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The Money Pit

The city’s half-baked $2.4 billion plan to save Baltimore’s schools may be doomed to fail before it begins

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Photo: Photographs by J.M. Giordano, License: N/A

Photographs by J.M. Giordano

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The Feb. 26 rally on Lawyers Mall in Annapolis made the TV news. Del. Curtis “Curt” Anderson (D-Baltimore), Baltimore City Public Schools CEO Andres Alonso, and Mayor Stephanie Rawlings-Blake were among the officials making the case for guaranteed funding to rebuild the city’s public schools.

“We’ve come up with an innovative way to try to raise money to build schools in Baltimore,” Anderson said. “This is exactly what people in Annapolis have been telling us to do for years and years.”

Andres Alonso told the crowd, “This is about you. This is about the kids. This is about the buildings they deserve—better buildings now.”

“We will not take no for an answer,” added Rawlings-Blake.

Viewers of WBAL’s nightly news broadcast saw all this, and readers of The Baltimore Sun, The Daily Record, and Patch.com got much the same story. But the details of the city’s audacious plan to replace or rebuild 136 public school buildings have garnered scant coverage during the nearly two years the plan has been in motion. And questions remain even as the legislature nears a decision on the matter.

The stakes are huge. For more than a decade Baltimore schools could hardly be mentioned without the prefix “crumbling.” Studies of the system’s facilities needs have estimated the price tag at between $2.4 billion and $2.8 billion.

That’s as much as the whole city budget, or two to three years of the school system’s operating budget. It’s also 50 times the amount of money the school system typically gets for capital improvements in a typical year.

The plan on the table would obligate the state to hand over at least $32 million to the city’s schools in each of the next 30 years as a “block grant.” Combined with money raised from the city’s controversial 5 cent bottle tax, plus several other sources, an estimated annual total of about $68 million would be amassed.

Those dollars would then be handed over to a nonprofit corporation which has not yet been chartered. That corporation, called the School Construction Authority, would then issue bonds, pledging the $68 million to pay them off.

The amount of bonds that could be raised this way: $1.1 billion.

Having a billion dollars available to renovate and build new city schools would be huge. In the words of the Jan. 8 report by the state Interagency Committee on School Construction (IAC), Baltimore City would be “implementing a construction program on a scale that is unprecedented in Maryland and would be one of the largest single-jurisdiction programs in the United States.”

But here’s the kicker: $1.1 billion is less than half of what the city says it actually needs. Within three years of receiving its unprecedented allotment of guaranteed state money, the Baltimore school system would again have to return to the legislature and other potential funders—this time with an even bigger funding request.

“It’s a huge lift, technically—and in terms of the financial thinking. . . and in public education and in the political process,” says Michael Sarbanes, executive director of the school system’s Engagement Office.

The fact that this enormous, creative, risky push for school financing would deliver just 44 percent of the school system’s minimum identified need is obvious to anyone who reads the school system’s plan or the IAC report. But it has not been featured in the media coverage of the funding drive.

Nor have these other details:

1. The latest $2.4 billion school building estimate does not include more than $100 million in furniture and fixtures that would be needed.

2. Maintenance of existing buildings during the proposed 10-year new-school build-out is predicated on doubling the school system’s bond cap from $100 million to $200 million. It is as yet unclear where the money to service those bonds would come from.

3. Given the 10-year build-out proposed, the 30-year payoff plan under discussion would actually be closer to 40 years.

“I’m not going to give you this as a definite,” Sarbanes says when asked how long the total bond payback time would be. “But if the last [bond issue] is eight years out, then. . . the point about it is, this is a long-term commitment.”

Sarbanes’ reticence is understandable. City and school officials have said little publicly about these challenges. Instead, the focus of the school board, the school superintendent, and the consortium of nonprofits called TransForm Baltimore that has been driving this policy since 2011 has been on the city school stakeholders—parents, students, teachers, and administrators—themselves.

“We asked them what should be taken into account. They told us,” says Sarbanes. “So that’s what drove it.”

This makes sense. Without presenting a united front, the city stands little chance of getting the state legislature to agree to the plan. With the school system’s users on board, hundreds of children can be bused to the capital for photo ops; those who oppose the plan can be painted as anti-kid.

