Part II - The Eventual Cost of DPS Liabilities to Michigan Taxpayers and Detroit Schoolchildren

DPS has two types of formal debt: operating and capital. Operating debt is a conversion of present and past annual operating deficits into ‘long-term notes’ sold to the financial markets, as well as more immediate debts owed to the State of Michigan directly. DPS capital debt exists only in the form of bonds which were sold to financial markets to purchase and rehabilitate facilities.  DPS’ formal bonds are identified by Series, which consists of the year issued and a letter suffix when different purpose bonds are issued in a single year.  The financial markets apply a further identifier, CUSIP, which is a unique identifier of municipal bonds by series and their intended dates of redemption.  All of the DPS debt sold to the financial markets has been enrolled in Public Act 92 of 2005, a program designed to reduce interest rates to local school districts in accordance with the 1963 Michigan Constitution’s Article IX, Section 16.  Most DPS debt is effectively secured by a general obligation to pay, which requires Detroit taxpayers to increase taxes and reduce spending should financial difficulties repaying arise.

DPS pays off its capital debt in annual installments of both interest and principal, before it pays off (or adds to) its operating debt.  Bond interest and principal payments are required by bond terms which – if ignored – would result in immediate default and bankruptcy.  The exact contract terms of DPS debt sold to the financial markets are laid out in official statements which detail all the formal legal and financial features of the bonds.  The official statement is essentially a contract between DPS and its bond purchasers.

DPS’ operating debt payments are somewhat more flexible than capital debt payments because only a portion of operating debt has been converted into formal bonds covered by statements; much of it is separately owed to the Michigan School Loan Revolving Fund. The SSLRF can best be thought of as a State sponsored credit card. School districts tap into it when they are short of cash, and pay off their balance when they are flush.  Operating debt is only converted into formal bonds when Michigan school districts exceed their limits at the SSLRF.  Those limits are not exact, and generally come into play when DPS goes through one of its periodic financial spasms.

 

DPS Operating Debt

DPS’ current operating debt burden is carried on their financial books in two parts: two ‘notes payable’ (Series 2011 and 2012), along with a balance due the State School Loan Revolving Fund. These are best viewed in DPS’s Comprehensive Annual Financial Reports, Note 7 to their ‘Basic Financial Statement’. The DPS 2015 CAFR shows this table on page 91.

DPS’s operating debt at the end of FY 2015 was $ 259.26 million outstanding on their Series 2011 and 2012 notes, along with $ 195.88 million owed to the School Loan Revolving Fund. A total of $ 455.13 million. Look at DPS’ FY 2009 CAFR, page 36 to see the comparable numbers on June 30^th 2009; for all intents and purposes before Robert Bobb was able to take any appreciable action. DPS’s operating debt at the end of FY 2009 was $ 180.46 million outstanding on their Series 2005B revenue notes along with $ 10.13 million owed to the School Bond Loan Fund (which they tapped because they could not pay their long term debt requirements). A total of $ 190.59 million.

During DPS’ 6 ½ post FY 2002 deficit years, DPS accumulated operating deficits before the Granholm Administration’s emergency declaration amounting to $ 190.59 million. DPS accumulated deficits in the subsequent 6 ½ years under emergency management amounted to $ 264.54 million. But there was a further line item in in the 2009 CAFR (pre emergency management) liabilities: ‘Unamortized Bond Premium’ in the amount of $ 70.7 million. Although the unamortized bond premium arose from capital bond issuance, it is essentially an operating deficit concealed in their capital accounts. So the corrected DPS accumulated operating deficits before emergency management actually amounted to $ 261.29 million. Given DPS’ lousy pre emergency management accounting, this is a wash.

It’s clear from the Crediful review on it that, DPS was running comparable overall operating deficits in the 6 ½ year periods before and after emergency management. But DPS was receiving much more State money before emergency management because they had about double the average number of students enrolled today. And property tax collections collapsed after the 2008 Great Recession. You cannot say that the Emergency Managers suddenly ran up huge operating deficits, while the preceding elected DPS school board did not. They both did, but emergency managers faced far more dire circumstances.

DPS Capital Debt

DPS outstanding capital debt is the result of two bond issuance campaigns, a 1994 campaign amounting to $ 1.5 billion and the 2009 Proposal S issuance of $ 500.5 million. Both of these capital bond issuance campaigns were approved by Detroit electors and used to purchase and rehabilitate facilities. These capital debts have been refinanced several times over the years to reduce interest payments (thus transition from one Series identifier to another), but can be evaluated by looking at their gross numbers at two points in time: 2009 & 2015. Let’s see how DPS’s capital debt progressed under emergency management.

DPS’s capital debt at the end of FY 2009 was $ 1.288 billion outstanding on their School Building and Site Improvement bonds. This is also found in DPS’ FY 2009 CAFR, on page 36. It is worth noting again that all these capital debts were authorized over the years by votes of the Detroit electors in accordance with Headlee, so no one can blame State emergency management for them. This amount then increased by $ 500 million after Detroit voters pass Proposal S in 2009. Robert Bobb, the State emergency manager, was a major proponent of Proposal S, but the electors of Detroit approved this debt at the urging of Michigan’s nitwit media.

