06/07/2010 05:12 am ET Updated May 25, 2011

$20 Million and a Hen House of Chickens

It's sad when you have to admit you are wrong. None of us likes to do it, least of all me. But I was wrong. Remember when I wrote that Thomas Boasberg couldn't claim he saved 8.5% by refinancing debt associated with the Denver Public Schools' retirement system? I was wrong.

For those who didn't read my last piece, Michael Bennet, then DPS Superintendent, and Tom Boasberg, then DPS' Chief Operating Officer back in 2008, entered into a $750 million financing plan as part of their management of DPS' retirement system. The plan, called Pension Certificates of Participation, or PCOPs, allowed DPS to use $400 million to fully fund the DPS retirement system, refinance $315 million in preexisting debt, and pay $35 million in fees, all at a fixed interest rate of 4.859% over 30 years.

You see, crafty Tom gave the Denver Public Schools Board of Education a spreadsheet explaining how DPS had saved $18 million as a result of these financial transactions. In this spreadsheet, Boasberg used the column header, Financing Cost @ 8.5% Interest, to claim his savings. I was wrong about what this column represented, but I wasn't wrong about saving DPS $20 million a year, or $18 million last year, because of the deal. Those numbers are entirely fictional. Boasberg is a clever guy, that old fox...

Boasberg, and his predecessor Michael Bennet, have to be foxes. They have, together, perpetrated one of the greatest tax payer scams in Colorado history, and that scam is all about a hen house of chickens called the Denver Public Schools Retirement System and its merger with the Colorado Employees' Retirements System, or PERA. And them's some tasty chickens, Br'er Fox.

The problem for Bennet and Boasberg is, between them and the hen house, sat the DPS school board and the state legislature. The way the foxes see it, the hen house is full of scrumptious resources, and it is taking up fox habitat. So, a little misdirection is in order -- get the school board and legislature to look one way while making an end run on the hen house.

To do this, Bennet and Boasberg entered into an enormously complex financial transaction, documenting most of it so that very few people could understand it, and then got the school board to approve it by telling board members they would save $20 million that could be put back into the classroom as a result.

But our foxes had to be even cleverer, or at least that's what they told themselves. So, Bennet and Boasberg entered into an interest rate swap, aka the dreaded derivative synthetic fixed-rate interest swap. That's a name only foxes could love, and these foxes really loved it. Here's how the swap was supposed to have worked:

  • DPS sends the swap counterparties, JP Morgan, Bank of America, and the Royal Bank of Canada, a fixed payment based on 4.859% of the principal amount of DPS' $750 million debt.
  • The counterparties then send DPS a payment based on the 1-month LIBOR (The London Interbank Offered Rates).
  • The pension certificates (think of them as bonds) are then sold at auction based on the 1-month LIBOR

Voila! The bond interest rate is "fixed" by the swap. Theoretically, DPS issues its certificates using the 1-month LIBOR, and the District gets paid the 1-month LIBOR by its swap counterparties. The interest on the certificates is "free," and DPS gets a low fixed rate of 4.859% on the whole deal.

Got all that?

Bennet and Boasberg were so pleased with themselves they told the school board they had come up with a master plan! They had used their advanced business knowledge to save DPS lots of money. Everyone would come out on top --

  • The students and teachers would have more money in the classroom
  • The pension system would get enough money to be fully funded
  • The school board would have eased cash flow issues in a time of shrinking fiscal resources

The school board was pleased, and said to the foxes, Go ahead with your plan. The foxes did, and DPS' fiscal troubles really started.

What Bennet and Boasberg failed to disclose to the school board was, if the certificates couldn't be sold at their weekly auction, DPS was in real trouble financially. You see, DPS had taken $750 million, and someone had to hold that debt. If the certificates couldn't be sold, there would be no one holding DPS' debt. That would be a really, really bad thing.

And that's just what happened. When the markets began to crash in mid 2008, the 1-month LIBOR plummeted and the certificates didn't sell. The reason is pretty simple: because the 1-month LIBOR is at an historic low (0.2373% in March 2010), and no one was interested in holding DPS' pension debt, not even for a week. It would be like giving DPS money for free. Would you do that?

Neither would the institutional investors who might have bought the debt at DPS' weekly certificates auction.

