Millot: What Kind of Charter Market Do We Want? (I)

My series on Dennis Bakke's memo and Imagine's behavior raises two issues of policy:

• Can today's charter laws be enforced viz a viz Management Organizations?

• Can Management Organizations achieve scale within current legal bounds?

It may surprise some of my new readers at TWIE that I am an unabashed advocate for a market in public school improvement. My focus is on student outcomes, and as the nation moves towards standards and assessment of what students need to know and be able to do, taxpayers can rely on direct measures of performance, rather than the indirect assurance of quality individuals may attach to a school's government, nonprofit or business status. The measures and measurements are incomplete and imperfect, but as they become tied to consequences for districts, schools, students, school staff and - I emphasize - providers, they will get better. (We've seen precisely this trend in the regulation of clean air and water.) It's not a perfect system, just better than the input-based accountability it replaced and the current alternatives.

As a citizen, a market advocate, and an "officer of the court" (a lawyer), I also expect business to be conducted within the boundaries set by law - not just the boundaries players or policywonks like, and ideally within the intent of the law as much as its fine print. If edwonks of the left prefer not to recognize the market's long and pervasive involvement in the public school classroom, those on the right have a hard time accepting the real meaning of "free market" economics. The idea is not a market literally free of rules, but one with the minimum regulation required to assure transactions that further objectives determined by legislatures.

The first policy issue raised by the Imagine fiasco concerns the integrity and enforcement of charter school law. Imagine has been operating well outside the bounds of acceptable behavior, given the rules of the charter game. Whatever that network's academic performance, the management organization should be required to conform its operations to the law or forced from the market. It seems that charter authorizers are putting a halt to new Imagine schools until the problems identified in Bakke's memo and related investigations are resolved. The IRS should decide if Imagine qualifies for 501(c)3 tax status post haste. It won't be easy, but courts can determine an equitable means to recover for individual charter schools any excess wealth Imagine extracted by sitting on both sides of its many school building transactions.

Still, we are left with the fact that chartering agencies are no more able to deal with management organizations than they were when this mess was uncovered. Imagine is probably the most sophisticated bad actor, but it is hardly the first to operate across state lines, let alone the first to violate the law, and provably not the most damaging. Today's statutes create a thicket inviting abuse and loved only by lawyers and accountants. If current laws remained unchanged, management organizations remain on the scene, and citizens desire market integrity, we'll need to beef up the capacity of chartering agencies, and expect some disruption and uncertainty while the courts in 43 jurisdictions rule on precise legal boundaries.

This leads to the second issue - Can Management Organizations operate within today's laws? 

This might strike some readers as akin to saying that if intentional unjustified killing were not murder, Ted Bundy would never have gone to prison. Nevertheless, if charter statutes allowed management organizations to hold charters directly, nothing Imagine did would be illegal. There's no public policy purpose for legalizing murder, but there is an argument for allowing management organizations to hold charters.

As I see it, Bakke and Imagine have made a very strong business case for the direct control of charter schools. The key to start-up, growth and sustainability in for- or nonprofit management organizations lies in sales-leaseback financing. These transactions permit a new enterprise to generate cash in excess of expenses rapidly, reducing the considerable start-up investment most have required thus far, and accelerating the transfer of control from investors who expect a quick return to managers with a long-term vision.

Sale-leaseback financing should be a win for the management organization, its investors, the taxpayer, school staff and students. The new management organization brings an important value-add to the negotiating table with new partners - a new school building. The sale of completed buildings supports a quick return of investors' funds, provides a separate stream of revenues to build and support the organization's central office capacity while it reaches break-even on an operating basis, and builds the cash reserves required to find the next desirable partner. The cash realized by the sale should permit more of the state per pupil payments received by each school to go directly to individual school start up and ongoing operations. In the short run, the ability to devote higher levels of spending on teaching and learning should make the management organization more attractive to new partners. In the long run, whatever educational model the organization has selected, the extra money should make it easier to improve student outcomes at the school.

I have expressed many doubts about the Management Organization model, but I'm ready to admit that Bakke and Imagine have a business plan that addresses many of my concerns with financial sustainability. Whatever excess value Imagine has allocated to itself only proves my point; another group of managers could decide differently. I might well participate as a venture investor in a new start based on this model - Imagine has grown quite well without much information on school performance.  I still would not participate a for-profit's Initial Public Offering - because I doubt that  they will be able maintain educational outcomes at scale that are consistently superior to similarly situated schools in the traditional system. But the jury is out on long term performance.

The management organization's financial model can work, but it requires direct control of local charter schools. The institutional investors who buy the facilities demand the security of long term leases, sellers with expertise to manage the financing of individual facilities and offer buildings in a package, and an ongoing business in the field that establishes their interest in a favorable reputation. There are ways to meet these market requirements with intermediaries, but from the investor's perspective, the management organization has the added advantage of a direct interest in making the lease payments that should keep it focused on its charter schools education performance.

The Imagine fiasco shows that, in most states, it is illegal for management organizations to "control" charter schools in ways that satisfy institutional investors. They can't hold charters, and I'm willing to bet that when confronted with a decision, most courts and chartering agencies will not permit indirect efforts to get what management organizations' can't achieve directly.  At present course and speed, state charter school statutes cripple the management organization's business model, leave today's organizations as "cash sinks" for investors, and ordains their failure as a strategy for quality at scale.

Next:  High Time for State Charter School Statutes to Settle the Status of Management Organizations.