Wednesday, May 12, 2010

Profit in charters? Yes

"There's a very fine line between what all of us do, and fraud..."--Whitney Tilson, hedge-fund school reformer


Skeptical friends continue to ask me: "Is it really possible to make a profit operating a charter school(s)?" I remember the above-mentioned Tilson mocking anyone who suggested such a thing and edu-business experts like Mark Dean Millot saying that running schools, "is a very unprofitable business." I've offered several explanations to my friends about why profits may be driving much of the charter school business.

Maybe Juan Gonzalez from Democracy Now, can convince them that there's gold in them charters. 

AMY GOODMAN: Juan, before we move on to the Gulf, you have a very interesting column in the "New York Daily News" today, an exposé around big banks and charter schools.

JUAN GONZALEZ: Yes, Amy, one of the things I've been trying now for a couple of years is to try to figure out why is it that so many hedge fund managers, wealthy Americans, and big banks, Wall Street banks- executives of Wall Street banks, have all lined-up supporting and getting involved in the development of charter schools. I think I may have come across one of the reasons.

There's a lot of money to be made in charter schools, and I'm not talking just about the for-profit management companies that run a lot of these charter schools. It turns out that at the tail end of the Clinton administration in 2000, Congress passed a new kind of tax credit called a New Markets tax credit. What this allows is it gives enormous federal tax credit to banks and equity funds that invest in community projects in underserved communities and it's been used heavily now for the last several years for charter schools. I have focused on Albany, New York, which in New York state, is the district with the highest percentage of children in charter schools, twenty percent of the schoolchildren in Albany attend are now attending charter schools. I discovered that quite a few of the charter schools there have been built using these New Markets tax credits. What happens is the investors who put up the money to build charter schools get to basically or virtually double their money in seven years through a thirty-nine percent tax credit from the federal government. In addition, this is a tax credit on money that their lending, so they're also collecting interest on the loans as well as getting the thirty-nine percent tax credit. They piggy-back the tax credit on other kinds of federal tax credits like historic preservation or job creation or brownfields credits. The result is, you can put in ten million dollars and in seven years double your money. The problem is, that the charter schools end up paying in rents, the debt service on these loans and so now, a lot fo the charter schools in Albany are straining paying their debt service- their rent has gone up from $170,000 to $500,000 in a year or- huge increases in their rents as they strain to pay off these loans, these construction loans. The rents are eating-up huge portions of their total cost. And, of course, the money is coming from the state.

One of the big issues is that so many of these charter schools are not being audited. No one knows who are the people making these huge windfall profits as the investors. Often, there are interlocking relationships between the charter school boards and the nonprofit groups that organize and syndicate the loans.

There needs to be some light on this whole issue and the state legislature right now is considering expanding charter school caps, but one of the things I press for my column, there has to be the power of the government to independently audit all of these charter schools or we're not going to know how public dollars are ending up in the coffers of Wall Street investors.

As you may know we covered a story about hedge fund managers getting in on the charter school action...

10 comments:

  1. Marc Dean MillotMay 30, 2010 at 10:28 AM

    Once again, I find myself caught between right and left.

    When charter school managers operate within: the "legal" market established by state charter and nonprofit laws, requirements for transparency, and decent basic oversight from chartering agencies, its not a great business for reasons I've noted.

    Operating outside those bonds can be financially attractive. All forms of stealing yield high gross margins. Example: Where a manager like Imagine recruits or otherwise captures the board of directors of what the law says must be an independent school, it is operating outside of law. If the results of that relationship are incredibly one-sided contracts that allow the manager to walk away with unreasonable profits and leave the school with all the liabilities, and the chartering agency misses it, that's not profit, its robbery. And that's not a market, its a market failure.

    A careful reading of most states' charter statutes suggests that legislatures - quite deliberately - did not create a legal environment terribly hospitable to the management organization business model. Indeed, one reason publicly-held firms like Edison did so badly and piles of institutional investment are not moving to EMOS is that they operated well within the law. This is a nation of laws not men, and no one has the right to ignore the law in order to create an attractive business model. Not drug dealer, not Wall Street, and not charter school operators.

    Whatever the context from which Tilson's statement was lifted, I reject it unconditionally. There's a fine line between the evidence required to send people to jail for 'fraud and release them back into society.If that's our ethical standard for business behavior, we're doomed.

    Fortunately, not everyone in commerce buys into the Wall Street idea that you have to race your competitors to the moral bottom if you hope to stay in business. Most of us are not deliberately skirting a fine line between how we treat clients, customers and partners on a daily basis and fraud. Most of us know the difference between "sharp" and "responsible" business practice. Most of us do want to do well by doing good.

    There are bad actors in every field of human endeavor. You've taken a useful point about bad actors and blown it far out of proportion. Its simply unreasonable to conflate criminal practice with markets, and its not entirely ethical.

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  2. Marc Dean MillotMay 30, 2010 at 11:38 AM

    BTW: The Democracy Now story helps make my point. In an arms-length transaction, community-based, bottoms-up charter schools (leaving legal realities aside - my preferred option on educational, social and business grounds) would have several options for tapping into financially attractive real estate development options. If the boards were truly independent, they would be able to hire the technical capacity to negotiate deals that meet the schools interests.

    In and of themselves, these kind of deals, as well as the sale-leaseback arrangements that have attracted attention to Imagine, are good for charter school students and taxpayers. A charter schools greatest financial asset is the long term flow of government payments. Some part of these payments must go to rent. If you were a rational investor or lender, you would realize the relative security of a charter schools revenue stream as opposed to many other potential renters or borrowers. Government often pays late, it rarely defaults.

