Saturday, April 21, 2012

20/20 Hindsight

Last month, I wrote a story about the natural gas purchasing consortium in which our school district participated as a measure to protect us from what looked then to be skyrocketing natural gas prices. Unfortunately, we ended up buying at near the high, with natural gas prices now about a third of what they were in 2008. A couple of Board meetings ago, we made the decision to buy our way out of that deal, and to enter into a new buying consortium. The question of course is which way we think prices are headed from here.

New Albany (Plain) Local Schools faced a similar situation with their capital borrowing arrangements, according to a recent story in the Columbus Dispatch.

New Albany Schools, like most school districts including ours, issues voter-approved bonds to finance the cost of constructing and equipping their school buildings. Those bonds are sold at whatever interest rate the market demands at the time of the sale, and the amount collected via property taxes is whatever is required to pay off the interest and principal on these bonds. When the voters pass a bond levy, this is what they agree to - to repay the money borrowed, with interest, within in a certain period of time.

As we know, the Federal Government - ie the US Treasury in concert with the Federal Reserve Bank - have for several years now been aggressive in driving down borrowing rates in the hope of stimulating American businesses to crank up their activity, and to put folks back to work.

This economic policy has also driven home mortgage rates to historical lows, prompting lots of homeowners to refinance, which lowers payments and/or shortens the time to pay off their mortgages.

As a borrower, a school district would like to do the same thing. We've engaged in a bit of this here in Hilliard, recently issuing new bonds a lower rate, which allowed us to retire other bonds we were obligated to pay off at a higher rate.

The folks in New Albany decided that 2007 was the right time to lock in a lower interest rate, just as we thought 2008 was the right time to lock in rising natural gas prices. However, none of their bonds where coming up on a 'call date.'  When a bond is issued, it's like a mortgage in that it specifies both an interest rate and a term, usually 20-30 years. The buyer of the bond expects to be paid interest for the entire term, and then at the end of the term, get back the original price ('face value') of the bond as well.

However, the issuer can choose to make a bond 'callable' on an earlier date, or several earlier dates. This gives them the option to pay off the bond early, just like a homeowner can pay off a mortgage early, except callable bonds can be called only on specified dates.

New Albany had issued callable bonds, but in 2007, the next call date was another five years in the future, and they thought it was likely that the very low interest rate environment wouldn't last that long. So they did a deal called a 'synthetic interest rate swap' to give them the benefits of calling in their bonds, albeit at a premium.

It turns out that interest rates did stay low, and had New Albany just done nothing for the five years, they would have been able to issue new bonds at a low rate, and used the proceeds to call in the older bonds issued at a higher rate - the customary route of refinancing. But they did do the synthetic rate swap, and have now decided to buy out of that arrangement.

So was all this a bad deal for the people of New Albany?  That depends on your perspective.

The New Albany officials are correctly pointing out that the actions they took will result in less total cost to the taxpayers than if the original bonds had just been paid out through the original maturity date in 2029. That's true, but this statement leaves out the fact that they had a call date coming up in 2012, and would have almost certainly exercised that right. They go on to admit that, saying that their 2007 deal will in the end have cost them more than just waiting until 2012 and refinancing in a more standard manner.

However, that's true only because interest rates have remained low when many people - me included - thought that the Federal Govt would have to resort to inflating the money supply in circulation to fund the stimulus, which would rapidly drive up interest rates - perhaps to what it looked like during the late 70s when the prime rate neared 20%. That is still likely, in my opinion, but it hasn't happened yet. We all need to stay on our toes!

So New Albany ended up somewhere between the best case and the worst case. That's not a bad outcome.

Running a school district is like coaching OSU football. For the folks running the district - the School Board and Administration - the clock is running, and decisions have to be made in real time. Everyone else gets to watch the films and analyze the statistics after the fact, then pass judgment from the perspective of hindsight.

I like to collect leadership slogans, and one of my favorites is "A Good Decision Made Late Is the Same Thing as a Bad Decision."  Our community spends a lot of money to operate our school district, and there are a number of multi-million dollar decisions that have to be made every year.

It's very challenging to make those decisions when there is so much volatility in our economy. The investment professionals who manage the treasury of the State Teachers Retirement System guessed wrong, and in 2007 lost nearly half the value of their fund - more than $30 Billion.

The leaders of our district had to make a decision about natural gas in 2008, when prices were skyrocketing. As Geddy Lee sang, "if you choose not to decide, you still have made a choice."  They made the choice to lock in at what turned out to be a high. It seemed like a good decision at the time, and I might have supported it had I been on the School Board then. All we can do now is lick our wounds, get out of that deal, and move forward.

Likewise, the New Albany leadership thought 2007 was a short-lived low period for interest rates, and took action. It cost them some money, and there's nothing anyone can do about it now. They're taking what seems to be the appropriate action going forward.

