While watching the shocking “Bloody Tuesday” banking industry collapse on September 16th, you may have been confused by the mention of “credit default swaps” (CDS) cited as one of several culprits in the banking collapse. The CDS’s they were talking about are the derivative first cousins of the “auction-rate securities” MAMU and MDFB have been swindling our cities into so they could get utility revenue bonds issued without the constitutionally required local voter referendum. With the derivatives, MDFB, MAMU and Wachovia bank could make money swapping the floating interest rates of our long term bonds. The definitions of these two types of derivatives (there are other kinds) are in the links above. In short, both are contributors to the meltdown and they are equally toxic but to different victims. The credit default swaps are bets between two bank gamblers that a third party will or won’t default on a debt. Auctions-rate securities are derivatives of long-term maturity debt instruments i.e. corporate or municipal bonds where the interest rate is regularly reset through a dutch auction giving the municipality a bouncing and unreliable interest rate. Like a truck load of angry rattlesnakes, auction-rate securities should not be dumped in any small town, school district or other public entity just so a few elected officials can get money for their pet pork projects but avoid the wrath of their constituents in the voting booth. As Jefferson County, Alabama learned to its sorrow, when it comes to public financing “Boring is Best.” Public entities should stick to plain vanilla revenue bonds with no derivative gambling features attached. Old-fashioned bonds are safe, easy to understand and they never slither up your pant leg and bite you in the ass.
What does the banking meltdown have to do with us? The federal bailouts are happening in the Wall Street stratosphere of high-finance. The guys begging for bail-outs from our politicians are greedy pinheads, the Gordon Gekko’s of the investment banking world, and they deserve to bleed out…slowly. Unfortunately the other pinheads in Washington who failed in their oversight duties will probably bail them out one way or another. We, on the other hand will sit here like ducks during hunting season holding our rotten derivative loans that our little towns got through MDFB and MAMU but because we have no Washington lobbyists to bail us out we will eventually have to pay for our stupid mistakes. Unlike the too-big-to-fail banks, no one is going to bailout the Rolla’s, Owensville’s or Hermann’s because we’re too-little-to-rescue.”
Example: On Wednesday morning the Bloomberg ticker announced: “Alabama County Sued by Bond Insurers Seeking Resolution to Debt Crisis.” Bloomberg’s ticker also said: “Princeton Interest Rate Quadruples on Lehman-led Debt Issue.” Both the Good ole’ Boy Alabama pols and the prestigious Princeton eggheads made the same greedy mistake. They both let slick investment bankers sell them “good as cash” derivative swaps like the ones MAMU sold their member towns – not credit default swaps like AIG’s, but auction-rate securities spun off their revenue bonds. Now the same crooks and liars that sold our dumb town officials these risky gambling instruments are going to be squeezing both the public and non profit institutions at the end of the sucker line to get the cash they need to cover their own losses. The quote of the fictional Gordon Gekko: "Greed is, for lack of a better word, good" wasn’t a movie invention, it was taken right out of the Wall Street playbook.
So with this collapse of the investment banking system the dominoes will fall on every bank including Wachovia. Our Secy. of State Robin Carnahan thinks she has a deal with Wachovia to pay back some of their individual victims but bigger sharks are after Wachovia for their own purposes and Wachovia may not last out the week. After the failure of the House bail-out vote it’s like watching one of those slo-mo films of an old casino imploding. Carnahan is still “thinking” about whether she will investigate or take any action against MDFB and MAMU. If somebody doesn’t, all of the MoPEP and MJMEUC members who let themselves be herded by MAMU into the very same auction-rate securities market will be like the kid at the end of the snap-the-whip line at the ice rink – they’ll be slammed into the wall at a high rate of speed just as Princeton and Jefferson County were when their auction-rate floating interest rates quadrupled. When the Minnows of MAMU say they can’t pay Wachovia (or whoever owns them next) four or five times the variable interest rate that they told their borrowers would be such a good deal, Wachovia will sue to get the money that – however immorally – is still quite legally owed to them. After all the Gordon Gekko’s need every dime they can find to cover their own losses in the rotten derivatives market they got us into.
