The “boring-is-best” rule of bonds
Neither the Cayman Island ‘Connection’ nor the collapse of the auction rate securities market seem to have rung any alarm bells with anyone on the board of the MDFB, a department of the State of Missouri they’re still processing revenue bonds for little MAMU connected towns with the same auction-rate garbage in them. Are the Lt. Governor and the board also among the useless non-reading officials we are burdened with who rubber-stamp an administrator’s proposals without checking the details? Why are MDFB and MAMU, at this moment, still pushing their members into the same toxic swap loans that have been under criminal investigation since 2005 by the IRS and the Justice Department? The fact that this derivative interest rate swap system has had the seal of approval of the Governor, eight of his political friends, the Lt. Governor and three heads of departments for at least eight years or more, tell us that the state condoned these impossible-to-track financings in offshore banks. Public money in a Cayman Island Branch of a foreign bank is not an accountable or transparent use of public funds nor can Cayman Island accounts be attached by agents of the law if public money someone is hiding there needs to be recovered. Why does the state of Missouri enable the money of a number of little Missouri towns to sit in a Cayman Island Bank right next to the loot of the world’s greatest crooks, criminals and drug kingpins?
The prime directive of government is “Do no harm.” It’s on the very first page of Missouri’s Bill of Rights. “That all constitutional government is intended to promote the general welfare of the people….that to give security to these things is the principal office of government, and that when government does not confer this security, it fails in its chief design.” Our highest state officials and the VIP’s of the Missouri Development Finance Board “failed in their chief design” when they threw us to MAMU and the wolves of the derivative swap market.
The public’s trust and good will has been exhausted. Decades of manipulation, lies and corruption scandals from Watergate to the local city pork projects have taken their toll on our attitude toward government at every level. People are fed up with being over-taxed and under-served. Capitalism has become little more than a bail-out for bloated corporations whose idea of a “free” market is that they are free to privatize their profits and they’re also free to “socialize” their losses on the backs of taxpayers. Elected officials quite correctly have learned to fear asking disgruntled voters to approve levy increases, tax or bond issues. Instead, they jump on every “alternative” money-raising scheme the special interest hucksters can invent, such as TIF and TDD, and Kincheloe’s Payday Loan Laundry, as long as these new “creative financing methods” give them more money to spend while circumventing constitutional requirements for voter approval.
Kincheloe’s MAMU financing offered them a loophole which he explained on page 2 of his bid letter to Rolla on their latest $18 million utility project, would give them the two things they craved, no public accountability and no public referendum on the project: “The Program [MAMU’s financing program] does not require lease-purchase participants to fund a Debt Service Reserve and no voter referendum is required.” The debt-service reserve is a protection for the taxpayers and so is a voter referendum so naturally the loopholes of “The Program” had great value to our politicians if it gave them a way to deep-six both accountability and fiscal prudence. They did not have to answer a single question to justify the project nor did they have to face any awkward discoveries they couldn’t explain about Cayman Island bank accounts during a prolonged referendum campaign. As the whole interest-rate swap market started collapsing after the February market shutdown, some governmental entities that had taken this sucker-bait found themselves paying - not the tiny rates and fees Kincheloe quoted in the Rolla bid letter – but interest rates of 10% and 20%, much more than the fees and rates they started with. Their interest rate swaps soured and their interest rates soared. Jackson County Alabama is a nightmare case study in what happens when officials “trust the experts” instead of doing the due diligence we require of our public officials.
The Fleecing of Alabama: The Bills Come Due
JPMorgan Chase led four banks in selling interest-rate swaps to Jefferson County at six times the going rate. Now, the FBI is investigating the bankers, the SEC has sued a local politician and the county is on the verge of going bust.
By William Selway and Martin Z. Braun, Bloomberg Markets - July 2008
As nighttime temperatures plunged in Birmingham, Alabama, last October, Dora Bonner had a choice: either pay the gas bill so she could heat the home she shares with four grandchildren, or send the Birmingham Water Works a $250 check for her water and sewer bill. Bonner, who is 73 and lives on Social Security, decided to keep the house from freezing. "I couldn't afford the water, so they shut it off," she says.
Bonner's sewer bills have risen more than fourfold in the past decade. So have those of others in Jefferson County, which has 659,000 residents and includes Birmingham, the state's largest city. What's threatening to increase them even more isn't the high cost of treating waste; it's the way county officials chose to finance the $3.2 billion in debt they took on to build a new sewer system. The county relied on advice from a bank, JPMorgan Chase & Co., to arrange its funding, rather than use competitive bidding.
Like homeowners who took out mortgages they couldn't afford and didn't understand, Jefferson County officials rejected fixed-rate debt and borrowed instead at rates that varied with the market. The county paid banks $120 million in fees--six times the prevailing rate--for $5.8 billion in interest-rate swaps. That was supposed to protect the county from rising rates for their bonds. Lending rates went the wrong way, putting the county $277 million deeper into debt. In February, the county's interest rate soared to as much as 10 percent, up from 3 percent just weeks earlier. The swaps have now compounded the risk that Jefferson County will file for bankruptcy as it faces its worst financial crisis since it was founded in 1819.”
