Michigan public schools pay for Wall Street meltdown

Bond failure means higher costs and uncertainty for schools

Last Dec. 11, the tuxedoed leaders of the Michigan Treasury Department and their financial advisers gathered at a ceremony in New York City to accept an award for an innovative strategy to help Michigan schools pay for infrastructure and cover cash-flow gaps. Two months later there is little left to celebrate, as Bond Buyer Magazine’s 2007 Midwest Deal of the Year is unraveling fast.

That Deal of the Year had involved a change in the way that the state borrows. Michigan, struggling to balance the state budget, had changed the format of its school bond program — until then backed by the full faith and credit of the state — into a $500 million “auction-rate” bond package, backed by a policy from MBIA Insurance Corp. and with rates determined by auction every 35 days.

Now that deal is falling apart because MBIA, which also insured billions of dollars of risky sub-prime mortgages, is reeling from mounting home foreclosures and investors have stopped bidding on the bonds that they back.

On Feb. 13, when $125 million of the Michigan school bond package came up for auction and there were no buyers, the interest rate was reset from 5 percent to 18 percent. Now state treasury officials are scrambling to get out of the auction-rate market and restructure the bond before schools are shocked by dramatically higher bond payments.

Continued -Tom White, executive director of Michigan School Business Officials (MSBO), was dismayed to learn about the bond market fallout on the School Revolving Loan Fund.

“It creates yet another pressure in a very difficult situation for schools, which are facing declining enrollment and volatile revenues from the state,” he told Michigan Messenger. “In the past, we have always been able to count on low interest rates on the bonds.”

White said that Michigan schools could absorb higher interest rates for a month or so, but any longer period of time would present big problems.

Joe Fielek, director of the state’s Treasury Department’s Bureau of Bond Finance, told Michigan Messenger that he is working to convert the failed auction-rate bond into one with an interest rate that is fixed for a year.

“By 35 days [before the next auction], we will have an alternative bond structure in place,” he said.

Though steps are being taken to contain the costs of the market upset, troubling uncertainties remain.

“I can’t explain what is going on in the markets now,” Deputy Treasurer Tom Saxton told Michigan Messenger. “I don’t think anybody can — it isn’t rational.” Saxton said that he is “somewhat optimistic” that bond market uncertainties will resolve but that it “will not resolve in two weeks.”

Michigan is not alone as it grapples to cope with uncertainly in the bond market. According to Student aid officials emphasize that MI-LOAN was a small program and that other lenders may meet student needs. Fielek of the Treasury Department noted that students who have already borrowed from the MI-LOAN program may face higher payments as a result of the bond market shakeup.