    So it makes a lot of sense for a charter school to use that stream of rents to build or improve a building, and it makes a lot of sense to borrow the money to do it. It makes sense to bring some investors into the deal to leverage the schools own assets. It even may make sense for the school to sell the building to investors, take the cash proceeds and invest them for the future, and make lease payments. The right course is a matter on number crunching.

    Where the scenario turns ugly, is when the charter school board is either captured by outsiders with their own interests. Its one thing for an independent charter board to negotiate with investors across the conference table; its quite another when they are on both sides. That assures a deal adverse to the school.

    How did we get to a place where the independence of many charter boards is querstionable?

    At first, no chartering agency had the capacity to identify problematic applications, and most had a greater interest in opening new schools (quantity) than in assuring solid operations (quality). That might be excused, but there has been no learning and little increase in the capacity or diligence of reasonable oversight.

    A second reason is that after charter laws were passed, the policy and political types with channels to grant money, did not turn the reins over to people with operational expertise in the various problems starting a new independent public school. Instead they formed quasi-political "technical assistance" centers, and studied basis problems like facilities finance to death.

    The consequence? Our intrepid grassroots activists starting charter schools had no access to people who might help them solve their real-time start-up problems. They share some blame here for not going to the as a group and explaining what they really needed.

    So a bunch of business people and private sector firms stepped into "help." Some were well-intentioned, some were not. Some boards foolishly delegated decision making to their partners, others felt they had no choice because they had no idea what they were doing. Some board members who did know things were heading south but couldnt change the schools course, left. New board members might be more pliable

    And now, discouraged by the lack of local capacity, the philanthropies that fund charters expect/need potential grassroots organizers to work with a CMO.

    Can this be fixed? Yes. But not until the grassroots charters get their act together to push change. The big foundations didn't get charter laws passed, it was grassroots organizing that caused state legislators to act.

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  3. Marc Dean MillotMay 30, 2010 at 7:01 PM

    This comment would make quite a bit more sense if at least the guts of my prior comment today were also published. ts not quite cricket to print the comment that tends to favor your view of the world, but not the earlier one that takes issue with it.

    If you feel I was too nasty to you personally - re the ethics of pairing me with Wilson, especially in the context of his remarks re fraud, excise the offending parts.

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  4. Don't know what the hell you're talking about Marc. I posted the only comment that came up on my blog. Had nothing to do with my agreement or disagreement. To tell you the truth, I haven't even waded through your first comment yet.

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  5. The last time we heard from Marc he was attacking those who AGREED with him. Now he attacks people who aren't there. Hmmm.

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  6. I honestly don't know what the hell he is saying. Something about grass-roots charters "getting their act together." What???

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  7. Marc Dean MillotMay 31, 2010 at 12:22 PM

    Gee Mike, why not just publish the first comment I submitted as well as the second and let readers figure it out?

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  8. Marc Dean MillotMay 31, 2010 at 1:06 PM

    Fred:

    I dont want to fight about whether or not I posted two posts. On my side, I posted a lengthy comment before the one you published. I went through the usual submission protocol that ends with the we've got it and it waits blog admin approval before publication. So I assume it made it into your system and is awaiting approval.

    Maybe it got dropped. Maybe you thought it was a duplicate and erased it. Maybe it got lost in the ether.

    As luck would have it, because I composed it directly on your blog site, I don't have a copy.
    If its lost, I'll have to compose another. I'll do that if you cant find it.

    I had two points:

    First, I stand by my assessment that charter management and charters in general are not a profitable business. State charter school statutes and the nonprofit law they import do not create a hospitable environment for MOs - E or C. This is largely a function of the general prohibition on for-profits holding charters outright, the establishment of charter schools as legally independent entities, the fiduciary duties of nonprofit board members, an the law as it applies to nonprofit boards. To oversimplify a bit, charters cant be subsidiaries, the board must act in the best interest of the school.

    Where charters cannot legally be controlled by outside entities or individuals, its impossible to gain the full value of economies of scale. Benefits, financial or otherwise cannot accrue exclusively to an MO, distributions risk and reward must be shared as the result of an arms length negotiation between the MO and the charter board.

    Stay within the legal bounds of the MOP marketplace, and you the MO owner will find it hard to make a business profitable enough to attract investors.

    Break the law, by controlling the charter board, and yes you can make real money, especially on the real estate deals. But all criminal activity yields high gross margins (profits after direct expenses, before chargin'g off marketing, central overhead and taxes. Thats a different kind of "profit" than the one I've analyzed.

    Second: I cannot subscribe to Tilson's views on acceptable business behavio - no matter what the context was of the remarks you quote. There may be a fine line between the evidence required to convict someone of fraud and letting them walk. But there is no such line between "sharp" and "honest" business practice. Most business people I have known do not spend their days skirting a fine line between their what they can get away with their partners, clients and customers, and fraud. Tilson's implication of as business culture ready to race to the moral bottom to beat competitors is more descriptive of Wall Street than Main Street. Every field has its bad actors, and I find it offensive to be tossed in the same barrel.

    Finally. There's little doubt that I dont fit into the usual mold of our k-12 debate. I am not happy to find myself in constant disagreement with both sides in the debate over markets in public education. I believe that's a function of the ideological extremes in ed reform becoming the mainstreams in public discourse. I don't want to join either club, they are the only clubs, and so I'm on the margin. So be it. Another reason I work for myself.

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  9. Thanks for the lengthy clarification Marc. One source of your confusion may be that I'M MIKE. My brother is FRED. He's the older looking one. He's also a blogger. Maybe you posted something on his blog and thought it was mine. Mistakes like this happen as you grow older. Believe me.

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  10. Uh, no. Nothing from Marc on my blog. I was tempted to write 1,000 words about how I'm NOT older looking. I am, however, parsimonious by nature. It seems unfortunate that Blogger doesn't have a Goofy Filter.
    -Fred

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