And the need is undeniable. The report released last June by Jacobs Project Management, the consultant hired by the city schools to assess the damage, tells a familiar story (familiar because it is the third or fourth comprehensive study of Baltimore school facilities undertaken in the past decade or so):

Nearly a quarter of the city’s schools were built before 1946; 69 percent of the system’s 182 schools are in “very poor” condition, according to an industry-standard assessment system. Fifty schools should be replaced or scrapped altogether.

When assessed in terms of “educational adequacy,” the average city school received a grade of 55 out of 100. Fail.

More than one-third of the district’s school space was found to be unused or underutilized. As the IAC review concludes, “In every assessment conducted, City School[s] did not compare favorably with other urban districts or any of the national averages.”

As Alonso says, “This is for the kids.” And it is.

Given the obvious need to close some schools, Sarbanes says Alonso has taken special care to develop the plan around the people who are here now: “One of the principles that went into the plan, with the guidance of the school board, was that if a community was going to be experiencing the closing of their school—and that’s one of the most painful things that can happen, because schools have enormous emotional resonance—then those children would be among the first to experience a new school.”

The school system’s plan is detailed to the level of each student, and how far he or she would have to walk to school if the plan is implemented. It is a case study in the art of managing tens of thousands of diverse constituents into a broad consensus.

But the parents of city public schoolchildren, upwards of 90 percent of whom receive free or reduced-price lunches, are mostly not the people whose taxes will be tapped to pay for the plan. Those taxpayers live in the counties, where, according to the IAC report, another $12 billion or $13 billion in school building projects are awaiting funding.

Here’s what the city is asking for right now:

The “block grant” concept is derived from annual capital improvement funds the state doles out to every jurisdiction each year as the budget allows. Over the past five years, the city’s average has been less than $32 million. The legislation—HB 860 and SB 743—would lock in the city’s take at $32 million, at least. That would give the buyers of any bonds backed by the grants the assurances they need that the bonds would be paid off.

But, as the IAC notes, the state budget fluctuates with the larger economy. Dedicating $32 million to Baltimore for the next three decades might cause a squeeze if there is another recession. “Within recent memory. . . the capital budget was set at $116.5 million in FY 2004 and at $125.9 million in FY 2005 as a result of severe State fiscal constraints. During those fiscal years, annual funding for even the largest jurisdictions was reduced to well below $15 million and State approvals of planning, which represent a commitment of future funding for approved projects, were also significantly curtailed.”

Even the act of dedicating $32 million to Baltimore might cause bond rating agencies to lower the state’s own bond rating, the report says.

That brings up the question: If Baltimore’s needs are so great, why does the state not simply bond the construction directly? The answer goes to the heart of the city plan’s creativity, which is more political than economic. “It doesn’t require voter approval,” said Frank Patinella, an advocate with the ACLU of Maryland Education Reform Project, which has led the charge for the plan. “It doesn’t count against the debt limit.”

In effect, the structure of the proposed financing system is designed to mask the size and effect of the borrowing, not from government bond raters but from the taxpayers who would foot the bill.

Besides the $32 million block grant, the city is counting on no less than $8 million annually from the bottle tax, plus its own general fund contribution of $15 million, which is also styled as a block grant. Gambling funds are included at $4 million, even though the casino in question is as yet unbuilt and the existing Hollywood casino in Perryville, citing market conditions, just won the right to reduce the number of slot machines by 23 percent. The final $7 million would come from an accounting change involving city retiree health benefits. The details of this are unclear in the documents City Paper has reviewed. Sarbanes was not able to explain it, except to say that the change will result in an additional $7 million in funding at first, and that will probably increase over time to $11 million.

As late as June of last year, the bottle tax and other city revenue were going to be combined to float a $300 million bond by the city itself to fund school construction. That plan, unveiled in November 2011 by Mayor Rawlings-Blake, was overtaken by the more ambitious—and four-times-more expensive—plan on the table today.

Under the current plan, $66 to $69 million a year would be handed over to the Construction Authority, an entity which does not yet exist. The authority—like the Stadium Authority—would be quasi-governmental, run by political appointees and accountable to the government via annual internal audits and a state legislative audit every six years.

The Authority would implement the school system’s 10-year-plan, says Sarbanes, and school system officials would “act as an agent to the Authority.” When disputes arise between what the school system wants and what the Authority’s bosses think best, someone—it has not yet been decided who—would get to make the decision. “The details have to get worked out,” Sarbanes says.

