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A Dangerous Game

August 15, 2012

For those of you who read my last article in the APB, “San Jose’s Bad Fiscal Policy,” I think you will find this article about California school districts using zero-coupon bonds interesting. A zero-coupon bond essentially means that the bond issuer offers a bond to investors at a discounted price, with the promise to pay the investor back for the full promised value of the bond on a specified date in the future, with interest, all in one balloon payment.  So rather than the bond issuer slowly paying down that debt over time through regular payments, the financial liability for paying that back comes all at once, in one single payment.  These kinds of bonds are a dangerous game, especially when you extend maturity dates into infinity. This Bloomberg article only confirms our addiction to debt and our complete inability to even have the remote understanding of what ‘living within in our means’ actually looks like.

“Poway is deferring all payments on $105 million in bonds issued last year until 2033 after officials promised voters four years ago that the securities wouldn’t raise taxes. By the time all the bonds mature in 2051, the district will pay $1 billion in interest, the data show.” This quote from the article we really need to stop and think about for a moment.

Let me try to personalize this. Let’s say you saw a fancy new car that you just had to have, but you have no money (in fact, you are significantly in debt). You ask the car salesman what that shiny new car is going to cost you and he informs you that you can drive it off the lot for a mere $200,000.

You explain that you don’t have a penny, but the salesman says that’s no problem, we are running a special; you can drive this car off the lot today — at this point you can’t hear anything else he says and sign the paper work he shoves into your hand. A few months later you discover that the insurance and maintenance for the car is killing your finances and you sell it for half the price and buy that shiny new boat you just have to have with the money from the sale of your car.

Twenty years later you get a notice in the mail about the document you signed when you obtained that fancy car that you just had to have but failed to understand the details of the purchase contract. The notice you receive informs you that not only your house, but your children’s houses, are going to be repossessed if you do not immediately pay the car dealer $2,000,000. Read the article; that is what we have done to ourselves for decades, but we have not learned from our mistakes and seem only to be increasing these horrible practices at an exponential pace.

Thank you, John, for sending me this Bloomberg article.

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