Beware the Bonds

junk_bondsSweet Briar College had many problems, most notably a high tuition and shrinking enrollment, but the kiss of death was a high debt load. The small women’s college, which announced its intention to close earlier this year, had issued millions of dollars in bonds to pay for such projects as a Village Green that provided eco-friendly residential facilities. The announced closure of the college may have been accelerated by a potential default on $25 million in two outstanding bond issues, reports the News & Advance.

The warning bells had been sounding for more than ten years. But in 20o8 the board of directors approved an $11 million bond issue to build the $3 million Village Green as  well as a new fitness and athletics center.

Last November, S&P  revised its outlook on the BBB rating of the college’s 2006 bond issue from stable to negative. “The negative outlook was a result of numerous factors, including Sweet Briar’s enrollment challenges and high tuition discount rate,” wrote reporter Sherese Gore. “S&P warned of a potential lowering of its rating on the 2006 bonds during the two-year outlook period if there were further declines in enrollment and increased operating deficits.”

Bacon’s bottom line: The big question that bond rating agencies are asking about college finances these days is how well are student enrollments holding up? For most colleges and universities, tuition and fees paid by students is the dominant source of revenue. The cost has gotten so high that many families are balking, and enrollments are eroding at many institutions. The loss of revenue is all the more acute for colleges that have loaded up on debt. The obligation to hold debt obligations sacrosanct accentuates budget cuts to programs. If the quality of education or the residential experience is compromised, colleges run the risk of further enrollment declines, setting off a vicious cycle.

The United States hasn’t appeared to have learned anything from the 2007 real estate crash, which was driven by excessive indebtedness. Federal government borrowing has reached record levels, both in absolute numbers and as a percentage of the GDP. Exploiting near-zero interest rates, businesses are leveraging their balance sheets, taking on debt to increase their return-on-equity numbers while using cash flow to purchase shares. Even households, chastened by the recession and real estate crash, are beginning to take on more debt, although they haven’t matched the excesses of the 2000s. Scarily, China, Japan, France, Spain, Italy and other major economies have been every bit as undisciplined as the U.S. There will be a global debt reckoning.

There is no way of knowing when that day will come. But when it does, the fear-of-debt contagion will spread with frightening rapidity as confidence unravels, transmitted through the international economy in ways that no one today can predict. Survivors of the shake-out will be those who maintain tight financial discipline. For those of us concerned about public policy, that means paying close attention to the finances of state and local governments, industrial development authorities and colleges and universities.

— JAB

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15 responses to “Beware the Bonds

  1. the “defenders” of Sweetbrier have a different take as I found out by commenting on another blog..
    they do not really mention the debt and cash flow issue but they are instead convinced that the current “operators” are up to no good and they are also mad at AG Herring for not intervening and also helping them to figure out how to use the endowment money to pay other costs.

    at any rate – maybe you have some “save Sweetbrier” folks reading here or you might know one who can add to the context and set folks straight.

  2. Will there be a global reckoning about “debt”? I think that’s highly unlikely. There was a small bit of unraveling/reworking in 2008. But it wasn’t anything like some were predicting in September 2008.

    From friends in finance, I’ve come to adopt their conclusions: there are just too many nations/consumers/businesses/organizations with countervailing interests for there ever to be a true “debt” crisis in global finance. In the age of globalization and markets, any “big mover” who moves is really writing their own death sentence b/c they probably have twenty different sets of exposures themselves if they ever “triggered” movement.

    Remember….10 years ago, it was all about “China” and “what if they called in debt” etc. But so much has changed in the past 10 years….If “China” which is a very broad term nowadays “moved”….it’s so exposed on debt markets that “China” would be shooting itself.

    Look at Greece…in 2010 we had every gasbag in the world screaming about “default” “debt” etc. And it’s true…Greece was and is a basket case. BUT….in 2010 when everyone (sovereigns, the EU, banks, private corporations, etc.) looked at what a “Grexit” would look like…..everyone took a step back b/c they realized the domino effects on their own leverage. Now we’re five years later and the “big players” have divested/unwound from exposure to a Greek default to the point that perhaps a “Grexit” can occur without Armageddon.

    I remind you: Greece is 0.2% of world GDP. If such an insignificant player can get five years worth of “reworking” due to fear of nations/bansk/business realizing the consequences of their own leverage….I can rest pretty easy at night not worrying about a debt Armageddon. I mean, the chances of a Grexit are still 50/50 at best 5 years later due to remaining fears of what a true Greek “default” would look like.

