien on revenues, which often enables full recovery. Industrial development bonds and multifamily housing bonds, the two sectors with the highest default rates, are often backed by collateral leading to higher than average recovery rates.”

    http://www.publicbonds.org/public_fin/default.htm

    To build on Drew’s numbers. The city borrows $105 million; the creditor expects to receive almost $1 billion for the loan, but in the case of default the creditor might only get $683 million.

  • steve Link

    Sounds more and more like the rubes at City Hall got taken by the finance guys.

    Steve

  • I think there’s an element of that. But then’s there’s the old wisecrack: you can’t cheat an honest man. City Hall was looking for a way to have their cake and eat it, too. TAANSTAFL

  • TastyBits Link

    @steve

    Sounds more and more like the rubes at City Hall got taken by the finance guys.

    It looks like the “rubes” are part of the hustle. By now, we should assume there are no more rubes, and all parties (including voters) are hustlers.

    Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools

    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.

    Money For Nothin’ And Chicks For Free

  • TastyBits Link

    @steve

    1) This makes a great case for the federalists. Local government is always better.

    This is a local problem, and it only affects the local government. If the state allows this, it is their problem. If the bond holders lose money, it is their problem.

  • Jimbino Link

    You misspelled TANSTAAFL.

  • steve Link

    @Tasty- Yes, I was just exaggerating a bit. From what I can tell, the pols guaranteed no new taxes, but needed to fix up a bunch of buildings. The pols got what they wanted. I cant tell about the taxpayers. I will put keeping away from Orange County consultants on my permanent to do list.

    Steve

  • Drew Link

    Steve

    The lender gets the fees.

    Like I said, I love you man, but leave the finance to the finance people.

  • Drew Link

    To build on Drew’s numbers. The city borrows $105 million; the creditor expects to receive almost $1 billion for the loan, but in the case of default the creditor might only get $683 million.

    Correctomundo. I’d still do that deal any day. Venture returns for debt risk. Like taking candy from a baby.

    Filthy, dirty pols.u

  • Drew Link

    Steve

    You do understand I’m being intentionally hyperbolic to make a point, right?

    You seem to have a reflexive need to provide exculpatory explanations for government malfeasance. Dave said it all in his original essay. These bastards know they won’t be around when the shixt hits the fan.

    Case closed.

  • Poway is right around the corner from me. Nice place, good people. But apparently, they just got sold a bill of goods. . .

  • Maria Link

    The loan situation is with the school district not the city/municipality.

  • Pat Link

    Goodness folks, get your facts correct. Maria is right, this bond debacle is with the school district which is totally separate from the city in this case. The city of Poway is one of the most fiscally stable cities in the state and that’s really saying something in California.

  • TastyBits Link

    @Maria & @Pat

    Unless there is a difference between school district bonds and municipal bonds, I do not see much difference, but I am not an expert on either. The discussion is not about Poway. It is more about the way government entities are financing debt.

    It is my understanding that Poway is not alone. There are a number of school districts doing the same thing. I would expect the city of Poway to feel the effects as well as the school district.

  • TastyBits Link

    @Dave Schuler

    … they should not be allowed to get themselves into such a mess.

    I disagree. Unfortunately, it will take 30 years before anybody feels the pain, and of course, it will not be the primary culprits. It is almost enough to make me turn in my libertarian credentials, but some of my libertarian notions will get thrown onto the trash heap.

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