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Creative financing in education is dangerous

Evanston Skokie School District 65 is less than 10 miles northwest of Wrigley Field in Chicago. For the first time in more than 50 years, the district will build a new elementary school in Ward 5. The district’s plan to pay for the new school shows exactly why creative financing in education is dangerous.

The new school building will cost about $40M. But Evanston Skokie School District 65 won’t be paying for the school with a traditional bond issue. Instead, the district put out a Request for Proposals for “Investment of Lease Certificates Proceeds and Arbitrage Rebate Management.” Five firms, which the district had pre-qualified, returned proposals.

If you’re accustomed to traditional public sector financing, your first question is probably, “What is a lease certificate?’ followed closely by “What is arbitrage rebate management?”

A lease certificate is a security issued by an asset leasing company (often special corporations created by brokerage houses, banks, and the originator – in this case the school district) to provide project financing. In short, the leasing company will finance the construction of the school and lease it back to the district. The leasing company will then issue shares of the lease to investors. The shareholders get revenue that is proportional to their share of the investment. So, if an investor holds half of the lease certificates, that investor will get half of the proceeds from the lease. At the end of the lease, the asset leasing company will turn over the ownership of the building to the district. In this case, the lease will run for 20 years. The school district will pay a fixed interest rate of about 3.5%.

School financing shouldn’t require SEC regulation

Then there’s the arbitrage. Municipal bond arbitrage involves hedging tax-exempt and taxable bonds of similar value, quality and duration to take advantage of differences in their interest rates. The school will fund the interest payment for the first year of the deal by borrowing about $4M more than it needs to build the building. The $4M will seed the investment portfolio that will then (in theory) provide future years’ interest payments. The lease payments will come out of the district’s general fund. (Provided that all goes well, of course. What could possibly go wrong?) The general fund, by the way, has newfound money to pay the $3.2M annual lease payment because the district eliminated its transportation budget.

If this sounds like a highly complicated way of financing the construction of a new elementary school, it is. But you could probably say that of any deal that requires a 160-page Securities and Exchange Commission filing.

My point is that certain members of our communities have become politically unwilling to finance the cost of public education. As a result, K-12 school districts are turning to elaborate financing deals that require SEC regulation to build buildings. Equally concerning, community colleges (like WCC) are turning to unrelated business activities to fund the college’s operations. The single goal of these separate approaches is to avoid seeking taxpayer support.

In the grand scheme of things, I don’t believe the taxpayers are resistant or unwilling to fund public education. (They’re certainly not reluctant to support education in this area.) Rather, I believe in service of their political philosophy, certain elected officials would rather force schools to adopt elaborate and risky financing deals to fund public education.

Does that sound right to you?

Photo Credit: Sustainable Economies Law Center , via Flickr