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What the Devil won't tell you

TUSD's decision to bond is not sub-prime

Just because it's debt, doesn't make it bad

I've been monitoring the debate about the Tucson Unified School District bond election, and a strain of argument has me feeling the need to flag the the "No" side with Conflating a National Problem with a Standard Business Practice. Fifteen yards. Automatic first down.

I'm not going to argue about Proposition 458 on its merits. Everyone else can do that. It's the chatter I've been hearing that compares bond debt to all that morally nebulous debt that is drowning Washington and destroying the economy.

They are in no way the same thing.

I've covered so many of these proposals and wished I had the room to explain how the hell bonds work — and why, no, not all debt is created equal when it comes to our governing institutions. A smarter Tucson is a better Tucson, so let me now unpack all those claims and misconceptions about bonding and debt in general, ahead of TUSD's $180 million question.

The federal budget is a nightmare. Congress sucks $3.5 trillion into a big vat of cash and then doles it out $3.9 trillion using that vat plus the sale of Treasurry bonds to make up the difference (the deficit). It's an absolute accounting horror show specific unto itself, and, truth be told, how most of us go about our financial planning. OK, maybe just me.

But debt, good people of Southern Arizona, can be good for you if it's used right.

Prop. 458, TUSD's bond question voters will answer by Election Day, makes financial sense. The annual cost is $52.54 for the owner of the average home in the district. And remember, voting no doesn't get the average taxpayer off the hook for the bill regarding air conditioning, roofing and school buses. It's how the district pays that counts.

Mortgages are a good example of smart debt, so long as homeowners don't keep clawing their way into bigger and bigger McMansions by cashing out equity. Student loans can be examples of smart debt, if you don't borrow money to go drinking every Thursday and manage to swing a decent job after graduating.

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Cash vs.debt

When I covered the crash of 2008, I had this conversation a lot when bankers and I discussed the good old days. That mirrored what I read in William Greider's "Secrets of the Temple" (if you want to read a 1,000-page non-fiction book about the Federal Reserve). I threw in the rich uncle part for a cash comparison.

Say, back in 1987, a rich uncle died and left you $75,000 and that was the price of a Tucson house you had your eye on. At the same time, you could qualify for that house with a $600 monthly payment. Would you pay in cash? The house would be yours, assuming you could pay the taxes. No one could take it away from you. Plus, you are making just $2,000 a month. It wouldn't be easy to make the payment every month, at first and would have some cash left over every month.

The pay-as-you-go people would argue to buy it now in cash.

Bad idea. The mortgage allows you to pay today's prices in tomorrow's money. That means five years and some compounding inflation later, and you are making $3,000 but your housing payment is now just 20 percent of your income. Ten years later, after a couple promotions and a decade of compounding inflation, you are taking home $5,000 a month. The housing component of your budget is just 12 percent of your income, which leaves 18 percent for investing, saving and otherwise doing cool stuff. By 2017, you are earning $7,000 a month. Your housing payment is now just 8.6 percent of your income. That leaves you with a 21.4 percent of your paycheck to go do things with, without necessarily hurting yourself.

Now, if you had invested that $75,000 in 1987 and just matched the Dow Jones Industrial average, today that inheritance would be worth more than $650,000. Had the house appreciated at 2.5 percent a year, you'd have a $158,000 house that is entirely equity and a spanking retirement account. So, by not buying the house in cash, you come out way ahead.

This is why your grandparents and parents lived in the same house for 50 years and didn't keep trading up to a better McMansion. They used the fixed-rate debt to beat down inflation, which drove up their income after they locked in their housing budget. A modicum of inflation is awesome when you are in debt so long as you get a decent interest rate. If inflation takes off after you took out the fixed-rate loan, well now. The borrower does great.

See why we want people to buy homes? It's not for the equity. A house is a giant hedge against inflation.

What to ask about bond questions

Debt proves ruinous if it's unaffordable and unsustainable.

During the 2000s, the country experienced flat wages and easy credit. So we experienced a disaster. Debt is bad when you are using it for daily maintenance and operations. You don't want to use debt to pay for your food or your gasoline or your bills.

Just because your cousin ran up $358,371 in Visa bills slinging hash at one of Bob McMahon's restaurants doesn't mean taking out a line of credit is a disaster in the making. Even if your neighbor had to walk away from a half-million-dollar house he bought while earning $31k as a newspaper reporter doesn't mean debt is an evil temptress.

It's important to ask, when the government wants to float a bond, if they are using any of it for regular expenses, rather than big-ticket investment too pricey for monthly cash flows.