Our problem is two pronged and only the second one has to do with derivative swaps:
PROBLEM #1 – MJMEUC audits have failed to recognize $2,160,352,403 in liabilities which are now the debts of MoPEP member towns because each town “owns” a % of that debt.
· If or when authorities finally investigate MDFB and MAMU, (as they so richly deserve) their ‘07 management letter says their accounts for the past three years are in such poor shape that it would be difficult - but not impossible - to figure out what the collateral damage is to their small town victims as a result of Kincheloe’s power plant shopping spree. The MJMEUC 2007 management letter confessed to “significant deficiencies” and “material weaknesses” of MJMEUC and all affiliates which means that at least their last three audits (or more) are generally worthless because, 1.) They use Quickbooks which is inadequate for the complex calculations they should have been making. 2.) The complex calculations they should have been making on MJMEUC-MoPEP liabilities for what is now a $2,160,352,403 debt for equity investments in eight power plants have not been reflected in their ’05 to ’07 audits so the audits are incomplete and totally misleading as to the financial condition of MAMU, MJMEUC and MoPEP. 3.) The MJMEUC accounting and billing staff are spread too thin and they were too inexperienced to cope with the “increased complexity of accounting needs.”
· Because of the “significant deficiencies” and “material weaknesses” of the incomplete audits of the prior years of MJMEUC audits, the 32 cities that are member investors in MJMEUC-MoPEP haven’t had correct contingent liability information from MJMEUC on the $2 billion in revenue bond debt which each member should have passed on to their own auditors so that liability could be correctly reflected in their city audits. The reason the information about their percentage share of MJMEUC’s $2.1 billion debt should have been included in their local audits is to show the full extent of each town’s contingent liability for the highly-leveraged revenue bond loans Kincheloe (MJMEUC-MoPEP) took out to buy equity positions ($2,160,352,403) in coal-fired power plants that have constantly rising construction costs. Why is this disclosure at the local level necessary? Because their monthly electric revenues are pledged as collateral for MJMEUC’s power plant investments! If things go wrong, their electric revenues can be seized to pay MJMEUC’s investment debts and this would leave the individual member cities with little or no revenue left to pay their own expenses. Full disclosure would at least provide them with a warning so they could take steps protect themselves against a major loss of electric revenue.
Example: To this date the City of Rolla alone has an estimated total contingent liability of $131,851,727.60 for the power plants (not including their other share of MJMEUC-MoPEP overhead and other debts that are passed through each month as a “direct cost”). The unfortunate utility rate payers of Rolla have no idea they have an outstanding obligation that is six times their annual city budget! To find out what the contingent liability of the total MJMEUC-MoPEP debt of $2,160,352,403.89 is for your MoPEP town, go to the updated 2008 Schedule M attachment to the MoPEP contract and do the math to see what your town is obligated to pay. The Schedule M lists are titled, “This Exhibit allocates shares of Resource Obligations for the purpose of implementing MoPEP #1 Agreement Section 15.8. [of the MoPEP contract].” It also says the “Allocations of Resource Obligations apply only to Pool members for whom the Agreement is cancelled,” but that’s not true. The Schedule M “Allocation of Resource Obligation” percentage determines the size of a lot of the bills MoPEP sharecroppers are paying now and the really big ones they will pay in the future.
PROBLEM #2 – the toxic MAMU pool loans with their floating interest rate derivative swaps.