    Globalization and the dominance of “markets” have leveraged everyone in the world. Tough to see how any “reckoning” ever plays out unless someone wants to commit suicide.

    • I hope you’re right.

      But, as much as I believe in the power and efficacy of markets, I also believe that markets are inherently unstable. I also think that market players are generally one step ahead of the central banks and regulators. And I think the central banks around the world have injected dangerous amounts of liquidity into the system.

      So, do you think it’s OK for everyone to borrow as much as they want?

      • I think there will be some burps and bumps along the way, but I really don’t know how anyone, no matter how smart they are or ahead of regulators, can make complicated financial transactions in this day and age without creating their own exposure.

        As to dangerous amounts of liquidity, I’d like to agree. All of my study in economics makes me believe that there is some validity to the claim. But there is a counterpoint about “this time’s it’s different”…now, those words have been written so much that they’re a punchline….but the thesis is this: today’s unprecedented degree of globalization does make markets different. There are simply too many players from around the globe. Captial markets have largely been dominated by London (pre-WW2) and NYC (post-WW2). But it’s safe to say that in 2015, there really isn’t a hegemon (just as there isn’t in foreign affairs any longer). So…no one market’s movements or investment strategies is dominating global finance. The thought is that as global capital diversity has hit warp speed since 2008, we’re unlikely to see huge bubbles like we saw in the past. Shanghai isn’t necessarily investing the same way London is which isn’t making the same bond bet that Riyadh is which isn’t putting capital in African water development like Moscow which isn’t loading up on automation like American markets seem to be…..etc., etc.

        It’s a theory. While one can poke holes in it, it does make some sense. We didn’t see an “emerging market” bubble like some predicted in 2009-2010. We didn’t see a massive economic shock when oil prices took a nosedive in 2014.

        Again, all my economic study agrees with you. But it’s also hard for me to look at recent evidence and wonder if there is something to the dispersion of capital throughout the globe being a check on groupthink (follow the hegemon b/f it’s too late!) bubbles when liquidity levels are high.

        Who knows? If we did, we would be making a ton of $$$ right now! : )

  3. I see the sense of what you’re saying, and it’s an interesting theory. Here’s what worries me. All the world’s largest economies — U.S., Europe, China and Japan — are pursuing flat-out expansionist monetary policies. There is massive liquidity sloshing around the globe. Whenever you have massive amounts of money sloshing around, you end up with massive mal-investment. Whenever you have massive mal-investment, people lose their shirts and start panics.

    Well, maybe mankind has finally created a financial perpetual motion machine that only creates prosperity and never leads to ruin. It would be really awesome.

  4. I read an interesting article in the NYT about bitcoins the other day.

    Can Bitcoin Conquer Argentina?

    the article was about Argentina but also about the test of the world.

    the long and short of it is that Argentina has a 25% rate of inflation but the govt will not let you move money through the banks at par value – so you take a hit when trying to move money especially to/from Argentina.

    that has, in turn, spawned a whole new business of money-changers – using bitcoin which is beyond the reach of the govt.

    so now – someone can move vast sums of money and not take the inflation hit .. and they are – especially the wealthy…

    don’t try to understand how bitcoin actually works – just understand that all the major countries in the world – including the US think’s it’s a legitimate currency that will allow moving sums of money without going through banks and without govt rules for moving money through banks.

    the implications of this – hurt my brain… but one obvious thought is that countries with economic and money issues – are subject to virtually overnight disaster once citizens have lost confidence and start putting their money into bitcoins.

    there are myriad other impacts – including investments..trade, offshoring, etc..

    here’s the article – if you don’t understand bitcoins -you may have to do a little further reading:

    http://www.nytimes.com/2015/05/03/magazine/how-bitcoin-is-disrupting-argentinas-economy.html

    this is yet another example of how young folks really, really need a top notch education that is mandatory in understanding concepts – like bitcoin.

    • larryg,

      I think you hit upon one of the biggest issues out there….except you believe it is possible for the “average” kid to grasp these things….I don’t.

      I think anyone who seriously believes we aren’t headed for democratic-socialism or socialism is really deluding themselves….

      The world is simply becoming too complicated. Heck, I have an MBA from Cornell and so much of today’s business/financial world taxes every brain cell I have. This blog is filled with people as smart or much smarter than myself (you, Don, Peter, Jim, Steve, etc.) And it seems like you all are just as taxed in understanding today’s business/political/cultural/economic trends as I am.

