Charter school bond financing - the next subprime crisis?
Page created Feb 12, 2011; last updated Feb 15, 2012
by C.A.S.I.L.I.P.S. - Citizens Against Special Interest Lobbying in Public Schools
One of the selling points of the charter school system was that charter schools would result in cost savings for taxpayers. The schools were to receive less money per student than traditional district schools, in return for which they would get greater freedom and flexiblity.
Ironically, no sooner was the charter school system established, than proponents began to complain of the unfairness of funding inequalities.
It is not entirely clear that a funding inequality truly exists for all charter schools, as a full accounting of all the benefits received by charter schools, including not only per-student state funding, but also startup funds, state and federal grants, and tax exemptions has not been made. The cost of oversight of charter schools is usually carried by the districts rather than the charters themselves. Some areas require district schools to grant charter schools use of their facilities when available. In addition, some charter schools have received private donations.
Tax-exempt bonds are being pushed to help charters acquire facilities
While some charter advocates have pushed for greater per-student state or local funding, others have focused on easing the burden charter schools face in acquiring building facilities, whether leased or owned. These financial obstacles were the subject of a report from January 2004, produced by the Institute for Education and Social Policy of the Steinhardt School of Education of New York University, partially supported by the Bill and Melinda Gates Foundation, and entitled "The Finance Gap: Charter Schools and their Facilities." It noted that charter schools must use a significant portion of their revenue to lease or acquire their facilities. The charter schools studied were found to be spending an average of 20-25% of their revenue to service their debt. Reasons cited included the inability of most charter schools to receive tax-exempt bonds, and the higher interest rates private lenders charge them because of the perceived risk.
The report noted several ways used to overcome the risk of loaning to charter schools:
(1) "To facilitate charter schools’ financing, some states and private entities have also created credit enhancement programs." While the report does not state it explicitly, most of these credit enhancement programs involve a government entity partially backing the loan.
(2) "As financiers become savvier about charter schools, more products, such as loan pools and bond pools, are being developed to provide affordable financing while decreasing lending institutions’ risk or exposure." While pooling does indeed reduce risk, we wonder if this does not also contain an element of re-packaging risky investments in ways to make them appear less risky, which would be reminiscent of the "creative" new financial instruments that lead to the subprime mortgage crisis and the recent recession.
(3) "While three of our study states have lengthened charters to as long as 30 years to make schools more attractive to investors, this shift may work against the performance-based accountability ideals of the charter movement." Indeed, a 30-year charter might as well be permanent, as far as any accountability is concerned.
High turnover means high risk
How risky is it to loan to a charter school? The website of the National Alliance for Public Charter Schools states that nationwide for the 2009-2010 school year, 160 charter schools closed, 443 new schools were formed, and the total number of charter schools was 4919. Thus, the nationwide closure rate for just that one year was around 3%. It is important to consider that while this percentage may not seem large, it represents only an annual closure rate, which when considered over a several-year time period points to a high degree of instability in the system. Furthermore, calls for more accountability of charter schools have been increasing, possibly leading to a higher rate of closures in the future. For example, new legislation was passed in 2009 in Ohio that forces closure of charter schools failing certain academic performance criteria. A June 28, 2010 article in the Columbus Dispatch noted that under the new law, "ten schools - two in Franklin County - had to close this month." The first line of the article, "At the same time that 31 Ohio charter schools could be ordered to close, another 41 could be gearing up to open," speaks to the constant turnover in the system.
Uncertainty regarding charter schools' long-term viability has led to their generally not being considered sound investments, as the Finance Gap report noted. The report ended by suggesting that private financing for charter school facilities must be "rethought." In plain terms, they proposed that the government provide additional money for charter school facilities, above and beyond the per-student funding they are already receiving. This idea, which might well result in charter schools costing as much or more per student than traditional public schools, does not appear to have caught on. However, tax-exempt bond-financing for charter school building construction and renovation has been tapped into extensively.
Charter school bonds have become a half-billion-dollar-a-year industry
A presentation made at the 2010 National Charter Schools Conference by Adam Porsch of the Bill and Melinda Gates Foundation showed that rated tax-exempt bond issues for charter schools in 2007 totaled $676 million. This amount did not include unrated tax-exempt financing. While Porsch et al found lower amounts for 2008 and 2009, large bond deals continue to be approved. On June 18, 2010 the Texas Insider reported on a landmark bond deal for the Cosmos Foundation, charter holder for the chain of over 30 Harmony Public Schools in Texas. The total worth of Cosmos' bonds sold in 2010 was 90 million dollars; many of these bonds will not mature until 2040. In 2009, KIPP, Inc received $67,285,000 in education revenue bonds from the Texas Public Finance Authority Charter School Finance Corporation, maturing in 2034. The Arizona Daily Star reported on September 12, 2010 and September 16, 2010 that the Board of Supervisors of Pima County, Arizona Industrial Development Authority approved a 90 million dollar bond deal for New Plan Learning, for construction and renovation of charter schools managed by Concept Schools in Ohio and Illinois, including several Horizon Science Academy schools and the Chicago Math and Science Academy. Questions were raised in both Ohio and Arizona regarding this deal, and it is not clear whether it will actually transpire. The owner of New Plan Learning, Vedat Akgun, was mentioned in the report "Authorized Abuse: Sponsors, Management and Ohio State Law" in connection with related-party deals that were said to not have met the standards of the NACSA (National Association of Charter School Authorizers).