· Most MoPEP members still don’t know they’re directly involved in the national news stories about the collapse of auction-rate securities and credit derivative swaps but if they borrowed money for diesel generators or any other local utility project over the last eight years through MAMU and MDFB they are hanging right up there with Bear Sterns, Lehman and AIG, it’s just that Kincheloe hasn’t bothered to tell them yet. If Wachovia (formerly A. G. Edwards and soon to be somebody else) like the other big 10 banks this week, is looking for cash to shore up their losses so they can avoid a Washington Mutual fate, they will do what other banks are doing to Jefferson County, Alabama and Princeton - suing to get what they can out of the customers they sold floating interest rate loans with derivative swaps. The con was perpetrated nationwide. In addition to MAMU’s victims, in Pennsylvania alone there are 110 school districts whose loans are contaminated with derivative swaps and who may be sued like Princeton and Jefferson County if they refuse to pay interest rates that may have suddenly doubled or quadrupled.
· The member towns MAMU pimped to get their utility project funded through the MDFB bond pools are 100% exposed to “Bloody Tuesday’s” meltdown in the banking-derivatives market but MAMU’s debtor towns don’t know how much their exposure is because MAMU has never given their auditors the information about the extent of their so-called “revenue bond issues” for their diesel generator or other utility project that was funded through MAMU and MDFB. The information on what the current “swapped” interest rate is on their floating interest rate loans would alerted their auditors to what the current interest rate swaps were costing them and what multiples they might have to pay if the system collapsed - as it just did. At the time he arranged their MAMU* utility revenue bonds through MDFB, Kincheloe did not explain to them how dangerous derivative swaps were. It’s quite safe to assume that none of the elected officials, who rubber-stamped the MAMU loan deals they were so happy to get so they could avoid a public vote, would know a derivative from a dumpster. They just wanted somebody to do the paperwork and give them a check. They always “trust the experts” anyway so no explanation was necessary. The Gordon Gekko’s figured it was a waste of time to give them information they don’t want and couldn’t understand. (*MAMU takes an administrative fee of 1.5% on the declining balance for the term of each loan so they have no incentive to advise anyone that this is a high-risk deal that they shouldn’t be in.)
· The ’07 William’s Keepers management letter confessed to “significant deficiencies” and “material weaknesses” of MJMEUC and all affiliates for the last three years but they were referring to the $2 Billion in new MJMEUC debt for the coal-fired power plants that has never shown up on MJMEUC’s books. The auditors do not seem to be aware that there is another “material weakness” which is MAMU’s involvement in the auction-rate securities market. Their audits have also not exposed the full extent of the liability MAMU has with the third-party loans they’re involved in and their risk of being sued by members when they figure out who led them into these toxic loans by not giving them full disclosure of the risks.
Our Secretary of State Robin Carnahan got a settlement out of Wachovia for some individuals who complained but it remains to be seen if Wachovia survives to pay them. Wachovia is now on the chopping block and Carnahan may not have a deal anymore or the remnants of Wachovia may not have the money to pay anyone back. That may be the end of her interest in this crisis but we hope not. We hope there are some elected officials in this state who aren’t Gekko clones.
If MJMEUC and MAMU ever get their bookkeeping problems straightened out it’s unlikely they will ever admit to their culpability by sending out a letter to each Mayor of the MoPEP member cities with the MAMU loans with a message that might go like this: “Greetings MoPEP-ers, Remember those coal-fired power plants we told you about? Well it’s the funniest thing but we have just figured out that you are now liable for $68 million of our hasty investments…”
Tuesday, September 30, 2008
Sunday, September 14, 2008
MJMEUC-MoPEP gets an “F” on their 2007 audit Management Letter
Alliance
Some genius finally stutters “A-h-h-h…is this ah-h…a clean audit?” The auditor smirks and says, “Well, that’s not exactly a professional term but yes, I’d say it was a “clean” audit. [I’ll say it’s a ring-tailed baboon if that’s what it takes to get my check and get out of here.]” The next day the local paper headline reads, “Idiots get a CLEAN audit” misleading the public into believing that no one is embezzling or mismanaging their tax money in city hall, the school district or county. The sad fact is that every case of embezzlement is preceded by several “clean” audits. Audits have only one chance in 327 of catching someone stealing public money. Embezzlers are not found out by auditors, they’re exposed by pissed-off co-workers who rat them out.
