How many local governments got sucker punched on fancy financial deals, and how much is it going to cost taxpayers to pay Wall Street? Nobody knows.

 

How much could complicated municipal bond side bets end up costing taxpayers? Nobody knows.

According to Pennsylvania Auditor General Jack Wagner, who said Thursday the deals “should be banned immediately,” it could be hundreds of millions of dollars in his state alone.

Securities and Exchange Commission Chairman Mary Schapiro also wants to know and last week ordered public hearings.

But Peter Shapiro, managing director of Swap Financial Group, said Thursday despite some examples of deals called interest rate swaps going bad, “for the vast majority of these cases, swaps have saved them (governments) a lot of money and worked well.”

Is this yet another national financial catastrophe taxpayers will have to bail out? Shapiro said no, “bottom line is: It’s over.”

But Wagner and Schapiro aren’t so sure the $2.8 trillion municipal debt outstanding, $4 trillion traded last year and billions more in derivatives based on them are Ok. Most importantly they claim lack of oversight puts taxpayers at risk.

In a speech prepared for delivery to the annual Investment Company Institute meeting, Schapiro called for SEC regulation of the municipal debt market.

She wrote, “we can see that there are disruptions in the markets for municipal auction rate securities and variable rate demand obligations, which, combined with the recession, have impacted both investors and issuers.” That means taxpayers.

Pennsylvania’s Wagner, who backed legislation late last year to ban certain deals, decided not to wait and Monday directed “all local governments, municipal authorities, and agencies of state government to file their swap agreements upon execution and to update the status and financial results of those swaps every three months. Taxpayers would then know how much was paid in fees and commissions for each swap, how much the swap costs the public entity each month, how much money the swap has lost, and how much could be lost under the worst case scenario.”

For municipalities and school districts already forced to cut services and lay off workers to pay retirees and fund irresponsible commitments, scraping bone to pay off reckless financial bets adds injury to insult.

According to Wagner, “A special investigation last year found that 107 school districts and 86 local governments had $14.9 billion in public debt tied to swaps. … Bethlehem Area School District in particular lost at least $10.2 million in taxpayers’ money through swaps.”

Earlier he detailed bad deals that cost taxpayers more than $400 million.

SEC’s Schapiro cited Jefferson County, AL, which defaulted on a $3.8 billion in sewer bonds. Four people went to prison.

“Including Jefferson County, there were 136 defaults on municipal securities in 2008, in an aggregate amount in excess of $7.5 billion. While most of these defaults involved conduit issuers in the health care sector, rather than general obligation municipal bonds, these defaults cannot be ignored,” she wrote.

Swap Financial’s Shapiro, whose firm advises governments on “the biggest market share” of these deals, agreed that “if you lay corruption over this, you can get some serious problems.”

But he said regulation in Pennsylvania and Tennessee cases, “ended up ironically making things worse” by leading local officials to believe states sanctioned swaps. “It had a backfire effect.”

He agreed “lack of aggregate data” is a big part of the problem. Municipal debt has “better disclosure than any other market, but it’s not centralized.”

Last year the Municipal Rulemaking Securities Board started collecting information on these deals for the first time and putting it in the Electronic Municipal Market Access database.

That may not be too little, but it may be too late. Right now nobody knows whether the smart-money boys sucker punched the bumpkins again or how big the bill could be.

With states and municipalities already trillions of dollars in the hole for unfunded retirement promises, neglected infrastructure and other deferred expenses, settling public officials’ bad bets could be the straw that breaks taxpayers’ backs.

Wagner put it this way, “We continue to find examples of hard-earned taxpayer dollars going to Wall Street. Money that should be invested in students, classrooms, and fixing infrastructure in Pennsylvania is instead lining pockets on Wall Street.”

Frank Keegan is national editor for the Franklin Center on Government and Public Integrity. frank.keegan@franklincenterhq.org

Tags: bonds, deficits, municipal, municipalities, states, swaps, VRDO

This entry was posted on Friday, May 14th, 2010 at 8:05 am and is filed under Blog.