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Wall Street vs Schools in California

California school districts, hit hard by declining tax revenues, are turning to Wall Street for “capital-appreciation bonds.” It’s a quick fix with a heavy cost: In return for delaying payments for decades, the districts will have to pay back much, much more than they borrowed—often 10 times as much. Needless to say, these cities will be in serious trouble if they can’t come up with considerable cash down the road.

State officials are beginning to get worried. This week, the head of the California Treasury Department is calling for a major reconsideration of how the state deals with these bonds, the Wall Street Journal reports:

Mr. Lockyer said he would ask legislators for overhauls including a cap on indebtedness of about four times principal. “That would still be a little high because the rule of thumb when we do borrowing is we expect debt to be two to three times the principal borrowed,” he said. Mr. Lockyer said he might also seek shorter time limits on repayment of the bonds. A spokesman for legislative leaders said they plan to take up the issue.

Pending any new legislation, Mr. Lockyer said he has met privately with underwriters to seek voluntary restrictions on CABs, including a possible moratorium on their issuance.

The schools’ debt has made strange bedfellows of unions, blue politicians and Wall Street financiers, but that coalition will be difficult to break. It’s unlikely this will go through without a fight.

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