Land of the fee
In 2011, the city of West Haven, Connecticut issued a school bond for $45 million. At the time, a couple years out from the great financial crisis, the school district was facing both budget problems and a teacher shortage. The budget problems necessitated the bond. This crisis also made them fire fourteen teachers to try and save some money.
Like everything else in finance capitalism, bonds themselves get a credit rating. But these credit ratings aren't free. You have to pay for the service. The firms that offer these services are called credit rating agencies. You might be familiar with them: Moody's, Standard & Poor's (S&P), Fitch's and some others. These agencies are for-profit companies that make money by assigning how much money you can make from certain kinds of money. Right.
Tragically, West Haven had to pay S&P and Moody's a combined $31,700 for the bond's credit rating. In a Bloomberg article written about the issuance, the reporter estimated that these fees--just the cost of getting a credit rating alone--could pay for a teacher's full year salary.
To repeat: the city had to take out a huge loan and fire teachers because of budget problems after the financial crisis. As part of the cost of taking out the loan, they had to pay the equivalent of a teacher's salary. They could've kept a teacher. Instead they had to pay credit ratings agencies.
When I write over and over again in this newsletter that school finance is a case study of capitalism's failure, this is the kind of thing I'm talking about. This anecdote is perverse in a variety of ways. Credit ratings themselves police the commodification of everything, from credit scores to bond ratings. And school districts, providing the public good of education, have to pay for the service of being commodified and policed.
But you haven't heard the worst of it. Rating agency fees are only one of nearly ten kinds of fee that public entities like school districts have to pay to take out private loans when covering big costs, like school building infrastructure. Marc Joffe wrote about these fees in a pair of jaw-dropping reports for the Haas Institute at UC-Berkeley a couple years ago. Here's a look at what he found.
Fee as the wind blows
After analyzing 812 municipal bonds (no easy feat), Joffe finds overall that 1.02% of bond issuance money goes towards the fees required for issuing it, totaling potentially around $3.5 billion annually across the country. But these averages cover up a lot of difference among those municipalities that shoulder high fees. Indeed, "these costs fall disproportionately on small issuers—which are often poorer rural districts that could undoubtedly use every extra dollar not consumed by financial industry interests."
This makes sense: if it costs a certain amount to take out a loan, then those fees are going to be roughly the same whether you're taking out a big loan or a small loan. So small municipalities taking out small loans have to pay relatively more. A Salt Lake City bond only had .13% going towards these fees. But a small school district in rural central California had a whopping 10.62% go towards fees.
Joffe compares two small school district bonds, one from California and the other from Missouri, to show what's going on here:
The graphic is helpful in a variety of ways. First, it lays out in one place the important features of a school bond. Here's a way to read a bond statement for its basics: the principal, premium, interest rate, yield, rating, total cost of the issuance and then a disaggregation of that cost (the second half of the graphic with the long green bars). Let's look at that more carefully.
Feedom isn't free
The underwriter is the investment bank doing the deal on the lender side. It's putting the whole thing together to make the sale. They take a piece that they call an underwriter's discount. These can differ from their legal expenses, since the underwriters hire lawyers too. The borrower also needs lawyers and agents for the deal who they have to pay. There are financial advisors who guide the lender and borrower through the process, who take a cut. Lawyers called Bond Counsels check the legality of everything. They get paid. A different law firm prepares the actual bond statement, giving a 10b-5 opinion, which is when they say the bond is all kosher--free of errors and omissions.
The ratings agencies collect fees too. Joffe did a study just on this aspect of the whole apparatus and found that these agencies, who rate the credit-worthiness of issuers and bonds, take $2 billion annually from municipal borrowers. He proposes a much more streamlined, public, and formula-based rating system that could save borrowers money. But you can imagine there's not a lot of incentive, energy, or popular consciousness to make that change.
In that report, Joffe also looks at an industry that's emerged around the overly-harsh credit ratings that municipal borrowers get. If you can believe it, people make money by selling insurance policies to municipal borrowers to make sure they don't get a bad credit rating. That costs money too.
And there's a longer list of stuff borrowers have to pay to get their bonds issued: verification agents, printing costs, CUSIP fees (which is the unique label the bond gets in the Municipal Review Board's search engine), appraisal fees, and contingency funds. Of all these costs, the underwriters take the biggest cut as this graphic shows. When you look at it, remember that neoliberals across the spectrum think that private markets are the definition of freedom. More like feedom!
How we get free (loans)
What to do about this mess? Joffe has recommendations in the reports. I mentioned the one about a public system for credit rating. Another could be state-level programs. One reason the Missouri bond fees in the graphic above are lower is a program at the state level that looks pretty good:
Cole County appears to have achieved lower issuance costs and a higher bond rating because the state of Missouri offers a “direct deposit program” through its Health and Educational Facilities Authority. Under this program, the authority pays bond investors directly and deducts debt service costs from state aid payments remitted to participating districts.
Generally speaking, state programs are really helpful in taking the burden off of local governments like school districts. At the district level, we might want to fight for state reimbursement programs and bond programs like this one. But a state program doesn't guarantee the state will fund the program, nor does it really address the root cause of the problem, which is the privatization of public credit. State programs move the problem around rather than solving it.
If we had a public authority that provided loans to public entities like school districts that provide a public good like education, this wouldn't be an issue. Expropriate this whole industry. Decommodify it. Public credit now.