Unrecognized Legacy of Prop 39: $137 Billion in Payments Due for Money Already Borrowed and Spent

How much debt has accumulated as the State of California and its local K-12 school and community college districts relentlessly borrow money for school construction by selling bonds to investors?

No one seems to know. In April 2013, the California Policy Center published a report entitled Calculating California’s Total State and Local Government Debt, which attempted to calculate a reasonable estimate of debt obligations of the State of California and its local governments. The report estimated an astonishing debt total of $1.1 trillion, but researchers could not identify any recent sources to estimate the debt from general obligation bonds issued to finance educational construction.

There is a way to determine the amount of debt service (principal + interest) outstanding for educational districts. Researchers for the California Policy Center were able to add up total aggregate debt service for almost all California local educational districts in which voters approved a bond measure since the November 7, 2000 election.

Debt service for those California local educational districts is $136,500,250,898 as of January 2015.

Put in plain English, between now and 2055, California’s taxpayers will make $137 billion in principal and interest payments to pay back funds that have already been borrowed and spent.

Add this number to the $56,668,673,695 in debt service resulting from the three statewide bond measures for educational construction approved by voters, and the total debt service is $193,168,924,593.

See Appendix I – All California Educational Bond Measures Approved by Voters Since November 2000 Enactment of Proposition 39 – Ranked by Aggregate Debt Service

Obviously this debt is substantial, even after accounting for all of the caveats listed below.

As noted below in “Limitations on Using Debt Service Data for Educational Construction,” debt service for some school districts could not be determined, which makes the number determined by the California Policy Center to be lower than exact. In addition, numerous districts are now calling their bonds and issuing refunding bonds, which makes the number determined by the California Policy Center to be higher than exact. We believe these circumstances balance each other out.

Total debt service is about $137 billion for local educational districts where voters approved bond measures since the November 7, 2000 election. Including the three statewide bonds that voters approved since the November 7, 2000 election brings the total debt service to $193 billion.

How Were These Numbers Determined?

Municipal bonds are not bought and sold on Wall Street. Instead of using a centralized place (such as an “exchange”), issuers and investors buy and sell bonds “over the counter” through dealers and brokers registered with the Municipal Securities Rulemaking Board (MSRB), a quasi-governmental organization overseen by the U.S. Security and Exchange Commission. These dealers and brokers act as underwriters or intermediaries between issuers and investors.

Federal law generally requires underwriters in a primary offering of municipal bonds of $1 million or more to obtain and review an “Official Statement” from the issuer of those bonds. Those statements disclose financial information meant to inform a potential buyer and reduce the chance of “fraudulent, deceptive, or manipulative acts or practices.” By law these statements have to be posted on a publicly-accessible and free-to-use website: the Municipal Securities Rulemaking Board Electronic Municipal Market Access system, or EMMA.

Official statements include a chart that indicates how much aggregate principal and interest the issuer of the bonds would owe each year if the bonds weren’t refunded (called in so new bonds can be issued at a lower interest rate) or paid off early. Different official statements may place the aggregate debt service chart in different locations in an Official Statement. Charts may differ in title, format, or details of content. A few charts may not even total up the annual debt service. But the information is usually available. (Issuers of bonds through “private placement” do not need to post official statements on EMMA, because the information is provided directly to the private buyers.)

California Policy Center researchers used the EMMA database to determine debt service for each educational district where voters approved borrowing money for construction through bond sales after November 7, 2000. (That is the election date when California voters approved Proposition 39 and reduced the threshold for voter approval of bond measures for construction from two-thirds to 55 percent.) Researchers entered each district name into the EMMA system, identified the most recent bond offering or bond refunding from the list of bond issues, downloaded the associated Official Statement, located the aggregate debt service chart, and calculated the total debt service for 2015 and/or later years.