So, DPS had to offer a better rate on the certificates, let's say 6% one notional week. This increased rate had to be included so someone would buy the debt. In this scenario, DPS sends its swap partners a check based on 4.859% of $750 million, it gets back an interest rate of 0.2373% on $750 million, and then it has to auction the certificates at 6% of the $750 million to get anyone to buy them.

By my math, that means DPS paid 10.6217% on $750 million during this one notional week. That translates to $1.15 million dollars spent in just 1 week. That's just on interest. Not one dime was paid on the $750 million principal. (In fact, DPS won't begin to pay off the principal until 2018. You, the tax payer, will just be paying interest until that time.)

I want to make sure everyone understands that I just made up the 6% figure. DPS has never released any of the auction rates paid since April 2008. Some weeks the rate might have been much better, say 1% at auction. Other weeks, it could have been much worse, 8%, let's say. Given the 1-month LIBOR, it is unlikely DPS will be seeing auction rates directly reflecting that rate anytime soon.

All of this means DPS is spending a lot of money to supposedly save $20 million. Why? Well, that gets us to the hen house.

For a long time, DPS had been hoping to merge with Colorado's state-wide pension system. In 2008, the merger looked really close. Bennet and Boasberg wanted to make sure DPS' retirement system was in rock solid shape at the outset of the merger so all would go smoothly. They took the $750 million to shore things up.

Then the old foxes worked a deal with the Colorado legislature. They said, we'll fully fund the DPS pension, but you will have to let us deduct 8.5% on our pension-related debt from our future PERA contributions. See -- there's that 8.5% number cropping up again.

Historically, the DPS retirement system has made 8.5% on its pension fund investments. Bennet said, if the retirement system is making 8.5% on its investments, DPS should be able to deduct that 8.5% from our future contributions to the system. The retirement system is profiting from our debt.

No one at the state legislature bothered to calculate how much that deduction might be. What Bennet said just seemed to make sense to a bunch of politicians, most of whom knew absolutely nothing about high finance.

Moreover, no one pointed out that the pension is not an us vs. them situation. DPS is ultimately responsible for the system. The retirement system is a benefit for DPS' teachers, and the system is subject to the whims of DPS' Board of Education.

Despite this, the state legislature said, Sure! Deduct the 8.5%.

Now, DPS, our kids, and we as tax payers are really getting it in the shorts. First, DPS is losing money on the transaction it set up to finance the retirement debt. Next, DPS is underfunding the pension, which creates more long-term debt. DPS claimed to be carrying $1.5 billion in debt in 2008.

Again, this is how it should work: in the good old days, DPS would make contributions to the teachers' pension at a rate established by the state legislature. For this year, that rate is supposed to be 13.75% of covered salary, or the salary paid to all the future retires from DPS. The District has a salary budget of $360 million, 13.75% of which is $49.5 million.

The other side of this equation looks like this: 8.5% of $750 million is $64.44 million, or the number Boasberg claims to have saved per year as a result of fully funding the pension and refinancing part the earlier debt.

I am no math genius, but that looks a lot like our state legislature set DPS up so it did not have to make an employer contribution to the retirement system for a very long time.

And that, folks, is how DPS will save $20 million per year -- on the backs of its retirees and teachers. DPS will be the only school district in the state of Colorado who doesn't have to pay into the teachers' pension fund. It will also likely be the only school district loosing $40 million a year for the next two or three years. But somehow using that math Bennet and Boasberg learned at Yale, DPS will get to say they saved $20 million per year.

See how the foxes work? One waves a $20 million savings in front of the school board guarding the hen house. The other waves 8.5% in front of the state legislature, most of whom go scrambling after this morsel. Both elected bodies agree to turn their backs on the teachers and their pension, either out of ignorance or malfeasance, and the foxes rush into the hen house, setting the table for dinner.

Pretty cleaver, huh?

So there sit the foxes, Bennet and Boasberg, picking their teeth after a tasty meal of teacher pension funds a l'Orange. One is quite proud of himself -- Br'er Bennet is in Washington D.C. palling around with his new chums in the Senate and with the old school mates of his youth. The other, Brer Boasberg, is sitting fat, getting paid over $200,000 per year, living and sending his kids to school in Boulder, while running Denver's public school system.

There is one other piece of this story, however. You, Mister Taxpayer, are out at least $50 million, if not $90 million, because of the way the foxes set the table. That's not just chicken scratch. It's a lot of feed in the hen house of public education.

Drumstick, anyone?