DPS’s capital debt at the end of FY 2015 was $ 1.526 billion outstanding on their School Building and Site Improvement bonds. This is found in DPS’ FY 2015 CAFR, on page 86. This number includes the $ 500.5 million in Proposal S indebtedness (the Series 2009 and 2010 bonds), and was reduced by what the emergency managers paid down. Emergency managers paid down $ 40.5 million in Proposal S debt and $ 222 million in DPS’s preexisting capital debt over 6 ½ years.

You have to credit State emergency managers with reducing DPS’ capital indebtedness under very trying circumstances.

DPS Other Liabilities

The DPS CAFRs for 2009 and 2015 also show DPS’ known ‘other liabilities’ on pages 35 (FY 2009) and 86 (FY 2015). Other liabilities are future obligations of the district which can be determined with some degree of precision by actuarial techniques, but which are not denominated in a bond or other financial instrument. DPS’ CAFRs limit the ‘other liabilities’ they report here to those required by GAAP (Generally Accepted Accounting Principles) accounting principles, but there are ‘other’ other liabilities, including unfunded pension and OPEB liabilities. Accounting standards for other liability reporting expanded with the implementation of GASB (Governmental Accounting Standards Board) Statement 68 during this period, so a direct comparison of FY 2015 to FY 2009 is difficult.

DPS’ directly comparable GAAP other liabilities amounted to $ 238 million at the end of FY 2009, before emergency management, and $ 235.5 million at the end of FY 2015 after 6 ½ years of emergency management. A wash. No improvement under emergency management, but not the relentless increases which had occurred under the elected DPS school board either.

However, DPS’ other ‘other liabilities’ may be a less positive story under emergency management. DPS seemingly stayed current on their Michigan Public Schools Employees Retirement System pension and post employment health care liabilities through FY 2009, but began seriously underfunding those MPSERS liabilities under emergency managers. The underfunding arose due to two causes: lower payments to MPSERS and higher annual payments being required by MPSERS due to State mandated reforms of MPSERS circa 2012.

DPS underfunding of MPSERS liabilities are $ 1.357 billion at the conclusion of DPS’ 2015 fiscal year. $ 873 million in unfunded actuarial accrued liability (UAAL) for pensions and $ 444 million in unfunded actuarial accrued liability for retiree health care. DPS’ FY 2009. This underfunding is best viewed in DPS’s FY 2015 Comprehensive Annual Financial Report, Notes 12 & 13 to their ‘Basic Financial Statement’. Their 2015 CAFR shows these notes beginning on on page 97.

There are no comparable notes in DPS’ FY 2009 CAFR, before GASB Statement 68. This would suggest no unfunded actuarial accrued liability for pensions under normal financial reporting, but there were certainly unfunded actuarial accrued liabilities for retiree health care, if not retiree pensions. Reporting of these UAAL liabilities expanded with the implementation of GASB Rule 68 during this period, so we just cannot know the extent of these legacy costs in FY 2009 without a reconstruction of DPS’ historical books according to post GASB 68 accounting standards.

DPS’ financial reporting also left much to be desired before emergency management. The respected accounting firm KPMG ceased to audit DPS after FY 2007. DPS went accountant shopping, a certain sign of serious financial problems. Its financial books were in disarray. The number of deficiencies found in the DPS’ post KPMG CAFRs exploded. Emergency managers gradually cleaned up DPS accounting, but they did not restate past numbers.  This creates a false impression of DPS finances worsening under emergency management.

The best summary of these DPS legacy costs can be found in a Citizen’s Research Council Memorandum 1138, starting on its page 3.

The Bottom Line

Sum up all the debts and other liabilities of DPS and you get a round number in the vicinity of $ 3.5 billion. Truthfully, this is the eventual magnitude of the DPS bailout because payments for all these liabilities will be extracted from the education of Detroit students – and Michigan taxpayers – over the coming years. A number much larger than the $ 617 million headline on the bailout legislation Governor Snyder signed this week.

$ 3.5 billion is a huge liability for a school district whose enrollment, and thus revenues, are shrinking dramatically.  Assigning some or all of these liabilities to an artificial school district still sucks down resources which could be used to educate Detroit students.  The $ 617 bailout signed by Governor Snyder this week does not really solve DPS’ debt and liability problems, rather it spreads them out over time.  Adverse events over that time period can – and will – unravel this patchwork bailout.  It is only a question of time.

Bankruptcy was specifically designed to rehabilitate debtors facing liabilities which can no longer be supported due to dramatic changes in a debtor’s circumstances.  The ever present possibility of bankruptcy is a discipline on financial markets, forcing them to practice risk management and thus – in turn – discipline debtors.  A serious adverse consequence of Public Act 92 of 2005 and the 1963 Michigan Constitution’s Article IX, Section 16 is the diminishment of that discipline.  This loss of financial discipline encourages reckless spending by the new DPS, planting the seeds for their next financial crisis.

In the next part of this story we will examine the bankruptcy alternative not taken and the specific obligations of Michigan to DPS creditors under PA 92 and the Michigan Constitution.