Nov. 13--In recent years Chicago Public Schools joined the rest of the country in getting scorched by the Great Recession. It looks like the district got outplayed by its bankers too. "Borrowing Trouble," a three-part series by the Tribune's Jason Grotto and Heather Gillers, explored how CPS, under chronic financial pressure, turned to new borrowing methods -- and now is paying a tall price.
To review the bidding: In 2003-07, the district pursued what it thought was a cheaper, more creative way to finance debt than selling traditional, conservative, fixed-rate bonds. But then the markets turned violently against the school system's investments. That leaves CPS' decision to borrow $1 billion through complex mechanisms tied to floating interest rates look risky and foolish.
The Tribune's analysis of the CPS deals concludes that when the books are finally closed on the transactions many years hence, the school system stands to pay an estimated $100 million more in today's dollars than it would have paid on fixed-rate bonds. CPS and its main adviser dispute that finding. But their analysis in turn was criticized in the series by several outside experts who backed the Tribune's more comprehensive projections. (Read the series at chicagotribune.com/cpsbonds)
CPS wasn't alone in getting hammered. Banks, brokerages, corporations, homebuyers, all were caught up in the recession's mayhem. But was it appropriate for a financially ailing school system, whose mission is educating children, to be playing in the same sandbox as Wall Street firms and other investors whose mission is to take risks and make money? If companies lose bets and go out of business, that's life and death in the private sector. A big-city school system can't pay the ultimate price, so it shouldn't be playing in that sandbox.
Yes, hindsight helps a lot in declaring CPS' debt strategy a debacle. But did district officials apply sufficient foresight? There were clear risks to the strategy from the outset that were accepted by, among others, David Vitale, a longtime CPS official and former banker who is now school board president. Many other government and nonprofit entities across the U.S. got into trouble over these complex, interest-rate swap agreements. But as the series points out, CPS did more of these deals than any other school district: From 2003-08, the amount of CPS' variable-rate debt grew sixfold, until it accounted for more than 40 percent of outstanding debt.
It's as if, when CPS officials were considering this strategy, nobody warned: "We know the next financial crisis is coming, we just don't know when. Where do we want our risk profile when it does?" Financial expert Andrew Kalotay told the Tribune that with deals as complex as these, "you find a very high probability that something is going to go wrong over 25 years."
As a result of the 2008 trauma, CPS has had to re-do much of its borrowing -- at great cost. The pain comes from higher interest rates, plus millions in penalties paid to get out of some financial instruments. Big penalties to escape a contract in some future year? This was the kind of warning bell CPS officials might have pondered. Illinois lawmakers weren't paying attention either. When legislation permitting CPS to invest in auction-rate securities arrived in Springfield in 2003, the ruling lawmakers didn't perform due diligence before allowing the district to proceed.
Illinois' overall financial troubles run deep and from border to border. Among the gravest concerns of governments statewide: CPS has billions in unfunded pension liabilities. We knew before the series ran that the district isn't above accounting gimmicks, such as its plan to cover fiscal 2015's budget shortfall by claiming, in advance, dollars from fiscal 2016. Yes, a public entity can't live within its means, so it spends 14 months of revenue to run schools for 12 months. Don't try that at home.
Despite CPS' bad experience with floating-rate instruments, we aren't calling for a blanket moratorium on the use of these securities. Money managers need multiple tools in their toolboxes. Good judgment dictates whether and when to use them. CPS has to do a much better job of assessing the risks involved in managing finances -- and not just during turbulent times.
If there is reason to believe that CPS can seek redress against the banks in court, district officials should pursue that avenue, even if it means acknowledging that bankers bamboozled district officials.
Beyond that, the district ought to tell Chicagoans it will manage its funds and its debts more conservatively. Better risk management guidelines should impose on CPS a less risky borrowing and investment philosophy because the stakes -- the operation of Chicago's schools -- are so high. Some states use a prevent defense, imposing stricter guidelines than Illinois does on financial risk-taking.
What's certain here: Many Illinois governments, school districts included, are in desperate straits. That crisis atmosphere tempts some finance officers to take higher risks than their predecessors would have taken.
But, again, we know the next financial crisis is coming, we just don't know when. And when it does come, how exposed do those finance officers, and their elected or appointed overseers, want their governments to be?
This has been an expensive lesson for CPS to learn, but one that all Illinois governments can go to school on.