      This isn’t 1787 or even 1987….the world we live in today is so vastly different from 15 years ago. You can go through a laundry list of these things: swaps, bitcoin, crowdfunding, automation, boutique medicine….just pick up a month’s worth of Economists….

      Unlike some, I don’t think the “top 1%” or “top 5%” is wholly about tax/regulatory policy (those are contributing factors at best). I think it’s about intelligence. And no, I don’t think any educational model (private or public) is going to help “level the playing field”…I think the coming decades are only going to see wealth concentrate even more to the top regardless of which party is in power. Or whatever tax or regulatory policies are applied.

      The truth is that the 21st century is going to belong to the smartest ones and that with the past 2 decades of “cognitive breeding” (the idea that smart people tend to reproduce with smart people…you rarely see anything else…how many people who got a Master’s or Doctorate or Professional degree in the past 20 years married someone without a Bachelor’s?…this is a global trend that’s been building for 20 years) we’ve in effect created a global elite primed to completely dominate the coming decades. These people are adaptable and extremely clever….they’re going to dominate whatever environment is thrown at them so long as the “currency” of the world remains knowledge/information.

      Perhaps I’m wrong. Perhaps somehow there will be a magical series of multiple market disruptions that will change the dynamic of wealth/power concentration. I wish I was wrong. But I think the trends are pretty clear at this point and I really don’t see much disrupting them unless we somehow go back to valuing manual labor over knowledge. Doubtful.

      Again, I don’t think this has anything to do with politics. Those arguments are tangential at best. This has to do with economic and societal trends that have been building since the 70s and are now primed (and already are) flourishing for the next few decades.

      • Just wait until members of the cognitive aristocracy are willing to buttress all their advantages of wealth and naturally inherited intelligence with genetically engineered intelligence for their offspring. Then what happens to America’s meritocratic ideal?

      • Building on your idea of the increasing complexity of society… I, too, worry that the world is getting so phenomenally complex that the ability of “average” Americans to cope is severely compromised. Add to that the *accelerating* nature of change. Thirty or forty years ago, Alvin Toffler called it Future Shock. It’s all I can do to hang on.

        • You bring up some good points.

          If you really want to know my thesis for “society” in the coming 20 years, it is this: We need to re-read Toffler and other futurists, even watch the Jetsons….why?

          Because the stuff that I, and people much smarter than I, are seeing with artificial intelligence and automation really does mean “this time it’s different.” It’s hard to find any serious business theorist who doesn’t believe a good 25 to 30% of jobs worldwide are going to disappear in the next 15 to 20 years. The automation that we’ve been hearing about since the 60s looks to finally be here.

          I think American society is going to have to come to grips with the idea that “work” and “employment” are going to radically change. We can no longer view “unemployment” in a negative light. There simply aren’t going to be “jobs” for everyone. There’s no other way around it.

          Obviously, one can view this as “awful”…but why? What if everyone was afforded a modest existence by the state. If you didn’t have work, you could pursue creative outlets, sacred outlets, community building outlets, etc.

          One can mock this, but the “future” really is coming fast. This isn’t “liberal fantasyland.” Go read the WSJ, they’ve run quite a few articles on automation and AI in the past year which come to the same conclusion….”work” just simply isn’t going to be available for everyone in the coming decades. It’s going to require an extreme rethinking of how we conceive of ourselves, the nation-state, technology, economics, and “work.”

          • Cville Resident steps to the plate.
            Here comes the pitch.
            Bang!
            That one is out of here. A home run.

            America is rapidly facing a choice for the future – Aldous Huxley’s Brave New World or Karl Marx’s Communist Manifesto.

            As an aside, I have come to believe that the world’s increased income and wealth inequality is being caused by the industrial revolution finally running out of steam (yes, obscure pun intended). There was virtually no economic growth in the 400 years prior to the invention of the steam engine and the start of the Industrial Revolution. Then, there was an unprecedented rise in productivity as steam engines moved to railroad which moved to cars which moved to airplanes, etc. All that ended around 1970 as the Industrial Revolution stopped driving the world’s economy. Unfortunately, the Information Revolution is not a broad based productivity improver. It enriches a relatively narrow slide of humanity while pushing a larger slice of humanity into permanent unemployment.

            Nothing is going to change in the fundamental economy. The only question is how many more Baltimores (or worse) will have to occur before our political class gets the problem.

