Please Read This, Even If You Think Municipal Bonds Are Really BORING: We’re Setting Up the Next Generation of Californians to Pay Staggering Property Taxes

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Today I attended the first annual conference of the California League of Bond Oversight Committees (CalBOC) in Sacramento.

Several speakers provided guidance on how to be an effective oversight committee for a school district and provided case studies of dysfunctional oversight committees. But for me, the most valuable part of the conference was learning that foolish bond sales to finance school construction today are leaving our children and grandchildren with a tremendous tax burden in 20 to 40 years.

Walking into the conference, I knew little about municipal bonds. Unlike many Californians, I had understood that taxpayers must pay back the principal on these bonds, must pay back significant interest payments to the investors who buy the bonds, and must pay fees for various professional services associated with selling the bonds. Bonds are not “free money.”

I will guess that even Californians who know that a bond creates a debt that needs to be paid back usually don’t consider that voters who approve a $100 million bond are usually assessing property owners with taxes of about $180 million (amount not adjusted for inflation) over the term of the bond, when interest payments and fees are included in the total debt.

Traditionally, school districts have sold typical “General Obligation Bonds,” in which investors buy bonds, receive regular interest payments, and then receive the principal at the end of the term of the bond. But the growing problem for future generations of Californians is that they will need to pay off more than 1200 “Capital Appreciation Bonds” (CABs) to fund school construction (or to fund the funding of school construction, in a few cases).

Capital Appreciation Bonds are sold at a price substantially less than the principal amount of the bond. Investors don’t receive interest payments regularly over the life of the bond, but instead get a single huge payment of the principal plus the accumulated compounded interest at the end of the term of the bond.

People tend to underestimate the power of compounded interest, in which interest is earned on the principal AND on the accumulated interest. One speaker claimed that Poway Unified School District (in San Diego County) sold 40-year Capital Appreciation Bonds that will cost taxpayers 2200% of the principal because of the compounded interest.

Elected school boards like Capital Appreciation Bonds because they defer payments on the principal and backload interest payments to the final years before maturity, therefore keeping the present tax rate for property owners under the maximum rate set in Proposition 39 as a condition to seek 55% voter approval for the bond (rather than two-thirds approval).

Evading higher property taxes helps school board members to stay in public office, of course. And the huge debt service payments resulting from the compounded interest in Capital Appreciation Bonds will start for taxpayers 30 to 40 years after the bonds are issued, at which time many of the voters who approved the bond measures will be dead, as well as the school board members who authorized the sale of Capital Appreciation Bonds so many years earlier.

Does this story seem far-fetched because you’ve never heard of it? I think ordinary citizens rarely hear about municipal bonds because the topic can be complicated and dry. It doesn’t sell newspapers and it doesn’t attract TV viewers. Perhaps my layman status will allow me in occasional blog posts over the next few weeks to clearly and effectively explain the long-term dangers of these Capital Appreciation Bonds.

7 comments

  1. Ken K says:

    I wonder if CABs along with their apparent voting and tax scam is unique to California or wide spread in other States.

    • Kevin Dayton says:

      Ken K.:

      There is hope. CABs were banned in Michigan in 1993 as a result of a series of articles in the Detroit Free Press newspaper written by a reporter named Joel Thurtell. Looks like he has a web site http://www.joelontheroad.com that focuses on his role in banning CABs in Michigan and the need to do the same in California. I’ll contact Mr. Thurtell and see if I can connect him with CalBOC and the Howard Jarvis Taxpayers Association.

      Kevin Dayton

  2. Dan Drummond says:

    How do General Obligation Bonds differ from Capital Appreciation Bonds? Your description of Capital Appreciation Bonds is downright scary and I’m wondering if this is a problem we’re working our way out of by going to GO Bonds, or if they’re one in the same thing. Thanks.

    • Kevin Dayton says:

      Mr. Drummond:

      Typical General Obligation Bonds cost less for taxpayers overall than Capital Appreciation Bonds – the interest rate is lower and the interest is not accumulated on a compounded basis. Remember, investors in typical GO bonds get a regular and periodic interest payment, while investors in CABs get the accumulated compunded interest when the bond matures (or is redeemed).

      Kevin Dayton

  3. […] and people are giving as much attention to my May 2012 articles about Capital Appreciation Bonds (Please Read This, Even If You Think Municipal Bonds Are Really BORING: We’re Setting Up the Next G… and Reporter Behind Michigan’s 1994 Prohibition of Capital Appreciation Bonds (CABs) Watches and […]

  4. […] presentation on Capital Appreciation Bonds and then reported it on my blog on May 11, 2012 as Please Read This, Even If You Think Municipal Bonds Are Really BORING: We’re Setting Up the Next G…, apparently being the first Californian to post a general report on the web about this practice in […]

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