Students over bondholders!
There's an interesting situation with the University of California's bonds going down that I wanted to pass along. Basically: bondholders are having a tantrum because the University of California system is trying to save money by refinancing some bonds.
But these are special bonds with a special story.
After the 2008 financial crisis, the Obama administration created the Build America Bonds (BABs) program, where the federal government would cover 35% of lenders' repayments on debt taken out as part of the program. Importantly, they're taxable bonds.
The UC system tried to sell a bond this month for over $1 billion. The money is meant to repay Build America Bond debt. But the bond does something interesting: it refinances the BABs as tax-exempt with lower yields, which means bondholders make less money on them.
They could do this using a clause in the BABs program, a "call option" that allows for "extraordinary redemption" in the case of an extraordinary event. What's the extraordinary event, you ask? Well, when the Tea Party got started in 2010 and then used the debt ceiling hostage tactic during budget negotiations to sequester funds from Obama's relief package, it compromised the BABs program.
A few years later, bond lawyers representing borrowers (like universities) won some court cases arguing that the sequestration constitutes an extraordinary event, making the bonds callable. It's neat little fightback against the libertarians' first and only victory using that debt ceiling tactic.
To use the call option, the borrower buys back the debt to sell it in a different way. The University is kind of 'calling it quits' on the deal to save money.
But the University's creditors are unhappy about this. They bought the bonds initially under certain conditions, thinking they'd make a certain amount of money. Now they're like "you're breaking your promise, we want our money!" But it makes sense for the university.
The Maryland Transit Authority used this extraordinary redemption call option on its BABs. For bonds worth $623 million, they were able to save $21 million. So the university stands to save maybe tens of millions of dollars. And that's where the story comes in.
The university's creditors say it's illegal: "The investors claim that Bank of New York Mellon Corp., the trustee, is prohibited from redeeming the debt and that executing that redemption constitutes “a violation of bondholder rights,” according to the letter.
The question becomes: what's more important, bondholder rights or student rights? Public education or private investment profits? If there's a clause in the contract then public entities should be able to use it, even if the creditors lose money. This impasse is structural. It reminds me of how Rohan Grey once wrote that the bondholder class should be euthanized. Certainly, public higher education should come before the interests of bondholders.
It turns out Purdue is doing something similar. Now I'm wondering whether universities in budget crises can do the same thing: save millions of dollars by putting students before the bondholders.
What we really need is a National Investment Authority controlled by governments so this situation doesn't even come up.