These bond issues, when considered against both the large turnover in charter schools as well as a number of studies showing that they perform no better and perhaps worse than public schools, raise concerns about what might happen to these tens of millions of dollars in bond debt if state governments start to push for the closure of some of the indebted schools. Already, there are concerns that, as the Finance Gap report phrased it, "the finance community’s criteria of an investment-worthy charter school are shaping important aspects of charter schools in ways that may not always be advantageous to the schools and their students." These ways include pressure to have charter school boards populated with members with business or financial experience. While this may help the schools' fiscal soundness, this emphasis on business rather than educational vision and experience may well take a toll on school quality. A further concern is that creditors of schools with large debt burdens might put pressure on government regulators to keep schools open in order to protect their investments, even when by academic standards the schools should be closed down.
Default can be messy
Indeed, this scenario played out on a small scale in Albany, New York in February 2010, when trustees recommended closure of the New Covenant Charter School. It turned out that private investors, including senior citizens, held 15 million dollars in bonds that were at stake in this decision. A representative for these investors spoke at the charter school committee meeting, trying to gain sympathy. But should the concerns of investors really be a factor in our public education system? Might this not have a detrimental effect on academic quality in the future?
It is noteworthy that a December 4, 2010 op-ed piece in the Houston Chronicle by Mike Feinberg, Superintendent of KIPP Houston, simultaneously advocated more bond offerings for charter schools and the closing down of low-performing charters. Being affiliated with KIPP, Feinberg may feel that it is a straightforward matter for our government to separate the schools that should be closed from the schools that should get bond offerings, and that there will be negligible overlap. We doubt this, as politics and other factors will enter into these decisions. The combination of large turnover and large private investment in charter schools is a recipe for the creation of numerous loans to non-credit-worthy parties, in other words, another sub-prime lending crisis.
In principal, school building facilities should function as collateral in the event of charter closure and bond default. In practice, investors can only recover part of their money at best. Much of the expenditure on a school building is specialized to its function, so that conversion for a non-school use will necessitate additional investment. School buildings cannot easily be liquidated, and are nearly always liquidated at a loss.
Are investors fully informed?
In addition to the risk associated with investing in any charter school, a large network of charter schools that includes both the Harmony Public Schools in Texas and the Horizon Science Academy chain in Ohio come with an additional wildcard that private bond investors are likely to have been completely oblivious to. These schools are all run by the Gulen Movement, a controversial and highly secretive politico-religious movement run by Turkish Muslims who have to date publicly denied any involvement with this Movement. The evidence for the connection is extensive, and is starting to be publicly acknowledged in various venues which have included USA Today, the Baker Institute, and most recently Religion and Ethics Newsweekly on PBS. It is yet unclear how the rapidly-growing public awareness of this connection will ultimately affect the viability of these schools, which until now have enjoyed positive publicity and a public perception of success, greatly facilitating the public approval of their bond issues.
Traditionally, government bonds have been considered the safest of investments. When state or county finance authorities approve tax-exempt bond deals for charter schools, do private investors really understand how these bonds are fundamentally different from the traditional bonds issued for highly stable entities such as district schools or utility companies? Do these investors know about the Gulen Movement's involvement in charter schools? Do they know that many questions have been raised regarding whether charter schools are really doing a better job of educating students?
Will the money disappear long before the bonds mature?
The agenda of the Texas Public Finance Authority December 19, 2010 meeting shows that Cosmos Foundation, which runs Harmony Public Schools, is currently seeking an 80 million dollar bond sale in 2011. One noteworthy point is that Cosmos' Chief Financial Officer, Umit Pecen, who was involved in presenting the bond proposal to the Charter School Finance Corporation, was, according to a resume located on the beyond.com website, Vice President and Chief Financial Officer of the now-discredited Marlali Property Investment Company. Marlali Property Investment Company was involved in a Ponzi scheme that bilked investors of 20 million dollars; the money disappeared to Turkey. The complaint document of the Securities and Exchange Commission's federal lawsuit against Marlali and its associates mentions that a Mercedes Benz ML350 vehicle belonging to Marlali was registered in the state of Illinois to Umit Pecen. Umit Pecen (also known as "Kenneth" Pecen) once resided in Illinois, where his wife, Fatma Pecen, was business manager for the Chicago Math and Science Academy, another charter school affiliated with the Gulen Movement. Moreover, Marlali Property Investment Company filed H-1B visa applications for financial professionals, very suggestive of the Gulenist modus operandi.
There will be only minimal governmental oversight of the Cosmos Foundation's use of the bond money. There is also much evidence that the Cosmos Foundation has goals other than education.
In summary, the private investors who bought into these various charter school bond issues are in an unenviable position. Much can happen between now and 2040, when many of the Cosmos Foundation bonds will finally mature. More revelations about lackluster charter school academic performance may emerge, and the public may tire of charter schools, or become disenchanted with the Gulen Movement. However sound a charter school may seem today, all it takes is a change of heart of even a fraction of its enrolling families to switch it from financial strength to a non-viable state. For all that we've been assured that public monies are not at risk in these bond issues, when private investors face losses in the tens or hundreds of millions, will the government be able to stand by passively?
Or is another government bailout awaiting us around the corner?
Addendum: On July 19, 2011, SB 1 went into effect in the state of Texas, allowing "financially sound" charter schools access to the bond guarantees from the state's Permanent School Fund (PSF) for school building construction and renovation. This means that if a charter school closes and its buildings are worth less than its bond debt, Texas taxpayers will have to pay the difference.