Tax Law

Did 'Fancy Pants' Financing Backfire on New York Law School?

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At one time, only nonprofit hospitals were allowed to float tax-exempt bonds, which they used to build new facilities. A 1986 amendment to the tax code changed that, extending the benefit to all nonprofits.

New York Law School was among the nonprofits that took advantage of that law, the New York Times reports. “Homeowners and businesses were not alone in taking on piles of debt over the last decade,” the story says. “Nonprofits of all sizes did the same, and now they, too, are paying the price.”

Some nonprofits ended up trying risky ways of financing debt, according to some experts. “They did auction-rate securities, interest-rate arbitrage, complex swaps—which backfired on them the same way it would backfire on any hedge fund or asset manager,” Clara Miller, chief executive of the Nonprofit Finance Fund, told the newspaper. “Organizations got to be all fancy-pants with their financial management.”

The Times gives details of New York Law School’s financing, which won an award for creativity. The school sold its library on prime Manhattan real estate for $136.5 million, added the money to its endowment, and then borrowed money for construction in 2006 by floating $135 million in auction-rate securities, which are sold at weekly auctions that establish the interest rate. Because of the credit crunch, the auction market dried up last year.

The school’s dean, Richard Matasar, told the Times that interest on the securities was originally under 4 percent, compared to 5.5 percent the school would have paid on ordinary fixed-rate bonds.

But interest rates for auction-rate securities shot up last year, reaching a high of 12 percent as buyers shunned the instruments. In December, the law school converted its securities into variable rate notes secured by a letter of credit, the story says. The school’s endowment had fallen 20 percent.

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