Yup. TUSD's bond proposal. They want to use it to buy school buses and upgrade air conditioning because it's known to get warm in Arizona come summer. There are classroom renovations an safety equipment. Are they frivolous? Eh. Maybe. Maybe not. They are one-time expenses.

Is it sustainable? Yup. You gotta know how bonds work. Sooooo ...

How bonds work

The debt the district is discussing would be paid with an increase in the secondary tax rate and voters control every bit of that rate.

City councils, county supervisors and school district governing boards decide your primary tax rate and that is used to pay teachers, buy paper, and  fill gas tanks. But secondary rates are reserved largely for things like debt or taxing districts voters must approve. If voters agree to repay a bond with a secondary tax, revenues from that tax can only be used to pay off the debt they approved. Period.

An aside from a watchdog reporter: Sometimes governments attempt to camouflage a tax increase as a tax cut as debt is retired.

It works like this: Say debt is being retired and the need for the secondary tax is going away, so a given taxpayer sees their secondary tax drop by $300 a year. A sneaky government will then raise the that taxpayer's primary tax bill by $250. Then they shop it to voters as a $50 tax cut. That is in no way a tax cut. The secondary property tax — approved by the voters, not elected officials — was coming down regardless. Politicians have no say in that. So they get cheeky suggesting raising the primary tax bill by $250 is anything other than a $250 tax increase. I call this "Doing the Huckelberry."

Back to the TUSD question (although you should ask the same questions if you live in one of the other districts that is looking at long-term financing).

If approved, TUSD will hire financial pros to find bond buyers at a given interest rate. The plan is to sell the bonds in three tranches, between 2018 and 2022. In the TUSD's election book that went out to voters earlier this month, the district calculated conservative 4.5 to 5 percent interest rates. The actual interest rate will be largely determined by two factors: TUSD's bond rating and fear of inflation.

TUSD has two different bond ratings, because this can't be easy. Moody's has it pegged at AA and Fitch is more generous with a AAA.

Right now, 20-year general obligation bonds on governments with AAA bond rating pays 2.5 percent interest and AA bonds are fetching 2.75 percent yields. Inflation stands at 2.2 percent for the year.

Fun with inflation

Inflation makes debt smart for the same reason we are all told now to take the lump sum should we win the lottery.

Bond interest rates are small compared to stocks returns — we're talking 2 to 7 percent — so inflation destroys the value of those returns. If I get 5 percent return with a 2 percent inflation, I'm making 3 percent a year in buying power. If I'm getting 2 percent return with 5 percent inflation, now I'm losing 3 percent. This is why the bond market talks about "inflation premium."

Now, I'm not going to pretend to be an expert in the bond market but if we sold bonds today at 2.5 percent and inflation should average 2.6 percent, then we are in great shape. We'd be riding the stronger dollar to beat down the interest rate. The increasing dollar's strength outstrips the cost of the debt so the district would get to draft behind inflation.

Even if we're not talking about best-case scenarios, bonding a perfectly OK arrangement. What's it worth to us to keep $180 million dollars available for our use today in return for paying off that amount in purchases over 20 years? And remember, you have to measure the actual cost against inflation. If that spread is 1 percent, then is it worth us paying bondholders 1 percent after inflation to keep $180 million handy? Remember what investing that $75,000 did for us.

I say that's a fine deal if it's sustainable.

The U.S. debt is about $20 trillion — give or take — on a $16.5 trillion annual gross domestic product. Even if we spent every dime of the economy on the debt for one year, we could not wipe away all that red ink. TUSD is asking for $180 million (plus interest) and the district's total property valuation is $32.4 billion. The district's debt limit under state law is just over $1 billion. The TUSD board is not jeopardizing the financial future of Tucson with this request to voters.

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Debt is a tool. Put a spinning drill to plywood and you have carpentry. Put a spinning drill to Ming china and you have a mess. Tucson, if it helps, just think of debt as a gun. Debt doesn't kill finances. Stupidity kills finances.

So now the only questions are: "Do Arizona school kids really need air conditioning? How big a deal are safe buses anyway?"

Blake Morlock is a journalist who has spent 17 years covering government in Arizona and also worked in Democratic political communications. Now he’s telling you things that the Devil won’t.

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have your say   

2 comments on this story

Oct 27, 2017, 4:22 am
-0 +0

Thanks for reading Abbie ...

Oct 21, 2017, 9:29 pm
-1 +1

That was a lot of words just to end with some bad questions in the end.

Do zoos and dogs need more resources?

Do preschoolers need preschool?

Will voting no cause all buses to be unsafe? Will all AC units fail?

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