The Management Letter. What no one talks about in the public meeting where the auditor is presenting his incomprehensible audit report, is the other document he was also required to prepare by Generally Accepted Accounting Principles or GAAP and that document is called the “management letter.” This important letter was concealed in a plain brown wrapper and slipped to the alpha dog official before the meeting started. It tells management what they’re doing wrong and management hopes you never find out about it. The “management letter” contains things the auditor found that were; violations of law, a breach of public trust, violations of GAAP or just plain stupid. All those goodies are hidden in the ‘secret’ management letter but the management letter isn’t really a secret - management just wishes it could be. The management letter is a part of the audit and both were paid for with your taxes so if you demand to see under the Sunshine Law they have to give it to you. Even though the management letter is supposed to tell the whole truth, most auditors tend to take it easy on their clients or use a lot of audit jargon to disguise what they’re saying or they tell the worst of the bad news verbally so as to leave no fingerprints. If they always told the bald-faced truth they wouldn’t be invited back to do more audits and make more money.
*GAAP: the Generally Accepted Accounting Principles is the standard framework of guidelines for financial accounting. It includes the standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements.
The “Sarbanes-Oxley Act” One fallout of the Enron disaster is the 2004 Sarbanes-Oxley Act which, in Section 404, requires CFO’s like Duncan Kincheloe to take full responsibility for their audit reports. If the audit report and management letter sucks then whining “But I didn’t know,” by the CEO making the big bucks can get him/her a jail sentence these days. The SOA also stuck it to “sweetheart” auditors who have been much too kind about what they say in their management letters to protect their sources of income. They are no longer allowed to whisper the worst of the bad news in the CEO’s shell-like ear or discuss it at a closed board meeting where the public can’t hear, now they have to put it all in writing in the management letter.
That’s why it was such a surprise to read the June 7, 2008, Williams Keepers, LLC management letter to the MJMEUC-MoPEP 2007 audit that “we identified certain deficiencies in internal control over financial reporting that we consider to be significant deficiencies and other deficiencies we consider to be material weaknesses.” That sentence said this was not going to be the usual tap-on-the-wrist management letter.
Material weaknesses and significant deficiencies in an audit are really bad things. How bad are they? The cover letter explained. “A material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected by the entity’s internal control.” Williams Keepers continued, “…because of inherent limitations in internal control, including the possibility of management override of controls, misstatements due to error or fraud may occur and not be detected by such controls.” “Material misstatement” is an auditor’s way of saying “everything in this audit may be false.” The term “management override of controls” means the books were cooked because the boss ordered someone to do it. (all emphasis marks when quoting the audit report are this editor’s)
A Nov. 18, ‘04 CFO.com article, “Where Material Weaknesses Really Matter” by Marie Leone explained that material weaknesses are divided into two categories: "Category A" material weaknesses, according to Moody's, concern control problems with specific transaction-level processes such as tax accrual, bad-debt reserves, and impairment charges. These require attention, but Doss maintains that external auditors can effectively "audit around" them and still deliver an unqualified opinion of the financial statements. The less-common "Category B" material weaknesses, however, cannot be circumvented by auditors. These offenses can derail an organization, stresses Doss, because they represent "company level" control problems such as ineffective control environments, audit committees, and financial reporting processes, encompassing everything from a lax code of conduct, to feeble fraud-prevention guidelines, to poor attempts at assigning executive responsibility.” The MJMEUC audit and management letter has a lot of “Category B” material weaknesses in it not the least of which is using Quickbooks (for Dummies), and not being able to find $340,000. Then there is the problem of being three years behind on recording the size of the contingent liabilities that each MoPEP town is responsible for due to the Billions in debt for coal-fired plants.
The phony Fitch Ratings reports. None of these systemic failures, these material weaknesses, show up in the 2005 MJMEUC audit and MJMEUC claims to have “lost” the 2006 management letter, but for the 2007 audit Williams Keepers suddenly got very busy and is going back over those three years to “restate” the audits. The Fitch Ratings analysts who gave MJMEUC their credit rating which was the only way they could take on so much debt, only saw – what the auditor now admits - were two very flawed MJMEUC audits and which Williams Keepers now says didn’t reflect MJMEUC’s real financial condition because they’re going back and “adjusting” and “restating” those old audits. Those audits didn’t even come close because the billions in debt weren’t included.
