First instinct: Why the hell didnât CPS reinvest its $1Billion surplus into inproving its own school system.
Second thought: so if the school system was perfect and fully funded for the foreseeable future, why didnât they return this surplus to the investor ie the public.
Third thought: this is hopelessly corrupt. At least it wasnât my state.
Fourth thought: my state probably did this too.
Final thought: why the hell is a stateâs public school system playing around with investment products completely unrelated to scholastic spending anyway. I thought they were funded by the state budget anyway. So either the school system either did a bunch of sales, fines and grants to earn an extra billion dollars beyond the annual budget, or they were budgeted a billion dollars more than they spent and didnât return the surplus to the stateâs education fund and instead spent it on junk bonds. How could that possibly be legal?
Beyond âmereâ malfeasance, this screams active criminality. Some (several) people should be in prison. Why are they not?
Oh, yeah⌠bankers.
Never mind.
This is what can happen when financially unsophisticated people are âinvestingâ other peopleâs money. In 2007, everyone was looking for big returns on investments, then 2008 happened.
About what youâd expect from the Chicago SchoolâŚ
Iâm just completely baffled by the idea of a state agency being given a large sum of money to invest as it sees fit in any random financial market. I thought that was the state treasuryâs job. Also, state treasuries are supposed to return budget surpluses to the tax base usually. Or else the state would move the money to its almost always lacking general fund.
ETA: THE GOVERNMENT ISNâT A BUSINESS. It is not supposed to run huge surpluses. Itâs supposed to return money it doesnât have a specific plan for. Iâm saying this as a liberal too! The government is supposed to provide services for the citizens, not make money, why the hell are state agencies given the ability to invest in risky financial products where it has no business?
âChicago Schools loses money to Chicago Schoolâ
Keynesian economist world-wide chuckled in morbid delight. âIt was the rational expectationâ one expert said before high-fiving colleagues and making loud noises.
That sounds too much like actual thought went into this whole debacle. It looks to me like dad gave his six year old a thousand dollars to invest then being disappointed that the kid came back with $1000 worth of rapidly dissolving cotton candy a carny tricked him into buying when the dad expected the uninformed kid to just have it changed into 2000 dollars worth of kreugerands.
No offense to the commenters or to Cory, but many people seem utterly confused about some of the basic facts of this story (and really, some basic facts about finance).
First and foremost, the schools did not have $1 billion in surplus. They did not have $1 billion in money sitting around that they were trying to invest.
Rather, the school needed money. It did what lots of entities do in that sort of situation, CPS borrowed it (aka, they issued bonds). That is, they sold IOUâsâŚa lot of them. This is how they got the billion dollars. Itâs all borrowed money that needs to be paid back with interest.
The issue here is that the particular type of bond they sold (along with the swaps) didnât pan out, and as a result, the interest they will have to pay to their lenders on the $1 billion they borrowed will be much higher.
To help clarify this, the first part of the post should be changed from:
In 2007, the school raised $1B, and instead of issuing bonds, it let the bankers whoâd been courting it talk it into issuing a floating-rate bond that it swapped into a fixed-rate issue.
to something like:
In 2007, the school raised $1B by issuing bonds. Rather than issuing simple fixed-rate bonds, they got talked into issuing auction-rate bonds and buying interest rate swaps, essentially converting them into fixed-rate bonds. Their financial analysts said that this would result in lower interest payments on the $1 billion they borrowed, but that analyst sucked, and instead, they will have to pay more in interest than if theyâd just issued the simpler fixed-rate bonds.
That doesnât really sound as nefarious though. Basically, they got bad financial advise and theyâll have to pay a higher interest rate because of it, and the people who gave them this bad advice probably made a ton of money.
No. Itâs really more like the Dad charged a ton of stuff on the credit card and someone convinced him that instead of making many small payments to the credit card company, he should go take out a payday loan to pay off the credit card, resulting in having much larger interest payments.
Iâm just completely baffled by the idea of a state agency being given a large sum of money to invest as it sees fit in any random financial market.
You should be baffled, because those things donât happen and didnât happen here. The state agency was not given a large sum of money and they were not investing it. They were borrowing a large sum of money, but they borrowed it in a dumb way which will increase how much itâll cost them to pay it back.
That doesnât sound any better to me. How is a public utility that operates by spending all the money itâs given supposed to pay interest on a loan. Itâs not like public schools get a cut of their studentâs earnings you know.
They should have been given what they needed in order to do their legally mandated task. Otherwise the public should be allowed to dismantle discretionary things like politicianâs salaries to fill the gap.
It makes sense to issue bonds for certain kinds of projects, such as building or upgrading school buildings or other kinds of rare events. It evens out the spending, and it puts the cost on the people who most benefit from the school, and it means you can get building right away instead of waiting until youâve saved enough.
I get that itâs necessary to issue bonds this way under our current system. I just am highly averse to running what is essentially a utility that is a permanent fixture of the state as if it were some kind of discretionary spending. Ideally, public schools should be budgeted to be given as much money as they need to educate the populous. Itâs not often that you hear about the state issuing bonds so that your lights stay on. You donât ever hear about your public water district running short on chlorine and flocculation compound and needing to issue a bunch of bonds to make sure whatâs coming out of your faucet is potable.
ETA: You especially never see your state representatives and executives worrying that theyâre going to have to go without their salaries for a few days of unpaid work while public schools go underfunded. Iâd rather see those people in my state capital tighten their belts in hard times than subject everyoneâs kids to substandard educations. For some reason, they never seem to have trouble scraping together the money to pay themselves when they take a few months off every year to do whatever the hell they want. Usually meeting with monied interests, instead of going out into the world and figuring out what the average citizens are in need of.
On its face, no it doesnât necessarily sound nefarious, but I think weâd have to understand the fees involved and other ways the financial institution that put the deal together actually made money. To me it sounds like the same kind of thing that was happening in the housing market at the same time; banks pushing people in to adjustable rate/balloon mortgages that werenât in the âclientâsâ best interest, but came with higher fees and/or increased the risk of default and penalties.
Thanks for explaining the situation better. It did strike me that the writer didnât really understand the underlying deal, and that confused commenters.
Well I take your point. Unlike the Southwest Stony Creek School District, where replacing the single high school is a âelephant in the pythonâ bit of funding, Chicago is big enough that it should be able to spread out all the different construction projects so that borrowing shouldnât be needed.
Utility bonds. Happens all the time.
I do agree it is perhaps a bit perplexing and possibly bad that it does.
I donât think it actually takes a lot of complex financial analysis to understand a scheme like this. It takes a very simple âtoo good to be trueâ analysis.
You want to raise $1B to buy infrastructure and, looking at the current market, you see that youâll sell your $1B in bonds over the term you chose at X% interest. Some banks come along and tell you that they have a scheme where you will pay Y% interest instead. Hereâs the question, if Y is less than X, then why would anyone be buying your bonds instead of the other products on the market?
Basically you are looking at two possibilities, either this complex scheme will dupe people in the financial market into taking less money than they otherwise would like to for the loan they are giving you, or you are the one being duped. Since the people who are telling you to do this are the ones who are lining up to collect on the scheme, which is more likely?
Kind of like those â1% mortgageâ promos during the runup of the RE bubbleâŚYou donât really have to read through the fine print to realize that thereâs a catch. Most of us figured that out a the ânot a flying toyâ stage but some people are easily convinced that THEY must the only person who is clever enough to beat the market.
In 2007, the school raised $1B, and instead of issuing bonds, it let the bankers whoâd been courting it talk it into issuing a floating-rate bond that it swapped into a fixed-rate issue.
This makes no sense â please correct it.