These aren't the last times such decisions will come before a school board. Had the Hilliard School Board not locked in natural gas prices in 2008, and those prices had followed oil (which has more than doubled since 2008), we'd be spending a painful amount more to operate our school right now, and lots of people in our community would be casting blame on the school board for not locking in low prices when they could have.

I've been a decision-maker for a long time, and I know that part of the role is getting feedback from those who weren't there when a decision had to be made. So I'm not complaining. I've given my share of post-game feedback as well. And I've volunteered to put myself in the position of being judged. So no complaints.

But every once in a while, it's worth asking for a little empathy.


  1. My comment is simple, is the person who recommended the action by the board held accountable? Will / does it show up in Mr. McVeys evaluation. I ask the same about the need to change the holiday vacation period.

    What is the total cost (packing, moving and construction costs to move the leadership out of the present building and the same for moving into the building by others. Why was that talked about during the levy? Was it Dale just doing after levy passing? Very poor communication or hide and tell and hope the tax payer does not remember at next levy. I thought we voted for a bare bones levy olny to learn about this!!!

  2. When the Superintendent first proposed building the Innovative Learning Center, there were indeed concerns raised by members of the Board in regard to the "no new programs" pledge made during the last levy campaign. However, we have been assured by the Administration that there will be no net new operating costs because of the ILC, and that the small amount of remodeling that will be needed will be covered by the funds received via the Permanent Improvement Levy which was approved by voters several years ago. Much of the labor will be performed by inhouse staff.

    To me, it makes lots of sense to encourage the Administration to continue to seek innovative ways to simultaneously improve service delivery while lowering costa if possible, or at least keeping costs the same.

    However, I also recognize that the day may soon be coming when we have to decide how much of our current programming we can afford.

    My wife and I attended the performance of "Bye Bye Birdie" at Bradley High School last evening. Those kids did an inspiring job in all aspects: acting, singing, orchestral accompaniment, stage management, prop construction, etc. I'm sure ticket sales offset some of the cost, but in no way did the revenue generated offset all the costs associated with running a top-notch theater program in our schools.

    There's nothing on our State Report Card that gives us any credit for having great extracurricular programs. I know the arguments that when kids participate in good extracurricular programming, the academic performance tends to improve as well, and have no doubt that there is a correlation.

    The question is who should bear the cost of those things we offer that surpass what is needed to deliver what the Ohio Constitution requires - a "thorough and efficient education?"

  3. Paul, I understand about encouraging administration to do new and innoventive things within education. But when there are no funds to add new personel, then other personel are going to be used. Thus taking away from our current buildings. With the limitations on hiring within the district, at this time, I really can't see nor understand how thinning staff at other buildings is going to benefit students as a whole. More is not always better when you take from elsehwere.

  4. It is unfair to compare refinancing long term debt (a decision made in the ordinary course of our business) to speculating on energy futures (something we shouldnt have been involved with in the first place).

    I'm not trying to beat a dead horse here. But I would love to know who our counterparties were in the natural gas futures...

  5. I see these two situations as very comparable. New Albany bet that interest rates had bottomed out were headed back up, giving them an opportunity to reduce interest expense. Our bet was that gas prices would keep rising, and that buying futures contracts would save us some energy expense. Both of us lost those bets.

    I'm not sure it matters who the counterparties are unless there is concern that: a) they would be unable to honor the deliverable; or b) there was some collusion between school district officials and the counterparty in order to skim the deal.

    Is it one of these things that concerns you, or something else?

  6. Anon: there are already personnel scattered around the various buildings who teach/tutor special programming, and kids are being transported from their 'home' schools to other schools where these programs are offered. My understanding is that the ILC concentrates many of those programs and staff to a central location.

    Let's give it a chance.

  7. Regarding counterparties- I think it is important to understand who you are dealing with, their motivations, and assess whether or not they have knowledge we don't.

    My concern is that somewhere there were investors much more sophisticated than us who were chuckling the moment we entered into the futures contracts.

    I see this a lot differently than dealing with known bond underwriters and investors.

  8. I take your point, and agree with the potential for mischief.

    This is one more example why it's important for our school board to be transparent in regard to these kids of deals, and for the people of our community to pay attention to what shows up on the agenda. You never know when someone is going to have a crucial insight that keeps us from being played...

  9. Looks like Reynoldsburg got into one of these interest rate swap deals too.

    According our Treasurer, Brian Wilson, and to your point T, JPMorgan was pushing these instruments pretty hard, apparently with intent for larceny: "At least seven former JPMorgan bankers are under scrutiny in a Justice Department criminal investigation of whether banks conspired to overcharge local governments on swaps and other derivatives. The bank also is embroiled in negotiations over how to resolve a debt crisis with Jefferson County, Alabama, where the county's former adviser says a group of firms led by JPMorgan, the third-largest U.S. bank by assets, overcharged it by as much as $100 million for financing a new sewer system." (Bloomberg)

    Brian had sniffed that out, and kept us out of that mess.