Limitations on Using Debt Service Data for Educational Construction

This data is a big step forward in informing Californians about the tremendous debt accumulated by educational districts that borrowed money for school construction by selling bonds. Nevertheless, the data has limitations. Here are 14 warnings about assessing the data out of context:

1. Some local educational districts have not yet borrowed any money as authorized by voters. Other districts have issued some bonds and plan to issue more bonds soon. Some districts have issued all of their bond authority. This means that debt service may be deceptively low in some districts that haven’t yet begun borrowing with gusto.

2. As mentioned above, educational districts in some circumstances can call in existing bonds and issue refunding bonds at a lower interest rate, thus reducing debt service. For this reason, school districts can argue that they intend to regularly issue refunding bonds, and therefore the amount that taxpayers will end up paying is somewhat less than what is listed for the current debt service.

3. For some educational districts, the current debt service will be paid off in a few years. For other school districts, the current debt service will be paid off in 40 years, thus allowing for a presumption that a long period of steady inflation and substantial increase in total assessed property value will mitigate the debt burden on property owners.

4. An argument can be made that borrowing a lot of money now at currently low interest rates is wise financial management, and debt service therefore is not an important issue to consider.

5. An educational district in a wealthy area can have significant debt service but also have high and stable total assessed property value. That debt service may be foolish, but it is not as dangerous as the same debt service in an less affluent educational district with unstable property values and an uncertain economic future.

6. Debt service becomes foolhardy and dangerous as the amount of interest owed increases relative to the amount of principal owed. Educational districts that issued a lot of Capital Appreciation Bonds in the past 15 years have debt service out of proportion to what they obtained through their construction program.

7. As mentioned above, some California educational districts are now issuing bonds through negotiated placement or private placement, which do not require official statements because the investors are qualified to perform their own assessment of the district’s financial status. Keep in mind that official statements are intended for the benefit of potential public investors, not for the benefit of taxpayers or other interested parties.

Private placements seem to be growing in popularity. Researchers were unable to determine current debt service for several small school districts without official statements on EMMA, and at least two of them (and probably all of them) used private placement for their most recent bond sales. It’s notable that the West Contra Costa Unified School District – perhaps the California educational district taking the most risks with school construction finance – apparently issued $135 million in bonds – including bonds with 40-year maturities – in February 2015 through private placement.

8. Debt service can accumulate from bond issues that occurred decades ago. California’s educational districts were winning approval for bond sales under the Proposition 13 two-thirds threshold for 20 years before Proposition 39, and some of that borrowed money is still being repaid back, with interest. For those school districts, debt service may look disproportionately high relative to the amount of money borrowed from 2001 to 2014.

9. There are a handful of local educational districts that have debt service from bond measures approved in 2000 or earlier but have not asked voters to authorize additional borrowing since the November 7, 2000 election. That debt service is not included in the total reported here. In addition, there are statewide bond measures for educational construction approved before November 7, 2000, including a $9.2 billion bond measure approved by voters in 1998 that included $6.7 billion for K-12 school districts and $2.5 billion for community college districts and California State University and the University of California campuses. The actual total debt service for all statewide bond measures and all local educational districts likely exceeds $200 billion.

10. Several K-12 school districts have merged in the past 15 years. Some official statements segregate debt service for the districts before they merged, and some combine the debt service.

11. Several community college district and K-12 school districts have created “School Facilities Improvement Districts” embedded within the complete jurisdiction of the districts. Some official statements segregate debt service for these subdistricts, and some combine the debt service for the subdistricts with the debt service for the complete district.

12. Certificates of participation, lease revenue bonds, and other schemes for educational districts to borrow money while evading Proposition 13 and Proposition 39 requirements are not included in official statements.

13. Community Facilities Districts funded by Mello-Roos bonds are not included in official statements.

14. Debt service is best considered in conjunction with information in annual financial statements prepared for the educational districts.

Despite these limitations, the debt service amounts available through the official statements posted on EMMA provide new insight into the debt owed by California local educational districts. Voters need to know that borrowing additional money via bond sales for school construction is adding to already existing debt.

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