Bill Holmes on McK’s school junk bonds
(Bill posted this on an earlier thread, and I thought I’d put it on the front — Mitch)
A few observations…..
First of all, these are junk bonds. Municipal junk bonds, but still junk bonds. There is a whole category of bonds called municipal junk bonds and dealers who specialize in them. One large muni junk bond fund has a current yield of 5,8% on muni junk bonds. Mactowns School Bonds deliver almost 7% so draw your own conclusions. They are risky for both the borrower (the MUSD) and they lender (the speculators who buy junk bonds.) The risk is that the school district will default, and the bonds become worthless or more usually some amount less than 100% set by some federal bankruptcy judge. Muni junk bonds that default currently return 44% of principal. That is why thier interest rates are high to compensate for the (expected) mathematical expectation of loss on the bonds.
Who owns them? Speculators. Maybe even some pension funds who have been suckered or pressured into buying them, or have bought them for corrupt reasons. People who are hedging against something or are diversifying a large portfolio with a small amount of this risk. These last two are at least rational. All the above is true but most real people don’t buy 40 year zero coupon bonds because who would buy a bond that matures after you are dead?
Can they be recalled? If the legalities can be worked out , yes. Calculating their fair market value is trivial. Maybe the MUSD will have to pay a premium of 1% over fair market to buy them back. They have not existed long enough to have grown in value significantly. The queston is who would refinance them, since MUSD has obviously bumped up against its credit limit. Force the people who put these deals toghether to pay back their fees and commisions. In the Bernie Madoff case they call this a clawback.
It goes without saying that a vice president at Security National, a company whose sole existence is about mortgages and securitized credit and debt instruments should understand the consequences, costs and risks of issuing zero coupon bonds. For him there is no excuse and his failure to communicate this to the community is inexcusable. The same can be said for several other board members. On the other hand there might be other board members there and in other communities around California who are just “good government” types of people, and they might be Republicans or Democrats, and these people might have simply believed what “staff” told them, or more likely what “staff” omitted. These people are victims, just the same as elderly victims of con artists. This is not a left right issue. Around California there is legit outrage at this from both “liberals” and “conservatives.”
But it is more complicated than just corruption. Sure there most likely is corruption at some level. And we will hope that it will be found out and prosecuted. But it is also a symptom of a systematic problem with our economy: over-financialization. Too much of our GDP now is tied up in Wall St. derivative products that have created essentially the biggest casino on Earth (And in the history of Earth!). Not enough is tied up in truly productive assets like factories and schools, and the social safety net, which is certainly a productive investment in our common social capital.
have a peaceful day,