4/14/2008
School districts roll the dice
I’ve heard from several folks up in arms about the five Wisconsin school districts (including Kimberly) cited by the Journal Sentinel as venturing into the realm of multi-syllabic, remarkably complex, foot-high debt agreements. The Collateralized Debt Obligations – CDOs – are meant to help districts fund OPEBs – Other Post Employment Benefits (primarily health care).
These new generation instruments are an attempt to generate extra income from a “carry trade” – an arbitrage of sorts - borrowing money at one interest rate and investing it at a higher interest rate. To earn the higher rate, some incremental risk must be assumed. Enter the CDO, a complicated derivative security. Unfortunately these higher risk securities, often mortgage related, have experienced increasing rates of default as the housing market has collapsed and the economy has slowed.
The queasiness in the markets is definitely cause for concern, but not a dire situation for the school district that intends to hold the CDOs to maturity.
Indeed, last week, State Rep. Bill Kramer, R-Waukesha (attorney, CPA, Certified Financial Planner and very competent guy in any dealings I’ve had with him) said he would not pursue an audit at this time, as
he saw nothing wrong with the Waukesha district's decision in 2006 to borrow millions of dollars to invest in collateralized debt obligations, which are bundles of debt that range from corporate bonds to subprime mortgages.
…"It seems to me that the School District tried to come up with a creative way to find ways to pay for the incredible benefits that the employees of the Waukesha School District get," said Kramer, who was e-mailed a request asking for an audit on Monday. "It's the enormity of the benefit that really should be the story." [Emphasis is mine.]
Exactly.
Kramer “defended the CDOs as less volatile than the type of investments made at the state level for school districts’ pension programs. ‘It’s something I hope they keep a close eye on, and I will keep an eye on it going into the future. Right now, it is performing as advertised.’”
Kimberly Schools superintendent Mel Lightner explained it well.
Lightner said Kimberly, like most school districts, established generous retirement packages decades ago to encourage early teacher retirements. Officials thought the district would save money by replacing them with lower-paid teachers.
Though the plan worked for years, [business manager Gary] Kvasnica said times have changed. As previously inexpensive health insurance costs climbed, the district found itself owing far more than expected, though it has been able to offset some of that burden through investments.
For the first time, larger school districts will be required to report their future unfunded liabilities (like OPEBs) in audits that will appear this fall. Though representing promises over decades to come, the numbers nevertheless are staggering – and will turn a few school board members’ heads. The Appleton Area School District board will likely see reported in October a future liability of something in the range of $100 million. That is a big chunk of change.
Todd Gray, Deputy Superintendent of Finance/Transportation, Oshkosh School District, said the mandatory reporting “has helped school boards come to grips with OPEB; if it doesn’t cause school boards to sit up and take notice, I’d be surprised.”
Lisa Maertz, the City of Appleton Finance Director, comments that debt is a critical piece of public policy.
All too often, debt is seen as a “way out” in the short term that has long lasting impacts that current administrations may or may not be around to deal with….
Maertz comments that “restraint programs” (spending and revenue caps) at the local and state levels, all contain a loophole that permits (encourages?) the issuance of debt. Under Maertz’s guidance, Appleton holds strictly to its debt policy, a self-imposed cap of 40% of the legal debt maximum. In addition, Appleton maintains only minor unfunded liabilities.
The school district situation is emblematic of the credit crisis the financial markets find themselves in today. Wall Street created new instruments designed to increase returns and disperse risk more broadly. They worked wonderfully while interest rates were low, the economy was strong and credit defaults were low. Now that the economy is weakening and the mortgage sector is experiencing increasing rates of default, the performance of these CDO instruments is deteriorating and the dispersed risk has reached the periphery of the risk pool—school districts and the taxpayers that flow their payments into them.
Nevertheless… the critical questions raised by the “school investment crisis:”
How and when will school boards rein in excessive retirement benefit (primarily health care) costs?
COMMENTS
Jo,
Right on. The health care relationship to school district costs and property taxes is but one solid logical path from a bloated inefficient health care "system" to the costs we bear in taxes. There are many, many others. Like I have stated before in this forum, health care costs are the root of much of the economic evil in our society. That and (in my opinion) the war distort everything we wish to do to be a great society.
dave allen (Mon Apr 14 21:43:41 2008)
|