 

The Construction Authority is part of the system needed to remove these bonds from the state’s balance sheet. It would also, in theory, remove direct control of billions of borrowed dollars from the school system itself, which has over decades developed a reputation for incompetence and corruption.

Between 2004 and 2008, 11 city school maintenance and facilities employees were criminally convicted in a corruption scheme that had operated since at least 1991. One contractor, Gilbert Sapperstein of Allstate Boiler Service, was sentenced to 18 months in prison for his part in a bribery and kickback scheme involving Rajiv Dixit, then-head of the school system’s facilities maintenance program. Millions of dollars were stolen.

Sapperstein—a longtime vending machine operator and generous political donor—served only one month in prison. The heating and air conditioning systems AllState never fixed have all along been cited as evidence of underfunding and the need for hundreds of millions in repairs and upgrades.

Sarbanes prefers not to dwell on this history. “I don’t have a 10-year perspective,” he says, stressing the improvements to the city’s facilities maintenance section that have been made in recent years. “They do good work and at a high quality. . . the big problem for years and years and years was that we didn’t have a strategy that would address the real underlying problem, which was that the buildings were deteriorating.”

In its 2006 audit of the city school system, the Office of Legislative Audits made “23 recommendations covering virtually every financial management area reviewed,” according to that 109-page document’s introduction. “The areas where more significant problems were identified included procurement, facilities, inventory control, transportation services and payroll/human resources,” the audit said, adding that the city school system’s “management must develop a plan and related strategies for addressing these audit issues, including mechanisms to monitor the progress of implementing corrective actions.”

The next audit, released just six months ago, found “Competitive Procurement Policies Were Not Always Followed,” continuing problems with procurement procedures on “two large contracts,” overpayment for overtime and leave, missing computers, and said the district “Did Not Ensure Contractors Had Properly Completed Maintenance Projects Prior to Payment,” among the 26 findings it reported.

And this: “A Long-Term Facilities Master Plan Was Not Prepared.”

David G. Lever, executive director of the Interagency Committee on School Construction, says he is confident in the school system’s abilities today. “As you know, the school system has improved very much in facilities management since 2005,” he says in a phone interview. “With new management—particularly Mr. [J. Keith] Scroggins and his crew—we have seen a significant improvement in the way the facilities are managed.”

Lever’s confidence had better be well-placed. Under the proposal on the table now, Baltimore City Public Schools would increase its staff of building professionals from the current 14 to about 34. “An additional 5 FTE’s [that’s full-time employees] would work directly for the Authority,” the IAC report says.

Even with all those extra bodies, Baltimore City’s staff would number 10 fewer than that of the Montgomery County school system, which manages about $250 million worth of capital projects each year—$20 million less than Baltimore would be handling annually if its plan is approved.

Under the plan, then, Baltimore projects itself to be significantly more competent and efficient than Montgomery County.

“They don’t have the breadth or the depth in the system yet,” Lever acknowledges. “It will take some time to build up to that level.”

 

Baltimore’s plan is modeled on a school building frenzy undertaken last decade by Greenville, S.C., a county of 461,000 souls that in 1993 was blessed by the arrival of a $450 million BMW factory. Tire giant Michelin also expanded there after buying out rival BF Goodrich in 1989. And General Electric, the area’s largest employer, builds turbines and aviation equipment there. The well-paying jobs have attracted thousands of young families and the county did not see how its school system could keep up with the demand.

In 1999 the Greenville school board developed a plan to take about $60 million and borrow about $800 million to build or renovate 86 schools in four years. The plan ended up taking about six years and finished 70 schools to serve its 70,000 students—at a cost of $1.06 billion. Despite the overruns, it has been touted as a huge success by the consultants involved —even though the state of South Carolina has, in the words of the IAC report, “modified the conditions for the further use of this method.”

Greenville and Baltimore City could hardly have less in common. Greenville is 77 percent white; Baltimore City is 32 percent white. Greenville’s household income is 7 percent above the state average; Baltimore City’s is 45 percent below. Greenville is a growing county with an expanding industrial base (in 2012, Michelin announced it would build a new $750 million factory nearby); Baltimore is losing population and industrial jobs.

Where Greenville built its schools to keep up with demand, Baltimore wants to build its schools in order to create demand—the construction jobs standing in for the tire and car-making jobs Greenville has. “There would also be a significant impact on these neighborhoods where this construction is going on which will be very helpful to the goal of growing the city,” Sarbanes says.