MJMEUC’s 2005 audit management letter contained only two mild cautions, one about their inadequate Quickbooks software and a recommendation to cross-train their billing personnel. They claim they can’t find the 2006 management letter. The 2005 and 2006 audits were the critical years for submitting copies of the audits and certain written assurances to Fitch Ratings to get a good rating for their participation in the Plum Point, Prairie State
Williams Keepers is now busy “adjusting” or shoehorning project cost schedules on the $2 Billion plant investments and “reclassifying” already recorded transactions to make them fit the GAAP accounting regulations. Gee, this will be swell news for all the non-reading MoPEP true-believers who have locked the financial future of their communities into this organization that unbeknownst to them has a perpetual first lien on all their electric revenues, an organization that has a choke-hold on all their power forever but which now they find out has been run by people who can’t keep their books straight. That is, it will be if they ever hear about it, but it’s highly doubtful that any of the true-believing Mo-PEP-ers have seen the ‘07 management letter or will ever see it. It’s even doubtful the board members of MJMEUC have seen it – as I said, it’s not a secret but management will try to keep it a secret if they can… including saying they lost the ’06 audit.
These were part of the material weaknesses they found in the 2007 MJMEUC-MoPEP audit:
1. Material Weakness in MJMEUC. MJMEUC has been using Quickbooks software for its general ledger. This is a material weakness for all their operations. With MJMEUC-MoPEP’s several unique and extremely complex business operations it would be impossible for them to perform some calculations such as figuring out why the MoPEP towns are spending $4 per kilowatt to make electricity out of diesel fueled generators (their WWII technology) but are selling it to MoPEP for a few cents on the dollar then letting MoPEP sell the same kilowatts back to them with MJMEUC’s markup. Using Quickbooks to try to keep track of the costs and liabilities on their $2 BILLION in highly-leveraged revenue bond investments is like sending Lance Armstrong to ride the Tour de France on a tricycle.
The auditor said that prior to MJMEUC’s involvement in the joint ownership projects MJMEUC’s activities largely consisted of, “passing along (sic) through monthly billing the costs of power purchased on behalf of its members with “appropriate markups to cover administrative overhead.” Being a markup middleman was a relatively simple process until Kincheloe went on a spending binge that ran MJMEUC and all the MoPEP and UPPA contractee’s into a massive $2 Billion debt to purchase shares in high-risk, coal-fired power plants. The auditors pointed out the difference, “MJMEUC now must account for the capital costs of these projects; for sophisticated debt financing transactions; for more complex arrangements for purchases from various power and transmission suppliers; and for the methods of recovering these costs from its members in periods sometimes far removed from the dates when costs were incurred.” Ouch! So, because Kincheloe - the business genius who invented the Great Diesel Generator Farm Project and who thought it was a good idea to rush into $2 Billion in shaky coal-fired investments when wiser heads were dumping them- has been using cheap software designed for Home Ec classes so your bills have probably been wrong but they’re not sure why they were wrong or by how much.
2. Prior audits were inadequate and left out a whole lot. The auditor has been trying to “help MJMEUC catch up on its accounting,” because they have apparently been behind since about 2005 or longer! The auditor reported, “MJMEUC’s accounting staff has not been able to maintain the general ledger on a timely basis in a manner that supports preparation of financial statements in accordance with GAAP.” The auditor explained that, “To further help MJMEUC catch up on its accounting, during the 2006 audit we analyzed and prepared documentation for the activity in the Bank of New York
3. Staffing problems. The 2006 audit had to be delayed until July 2007 in part because of “the many accounting adjustments.” MJMEUC’s staff couldn’t cope with all the demands of maintaining a correct “general ledger and supporting documentation in accordance with GAAP during 2007.” The auditor noted that another factor was that the staff was spread too thin and they were too inexperienced to cope with the “increased complexity of accounting needs, and lack of available supervisory time.” Then it gets worse.
