Inside the Hedge Fund Infatuation with Charter Schools

Charter schools are public schools created to improve the United States public school system and offer more autonomy, innovation and choice in curricula. The concept was first created in Minnesota in 1991, and since the schools are public, entrance is open to all children with no tuition or special entrance examinations. California joined the charter school movement in 1992, and in 1992, President Clinton pushed for the creation of 3,000 schools over 10 years. President Bush subsequently asked Congress for $200 million to support the charter school concept. Meanwhile, since 1994 the U.S. Department of Education has provided grants to support these schools, and by 2015 there were 42 states with charter schools.

Interest in the charter school idea, however, is not limited to politicians and government bureaucrats. For example, high-tech moguls such as Mark Zuckerberg and Bill Gates have made large donations to charter schools. Moreover, real estate companies, including Eminent Properties Trust, actively contribute to charter schools because they help the schools acquire or rent property, very often in inner cities. The deepest and most obvious interest in funding chart schools emanates from the hedge fund community. In April 2014, a dinner in Manhattan raised funds for the Success Academy Charter Schools. Jeb Bush gave the keynote address and attendees included hedge fund heavyweights such as John Paulson, Daniel Loeb, Joel Greenblatt and Kyle Bass, among many others.

The obvious question is why billionaires and hedge funds are so interested in charter schools. There is no doubt that some of these people are acting with a sense of true philanthropy, and it would be unfair to believe otherwise. Hedge fund star Paul Tudor Jones II, for instance, established his Robin Hood educational fund in 1988 and has raised more than $2 billion. However, looking deeper into the nexus of hedge funds and charter schools, it is obvious that tax advantages play a role in motivating big contributions to the schools.

For years hedge funds have enjoyed a carried interest tax advantage, which caps tax rates on hedge fund profits at 20%. To most observers, including the 2016 presidential candidates, it is a gimmick that allows them to avoid the much higher ordinary income tax rates that would apply to any other citizen. The tax break that applies to Charter Schools may not be a gimmick, but it is extremely lucrative. It is the New Markets Tax Credit (NMTC), established by President Bill Clinton in 2000 with the intent of aligning the private sector and the federal government with the goal of bringing economic and educational benefits to low-income communities. Less widely understood is that it provides a tax-advantaged way and direct way for hedge funds to cash in on the charter school juggernaut.

The NMTC has two components: a 39% tax credit on charter schools contributions over a seven-year period plus the ability to collect interest on the money they contribute. A hedge fund could double its investment in seven years, and the tax credit can be combined with other tax breaks without limit. It is not surprising that hedge funds have flocked to this deal handed out by the federal government. For critics who believe that hedge funds are controlling a game of three-card Monte where they never lose, the future doesn't look bright. The U.S. Congress recently extended the NMTC for five years at $3.5 billion annually in the fiscal year 2016 Omnibus Spending Bill.

Charter schools have done well in many communities, but critics are lining up with examples of debacles, conflict-of-interest issues and wanton squandering of federal tax dollars. However, it is almost impossible to find hedge funds with anything bad to say about the charter school concept. There is no way they will voluntarily give up a privileged tax break that is all upside and no downside for them. They could never find an investment in the markets with those odds.