The same subprime chaos that has felled chief executive officers on Wall Street and forced banks to write off $322 billion has plowed into Jefferson County and other municipalities. That means local officials now have to pay to banks money that otherwise might have been used to build schools, hospitals or public housing. Meanwhile, the U.S. Securities and Exchange Commission and the Justice Department are now investigating bankers and officials involved in Jefferson County's swap agreements. Bankers who worked for New York-based Bear Stearns Cos. and JPMorgan when Jefferson County bought its swaps have been told they might face criminal charges under an antitrust investigation of the municipal derivatives industry, according to records filed with the Financial Industry Regulatory Authority Inc. On April 30, the SEC sued Larry Langford, the former county commission president, for fraud in allegedly accepting $156,000 from a local banker while refinancing the sewer debt. Langford denies any wrongdoing. JPMorgan spokesman Brian Marchiony declined to comment for this article.
The Federal Bureau of Investigation has raided financial advisers in California, Minnesota and Pennsylvania to get files. In January 2007, Charlotte, North Carolina-based Bank of America Corp. agreed to cooperate with federal prosecutors in exchange for leniency. Bank of America spokeswoman Shirley Norton declined to comment.
Jefferson county--which weathered the U.S. Civil War in the 1860s and racial strife in the 1960s--is now scrambling to avert what would be the biggest municipal bankruptcy in the nation's history, measured by outstanding bonds. "It's going to come back to us, to the people," says Bonner, a retired waitress. "Whether you're poor or you're rich, you're going to end up paying." JPMorgan, Bank of America, Bear Stearns, and Lehman Brothers Holdings Inc. charged Jefferson County about $50 million above prevailing prices for 11 of the interest-rate swaps the county bought between 2001 and '04, according to the September 2005 issue of Bloomberg Markets ("The Banks That Fleeced Alabama").
None of the fees were disclosed to the commissioners, records show. Porter, White & Co., the Birmingham-based financial advisory firm later hired by the county to analyze its swaps, said the banks raked in as much as $100 million in excessive fees on all 17 of its swaps. The swaps are contracts in which the county and the banks agreed to exchange periodic payments based on the size of the outstanding debt and changes in prevailing lending rates. Swaps are derivatives, which are unregulated financial contracts tied to the underlying value of a security, commodity or index. (More….)
In the Bloomberg article, Alabama Congressman Jim Bachus summed it up, “The entire controversy would have been avoided if Jefferson County had simply used the kind of financing all municipalities once used: fixed-rate bonds, which through the early 1970s were almost always sold through competitive bidding. On a 30-year issue at a fixed rate, then everybody knew the risk," Bachus says. "Now, with these swaps and these different transactions, the taxpayers, the ratepayers, even the county--I don't think they understood what they were getting into." Even the culpable Jefferson County Commissioner Smoot admitted they’d been conned. He said the commission “misplaced its confidence in the bankers and advisers.” Smoot said, “I blame the people who said they were the experts. The big Wall Street bankers, where are they now, they violated our trust.” Smoot was wrong. He and his fellow commissioners were responsible; they are entirely to blame. Who told Commissioner Smoot that his job was to become a “we-trust-the-experts” chump for Wall Street con artists?
If you don’t understand anything about derivatives, interest rate swaps and auction-rate securities you have lots of company. Almost no one understands them except the people who invented this dangerous game and most of them have quite deservedly lost their jobs. Some, but not nearly enough of them, are going to prison. There are a few things to be learned from this fiasco. We obviously have a generation of elected officials who do not understand, and appear to never have run across the concept of prudence and conservative money management in public affairs. Like a toddlers they cannot be left alone for one minute to run our cities, schools and other public bodies without our constant supervision. Their addlebrained philosophy that they should “trust the experts” is simply a cover-up for laziness and lack of aptitude and it has landed us in one financial mess after another – the most damaging and costly messes for us are the ones originating from MJMEUC-MoPEP and MAMU.
The Birmingham News on March 02, 2008, published an editorial written by finance editor Jerry Underwood, “Jeffco ignored boring-is-best rule of bonds” that should be required reading for everyone elected to any public office, “This March, Jefferson County officials admitted the county (read: the taxpayers) must come up with $184 million in collateral or its swap agreements could be terminated. If that happens, the county would have to pay as much as $341 million to cover its part of the “swap” deals.” Underwood said, “Jefferson County's financial practices will go into a textbook outlining the folly of officials who blundered their way into what could be the largest municipal bankruptcy of all time.” The legacy of the elected officials who “trusted the experts” is going to be that they were the biggest schmucks in Jefferson County’s entire history.
Underwood concluded: “There is a reason municipal finance is supposed to be a snooze. The financial crisis that's bringing Jefferson County to its knees illustrates why that has long been the rule. County governments are supposed to issue boring, plain-vanilla bonds. They're not exciting but at least you know how much you owe and when those payments are due. Plus, it's never a good idea to pile on any more debt than you have to, because you just never know what treacherous curve lurks just around the corner. There is one more rule in this boring-is-best strategy: Steer clear of the blandishments of Wall Street bankers, who always have an exotic product to pitch to unsuspecting rubes who can't tell a ticking time bomb from a legitimate investment. Looks like Jefferson County ignored all these rules, and probably others. Fact is, these wounds appear to be self-inflicted - and we are all going to pay for them for many years, if not decades.”
Our elected officials didn't use the Boring-is-Best rule either.