4. Material Weakness in MoPEP Power Revenues and Costs. During the 2007 audit the staff noticed that the “revenues and costs on their Quickbooks general ledger for the year’s power sales and related costs did not appear to be accurate. Costs recorded in Quickbooks exceeded recorded revenues from MoPEP members by a significant amount.” The auditor concluded that, “There was either a problem with the accounting or a problem with the billings that had been rendered to members.” They identified about half the losses which were delayed MISO billings but can’t find the other half. As of the time of the management letter the accounting company had made “accounting adjustments….that significantly reduced the loss…to costs that should have been passed through dollar for dollar to members to approximately $340,000.” So out of about $700,000 or more of this mysterious vanishing money they adjusted half of it to reduce the embarrassment but they still can’t figure out if the remaining $340,000 fell behind a filing cabinet or its bills they should have passed down the billing pipeline to make the MoPEP members pay. Guess which one it’s going to turn out to be.
The upshot of the whole management letter is that there have been not minor but significant irregularities, significant deficiencies and large errors in MJMEUC’s bookkeeping going back to at least 2004 or earlier which still haven’t been satisfactorily identified or resolved they’ve only been partially… “adjusted” or “reclassified.” Those errors have not only impacted the MoPEP billings which were passed on down the line to local ratepayers but this amateur fumbling has also kept the audits and all financial reports to the members from accurately reflecting the information members should have had on what was happening with the cost overruns in $2 BILLION of high-risk, highly leveraged investments in power plant projects.
So, even if MoPEP members had been inclined to ask the right questions to make MJMEUC show some accountability to its members, and even if Kincheloe had been inclined to tell them the naked truth about their bloated and growing financial hazard, they wouldn’t have gotten the right answers because MJMEUC can’t keep their books in order so they wouldn’t have known what the right answers were! Now they’re going to buy better accounting software to replace their Quicken (for Dummies) bookkeeping system but like they say, “garbage in, garbage out.” Computers are only as accurate and as honest as the people who use them.
When will the 32 city council’s that walked blindly into their MoPEP contract without reading it get the answers they’re entitled to about Kincheloe’s investments, answers they should have gotten from the 2005, 2006 and 2007 audits? Where are the facts about the contingent liabilities for MJMEUC’s debt that each city needs to know and the reports on the cost overruns on Kincheloe’s coal-fired plant projects? The MoPEP contract made the city members responsible for every penny of MJMEUC’s investment debt therefore it is a “contingent liability” and as such should be shown in all their audits as it was for the first time this year in Owensville’s audit by Verkamp & Malone, CPA’s of Rolla.
How have the plant construction cost overruns impacted our MoPEP bills already and what will the impact be on local electric rates for the next 40 years? Have the project engineering reports on cost overruns been kept secret from MoPEP members because Kincheloe and the MJMEUC board are afraid their MoPEP sharecroppers will bolt if they know how bad the cost overruns are or have they been kept a secret because MJMEUC is running an amateur back room operation so bad that even the MJMEUC board doesn’t know how great a financial mess they’ve dragged everyone into with their investments?
These are the 2008 “Leaders” of MJMEUC, the board members who have had direct contact with the auditors. They’re the men who should have known all about these “material weaknesses” and how serious they were. These are the utility managers, the MJMEUC board members who are responsible but who were obviously asleep at the switch while all these problems were piling up: The MJMEUC Chairman is Bob Williams (Carthage ), Vice Chair is Jim Roach (Jackson
Audits and management letters are the CEO’s report card. This audit and management letter gets a big fat “F.” Normally when an executive gets an audit with management letter this lousy he is invited to resign. What is the MJMEUC going to do? Will they clean house starting at the top or take the cowards way out and pretend this bad report card doesn’t exist?
Subscribe to:
Posts (Atom)