Home > Uncategorized > Bill Holmes on McK’s school junk bonds

Bill Holmes on McK’s school junk bonds

moneydice(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,
Bill

  1. Floyd
    December 4, 2012 at 1:44 pm

    The school district is required to retain an archive of e-mails sent by staff for a number of years.

  2. December 4, 2012 at 2:52 pm

    Thanks, Bill!

  3. December 4, 2012 at 3:09 pm

    Great observations Bill.

  4. Anonymous
    December 4, 2012 at 4:02 pm

    Thanks Mitch and Bill for your efforts to explain this. It is complex at first with a pile of new vocabulary but I am beginning to understand not only the danger of the bonds but the self serving town killing corruption behind them.

  5. December 4, 2012 at 5:33 pm

    As mentioned elsewhere in these parts, appreciative thanks, Bill. That’s very clear.

  6. Not A Native
    December 4, 2012 at 5:53 pm

    With the kinds of background those board members have(wealth held in land), they certainly believe that this is a non-problem. it will be taken care of by ‘inevitable’ increases in real estate values.

    In their view, real estate must inflate much faster than the bond interest rate. Newly developed housing will always have larger than average assessed values. So the bonds will be paid off mostly by the ‘newcomers’. And with ‘sure thing’ increases in real estate prices, each time an existing property is sold or renovated, its assessment will skyrocket. Again, the people ‘moving in’ will pay the lion’s share. While those who inherit pay little.

  7. Anonymous
    December 4, 2012 at 6:48 pm

    So, what specifically are “municipal junk bonds”, what makes McK’s bonds “junk”?

    G.O. bonds are marketed among the safest investments out there, 7% is not outrageously high for a bond investment, considering the high risk and high interest of most private-issued investments.

    If issued by a state they cannot go bankrupt, if issued by a school or service district, they are repaid first in the advent of bankruptcy, all are typically insured. Local brokers will tell you that defaults or bankruptcies are extremely rare, are they lying?

    Can we get a response from a local broker on this perplexing issue?

  8. December 4, 2012 at 7:09 pm

    #7,

    To a first approximation, all you need to do is look at the interest rate being offered. When someone is offering more than 6% in this environment, you can be pretty sure it’s what Wall Street would call “junk.”

    Just google “municipal junk bonds” and you’ll find what you’re looking for. Here’s a starter: http://www.bloomberg.com/news/2012-08-14/california-schools-barring-taxes-push-bills-to-2051-muni-credit.html

  9. Frank Zapper
    December 4, 2012 at 8:54 pm

    from the Bloomberg

    quote “State law allows districts to issue bonds maturing as long as 25 years into the future on their own; greater maturities require approval from county treasurers. ”

    Does that mean that Humboldt County Treasurer signed off on the McKinleyville deal?

  10. Seamus
    December 5, 2012 at 6:25 am

    Is there a record of who bought these bonds, and who owns them now? Cui bono?

  11. December 5, 2012 at 9:41 am

    If we want our grandchildren to curse us all we have to do is keep acting the way we are acting.

    have a peaceful day,
    Bill

  12. Anonymous
    April 7, 2013 at 12:28 pm

    ARTICLE XVI PUBLIC FINANCE [SECTION 1. - SEC. 20.] ( Article 16 heading amended Nov. 5, 1974, by Prop. 8. Res.Ch. 70, 1974. )

    SEC. 18.
    (a) No county, city, town, township, board of education, or school district, shall incur any indebtedness or liability in any manner or for any purpose exceeding in any year the income and revenue provided for such year, without the assent of two-thirds of the voters of the public entity voting at an election to be held for that purpose, except that with respect to any such public entity which is authorized to incur indebtedness for public school purposes, any proposition for the incurrence of indebtedness in the form of general obligation bonds for the purpose of repairing, reconstructing or replacing public school buildings determined, in the manner prescribed by law, to be structurally unsafe for school use, shall be adopted upon the approval of a majority of the voters of the public entity voting on the proposition at such election; nor unless before or at the time of incurring such indebtedness provision shall be made for the collection of an annual tax sufficient to pay the interest on such indebtedness as it falls due, and to provide for a sinking fund for the payment of the principal thereof, on or before maturity, which shall not exceed forty years from the time of contracting the indebtedness.

  13. Anonymous
    April 7, 2013 at 12:31 pm

    Seamus :
    Is there a record of who bought these bonds, and who owns them now? Cui bono?

    Yes the ownership of bonds now are recorded electronically in a central data bank. Paper bonds are no longer issued and mailed out to bond buyers. The current ownership can be easily verified.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

Join 1,162 other followers