One thing Baltimore does have in common with Greenville is the desire to get around existing laws limiting debt. Greenville’s bonding authority had been capped to 8 percent of its tax base by the South Carolina constitution. As one of the Greenville school board members wrote: “The constitutional debt limit does not apply because the nonprofit is an independent legal entity.” The structure also sidestepped a law forbidding lease-purchase arrangements.

Brent Jeffcoat, then bond counsel to the Greenville school board, blessed the structure as “legal.” Last summer, officials with TransForm Baltimore, the consortium of nonprofits that is nominally driving this process, flew Jeffcoat to Baltimore to solicit his advice. Jeffcoat is one of several consultants that the Baltimore is counting on to help structure the deal.

The Baltimore school system’s financial advisor is Public Resources Advisory Group (PRAG), a 28-year-old, New York-based company that prides itself on working exclusively for government entities so as to avoid conflicts of interest. PRAG, which also counts the Maryland Stadium Authority among its many clients, has consistently ranked among the top financial advisors in the country.

In 2010, PRAG managed 172 municipal bond issues totaling over $42 billion.

Every deal PRAG structures is different, but the school bond concept bears similarity to a much smaller deal the company facilitated in 2006—right down to the concern about political fallout.

In 2006, as the facts of the 1990s utility deregulation fad came clear, Baltimore Gas and Electric demanded—and the Public Service Commission approved—a 72 percent rate increase. Collecting it all at once would have caused an electoral revolt, so government and utility officials called on PRAG founders William W. Cobbs and Wesley C. Hough to stamp their approval on some structured finance magic.

Testifying before the PSC, Cobbs and Hough’s expertise allowed the PSC to approve the scheme in which BGE would issue the bonds through a shell corporation so as to “insulate the bond investor from the credit risk of the company.”

In that deal, BGE “sold” its right to collect the huge rate increase to a new corporate entity—RSB BondCo LLC—which then took the ratepayers’ money as collateral for long-term bonds it issued. BondCo then forked over the borrowed cash upfront to the utility.

This way, ratepayers had only to pay a 15 percent increase up front, and BGE still got its windfall. Bond investors got a steady stream of income, and Governor Martin O’Malley was able to claim that he reduced the impact of the unavoidable rate increase.

All this was done and all true, despite the fact that the scheme increased overall costs from about $600 million to more than $800 million, including $11 million paid in “bond issuance fees.”

In 2012 Baltimore County called upon PRAG to bless a scheme to finance with bonds a projected $250 million pension shortfall by borrowing that sum at 4.25 to 4.5 percent interest and investing it elsewhere. This is supposedly going to save big money down the line, as the money raised earns a bigger return for years before it is disbursed to retirees.

It’s rather like a homeowner taking out a second mortgage to play the stock market: It might get him a big boat or it might put him into foreclosure.

As Keith Dorsey, Baltimore County’s director of budget and finance, writes on Baltimore County’s website (with Cobbs as a co-author): “In the opinion of the County’s financial advisor, Public Resources Advisory Group, based upon preliminary discussions with credit analysts, the POBs [pension obligation bonds] will not negatively impact the County’s Triple AAA bond ratings although there has been no formal confirmation from the rating agencies.”

PRAG has fewer than 50 people on staff and wears its white hat with pride. As the company boasts on its website: “We are not, and have never been, the subject of an investigation.”

 

About the TransForm Baltimore plan, the first $1.1 billion round of funding still awaits a vote. Much is still to be determined—from the makeup of the proposed Construction Authority, to who makes the decisions when budget and philosophy clash, to the big question of where the second round of financing—at least $1.4 billion—would be found.

“We’re gonna have to figure out where does the rest of the money come from,” Sarbanes says. “But at that point, we’re going to have more experience, we’re going to have momentum, and we’re going to have a proof that doing [it] this way is good for the kids and good for the city.”

“Throughout the construction phase, we’re going to see cost escalation,” Frank Patinella acknowledges. “We don’t know what the bond market is going to look like. But we know that if we wait, it is going to cost more.”

“At this point, I would have to say that I don’t have a full grasp of the details of how this would be financed,” David Lever says. “Stage two is not completely clear to us either.”

UPDATE:
In a previous version of this story, the 13th paragraph quoted Michael Sarbanes saying "“It’s a huge risk, technically..." Mr. Sarbanes claims the reporter mis-heard him and that he said "It’s a huge lift, technically..." The story has been changed to reflect that.

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