  5. bitcoin is a wild concept. the “good faith and credit”, the gold standard.. none of it is like bitcoin which has not one red penny – or one oz of gold behind it.

    it’s purely basic on people’s perceptions and trust.

    however there is one thing very telling about bitcoin – to this point.

    you use it to move money – yes..

    but then do you keep you money in bitcoin for a month or a year or longer?

    so far, most folks are a little skittish about longer term… but PHDs are writing papers about the concept… which does not exist on any one computer… there is no central control.. the govt (so far) cannot mess with it much less figure out who owns what, much less stop them from moving money to somewhere else.

    the only way is if the govt makes bitcoin currency transactions – illegal .. and that will be almost impossible … because bitcoin lives anywhere someone can get onto the internet…

    My fear is along the lines of Cville R – I struggle to understand modern concepts which are evolving at light speed – and I see a world with a chasm between those are are digitally competent/proficient and those that are not.

    wait until govt finds out they can get way more bang for their bonds if they do them in bitcoin or conversely the bond market or worse hedge-funds start trading in bitcoins!

  6. I gather from this item in Bacon’s Rebellion (“Beware the Bonds,” remember?) that Sweet Briar College was trying to develop some of its 3,000 acres into an income-producing asset seven to 10 years ago. I know nothing more than what’s reported by Bacon’s Rebellion; Key quote:
    “The warning bells had been sounding for more than ten years. But in 2008 the board of directors approved an $11 million bond issue to build the $3 million Village Green as well as a new fitness and athletics center.”

    My educator’s view: Educational institutions should not be involved in “unrelated business activities,” especially when the real mission of the school or college is in jeopardy. Thus Woodberry Forest School (where I was in development, 1967-77) got out of the commercial dairy business, many years ago, c. 1973. Market reason: small dairies were starting to lose money by the 1970s and our board and admin took action. (What did Sweet Briar do with its dairy? I don’t know.)
    In planning and development at Woodberry, we concentrated on laying the foundation to build an endowment that would secure the school’s future, through good times and bad.
    One main job of an effective board of trustees: Keep institutions from getting into dead-end situations, as SBC has done. It is incumbent on the head of the institution (president), however, to tell the trustees the plain truth — about what’s happening at the institution, in its segment of the market, and in its sphere of the nation and world. Not always an easy task; requires “speaking truth to power,” vision and backbone, and tactful, shared leadership.
    Friendly persuasion is better than back-room, divisive vendettas (such as Helen Dragas is reported to have employed at UVa in getting the president fired by a rump gathering of the BOV). For eventually, all factions must sit down together again — if long-term institutional success is to be achieved.
    The best colleges and their leaders may remember what Ben Jonson said of Shakespeare: “Not of an age, but for all time.” English not management.
    Maybe that’s why Jefferson based his university on the liberal arts rather than a business school curriculum, and put a library at the center of his grounds, rather than a chapel. And it was Emerson who wrote, “All are needed by each one, nothing is fair or good alone”?

  7. Maybe that’s why Jefferson based his university on the liberal arts rather than a business school curriculum, and put a library at the center of his grounds, rather than a chapel. And it was Emerson who wrote, “All are needed by each one, nothing is fair or good alone.” What was this philosopher and poet talking about?
    Time will tell.

  8. DonR,

    Really good points about the Industrial Revolution and Baltimore. I, too, agree that we’re likely to see a lot more Baltimores in the coming decades until our political leaders realize that this world is going to be something that is completely foreign to our conceptions of humanity. I, personally, think the first thing we need to do is change the attitudes toward “work.” Plenty of good folks are simply not going to have “work” in 20 years unless the gov’t creates make work projects. That’s a reality. If we continue to treat unemployment as “bad” and “on the dole” and “parasites”, the atmosphere will be treacherous and you can almost bet on riots.

    Again, it doesn’t have to be this way….there are humane/civil ways to make this transition that’s coming at us like a freight train. We could start to focus more on creativity/sacred/recreational/educational pursuits. Instead, I think, so long as the Tea Party has steam and thinks it’s still 1787, we’ll continue with the attacks and believe that there’s some magical tax rate or repeal of regulation that will lower the 25% “unemployment” rate that we’re likely to see in 2025 or 2030. It’s not the tax rate or anything that gov’t is going to do or not do, it’s going to simply be a lack of jobs. So long as firms are accountable to stockholders or owners, they’re going to maximize profits. The technology is getting closer and closet to automate a huge chunk of jobs.

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