With April 24 looms an important deadline for DPS’ finances.  This is the date in which one of the key stakeholders in our volatile pension financing scheme contractually bows out of the deal, potentially leaving us with having to cough up $750 million in cash reserve to keep the entire wispy deal intact.  Fortunately, much progress has been made toward a more stable disposition of the deal, thanks to the incredible leadership and pushiness resolve of my colleague, Jeannie Kaplan (Central Denver), as well as the cooperation of Treasurer Mary Seawell (at-large).

Sewing up the pension deal hole

Here are some incredibly important wins Jeannie has been able to achieve:

• An impartial financial advisor to the Board has been hired.  We’ve retained Tim Schaeffer of  Magis Advisors, who advises public sector clients on their bond programs and their debt.  To paraphrase Vice President Biden, this is really a big flippin’ deal.
• Discussion of this pension bond deal, and the pitfalls, have been now moved to a wide-open public forum, and DVDs of the proceedings have been made (I have copies, if anyone wants to see them).
• Some members of the Board now have a much more cogent understanding of how this deal works, as well as the pitfalls and missed opportunities.
• The Board agrees now that the deal must be restructured so that impact to classrooms and pension fund health is either drastically eliminated or removed.

You see, previously, it was asserted that Jeannie and the other two of us only wanted to talk about the pensions because it was “political.”

Missed Opportunities

There were a few chances to set things on a more stable footing throughout the life of this deal, and I’m cataloging a few here:

• At the time of the pension refinance, when the district was moving toward merger with the state pension system (PERA), there was no real reason or requirement to bring the pension fund to a 100% funded status.  We were at around 75% or better, which is an extremely healthy pension fund.  Most funds around the country are at 55% or so.  We lost out on the opportunity to leave things as they were.
• We had an opportunity to move to a fixed interest rate without taking a termination fee hit at a few times over the last couple of years, most notably around the end of October 2010 (yes, a few months ago), when interest rates took a nosedive.  There still would have been termination fees, but the cost savings of moving to a fixed, much lower rate, would have made it a wash, at the very least.
• Because of the (extreme) reluctance of district staff to put all facts on the table when initially requested, we now have to make the best decisions we can while possibly not fully investigating all options due to the shortened time frame.
• We’ve wasted a lot of time wrangling over the need for a financial adviser, when we could have been working with him to develop sound fiscal and investment policies going forward.  Now we have to craft these policies after the horse has left the barn.

The graph below shows what has been happening with treasury notes, or the foundation of our interest rates, over the last few months.  The top line is for 30-year rates, the bottom for 10-year rates.  Interest rates are calculated with these treasury rates plus some factor that reflects base risk.

Top line is 30 year, bottom is 10 year. Click to enlarge..

And so as we move toward a resolution of this situation, here are a few of my guiding principles.

Principle #1: No unnecessary risks should be taken.

While the interest-rate swaps that are part of this pension bond deal might be a good idea for the private sector, the Denver Public Schools is decidedly a public-sector entity (note the word “Public” in our title), and therefore we do not have the same risk tolerance as a for-profit company.

There are some for-profit companies that have made off very well in deals like this.  This deal depends on a relative stability in interest rates, and along the lifecycle of such a deal, there can be very scary market fluctuations that create cash flow problems.  For longstanding private entities with lots of assets, this may not be an issue.  If a cash flow problem arises, they can simply sell off assets to shore up the difference.

For the Denver Public Schools, on the other hand, our assets are school buildings, school buses, lunchroom tables, computers, and the like.  In other words, every asset on our books is mission critical.  We can’t just sell off, say, East High School just to raise cash to cover a cash shortfall caused by market fluctuations.  If we do, we rob students of their rights to an education and thereby destabilize their futures.  Yes, those are the stakes.

Principle #2: Move to the safest, least volatile investments possible, immediately.

Interest-rate swap deals are unnecessary if a fixed interest rate is available.  They serve no one but the banksters that sell these instruments.  Because the bonds have to be “remarketed” often, sometimes even weekly, transaction fees and commissions are paid to the financial entities that “sponsor” them.  There were times during the life of this deal that we were absolutely paying out much more in fees than in proceeds, especially as the financial crisis in Greece came to a head (their problems are related to deals like ours).  These are also incredibly complex deals that were never intended for the public sector.

Over the life cycle of the deal so far, are we in a net positive or negative?  Does it matter?  Since I’ve explained that every asset (including cash on hand) is mission critical, can we afford to take periodic hits due to market fluctuations? I say, “no way.” In my opinion, the mentality that thinks it’s ok to suffer losses over 30 years, only to be in the black at the end, is completely inappropriate for a public school district.  Because of the looming state budget cuts, we can’t EVER afford to suffer losses, because kids are in school every year.  Period.

Principle #3: Our public employees have earned a safe pension.

Pensions are a sacred trust we make with public employees, who in return have to give up social security and other public benefits.  I do not believe in defined contributions.  I believe in defined benefits.

Now, should there ever be a situation in which we ask employees to contribute more to help us keep the pension fund healthy?  Absolutely yes, but that requires us to adopt a more collaborative spirit with our employees and to have all facts on the table so that we can have honest conversations between adults.  Our employees understand the concept of shared sacrifice, and they are dedicated to the mission.  They just ask that we’re straight with them and respect them as stakeholders.

Principle #4: No more gambling with public money.

The public money is not to be trifled with.  You, Mr. and Ms. Awesome Taxpayer, do not fork over your hard-earned green so that we take it to Vegas.  You are not asking us to make a profit.  You provide what we tell you we need, and you expect us to be as thrifty as possible and still ensure that kids are educated well.  If we can save money, great.  If costs go up, we need to justify them to you.  But you realize that this public education system is not about making money.  It’s about providing for our children.

Moving toward a solution

I reiterate my position on the nature of the deal going forward, which we should have little-to-no risk and that we should take advantage of fixed interest rates as quickly as possible.  The district seems to prefer a scenario in which we refinance around 75% of the bonds in a new interest-rate swap and 25% in fixed-rate traditional refinance.  It appears that they’re basing this scenario on their belief that we will not be able to get a good fixed rate.  I don’t happen to agree; in fact, it’s my and Jeannie’s belief that we could get as low as 7.25% fixed interest, saving a whole lot if we move all $750 million (we currently pay the equivalent of 8.5%).

The problem again centers around the volatility of the markets.  So, we’re proposing the following guidelines for the refinancing of the pension bonds, going forward (this is not intended to be a complete list yet):

• We will not accept leaving the bonds in the  interest-rate swap arrangement that currently exists.
• We should move as quickly as possible, as much as possible, to a fixed rate.  If the interest rates are anything lower than 8%, we should move all the bonds to fixed.
• If the rates are anything higher than 8%, we should evaluate the cost difference between moving half or more to fixed, leaving the other portion in swaps, in order to minimize the cash outlay in fees.
• Since the district believes that we might pay as much as $9.5 million in fees, depending on what the refinancing mix ends up being, Jeannie, Arturo Jimenez and I will be recommending a series of cuts we’ll need to make in order to offset those fees (my personal favorite: trimming back some of central administration).
• We should leave standing orders with our adviser to give monthly reports of the current interest-rate situation, and when interest rates move below a certain level, they will be authorized to move more bonds to a fixed rate.
• We should evaluate the cost difference between refinancing (either fixed rate or swap) over a 30- or 10-year scenario, especially if we still have a blend that includes swaps.

We’ll keep you posted as the negotiations move forward.