Schools Pass Debt to the Next Generation
Comment of the Day

August 17 2012

Commentary by David Fuller

Schools Pass Debt to the Next Generation

Here is the opening from this informative column by Floyd Norris for the NYT and IHT:
The deleveraging of America is well under way, as individuals and companies recover from the excess borrowing that helped to produce the boom and left many people vulnerable when the bust arrived. Household debt is down nearly $900 billion over the last four years, partly from repayments and partly from defaults.

During the crazy times, homeowners could get mortgages that allowed them to pay less than the full amount of interest being charged, with the rest added to the principal. Commercial property owners generally paid the full amount of interest, but did not have to repay any principal until the loan matured in five or 10 years. For both homes and commercial properties, lenders were willing to rely on extremely optimistic appraisals.

For property buyers, those days are gone,

But for some borrowers, it is still possible to borrow now and pay nothing for decades.

There is a furor in California because the Poway Unified School District, in San Diego County, borrowed money last year on terms that even Countrywide would have laughed at during the boom. It will not pay a dime of interest or principal for more than two decades. Only then will it begin to service the bonds.

It is paying a high price. Although it has a good credit rating - Aa2 at Moody's and AA- at Standard & Poor's - it will eventually pay tax-exempt interest of up to 6.8 percent for the borrowings. When it issued more conventional bonds last year, it paid rates that were much lower, ranging up to just 4.1 percent.

For borrowing $105 million in 2011, taxpayers - or perhaps it would be more accurate to say the children and grandchildren of today's taxpayers - will pay $877 million in interest between 2033 and 2051.

In San Diego, the bond issue first gained attention on The Voice of San Diego, a Web-based publication, which published an article this month headlined "Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools." As the Voice noted, others, includingJoel Thurtell, a Michigan blogger, had written outraged articles about the bond issue. But it was the Voice article that attracted national attention, including a report on CNBC.

David Fuller's view The IHT's headline for this article read: "Borrow now and let your kids pay bill", to which Eoin commented: "Borrow now and let your kids default."

This is a shared problem in debt-saddled national and regional governments from the USA to Europe. The ideal solution would be for them to grow their way out of trouble but that is now very difficult, as we all know, because these debts have been allowed to spiral out of control.

There are limits to the amount of additional taxes that can be levied because that soon becomes counterproductive, as the article above points out. People will rebel and vote down what they regard as onerous taxes. If that is not possible, businesses will close or relocate elsewhere and other people will also move.

We know how these stories end because we have seen or heard about it many times before. If countries cannot pay their debt, services deteriorate, entitlements are cut and the currency is debased either stealthily or with a sudden devaluation or default. The result is stagflation or worse.

How can investors protect themselves in this environment?

It is Caveat Emptor for those who think the last thirty years in government bonds of increasingly heavily indebted countries can be repeated over the next 30 or even 5 to 10 years. The safer alternative is a combination of bonds in countries or companies with strong balance sheets.

Autonomies and Dividend Aristocrats with strong balance sheets are favoured by Fullermoney.

Gold and other precious metals should continue to hold their purchasing power over the long term. They are hard money in a fiat currency world.

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