Saturday, August 7, 2010

How Elite Wall Street Bankers Ripped the Denver School System

Here's another reason children's education should be left up to the free markets. When you create a government power center, with hundreds of millions of dollars (and the same amount of borrowing power)floating around inside it, the slicksters will figure out an angle to get their hands on a good chunk of it. They'll grab it, even if it's school kids' money. Hayek wasn't kidding when he said the worst get on top when governments rule.

NYT's Gretchen Morgenson explains what happened in Denver:
In the spring of 2008, the Denver public school system needed to plug a $400 million hole in its pension fund. Bankers at JPMorgan Chase offered what seemed to be a perfect solution.

The bankers said that the school system could raise $750 million in an exotic transaction that would eliminate the pension gap and save tens of millions of dollars annually in debt costs — money that could be plowed back into Denver’s classrooms, starved in recent years for funds.

To members of the Denver Board of Education, it sounded ideal. It was complex, involving several different financial institutions and transactions. But Michael F. Bennet, now a United States senator from Colorado who was superintendent of the school system at the time, and Thomas Boasberg, then the system’s chief operating officer, persuaded the seven-person board of the deal’s advantages, according to interviews with its members.

Rather than issue a plain-vanilla bond with a fixed interest rate, Denver followed its bankers’ suggestions and issued so-called pension certificates with a derivative attached; the debt carried a lower rate but it could also fluctuate if economic conditions changed...

Since it struck the deal, the school system has paid $115 million in interest and other fees, at least $25 million more than it originally anticipated.

To avoid mounting expenses, the Denver schools are looking to renegotiate the deal. But to unwind it all, the schools would have to pay the banks $81 million in termination fees, or about 19 percent of its $420 million payroll.

John MacPherson, a former interim executive director of the Denver Public Schools Retirement System, predicts that the 2008 deal will generate big costs to the school system down the road. “There is no happy ending to this,” Mr. MacPherson said. “Hindsight being 20-20, the pension certificates issuance is something that should never have happened.”..

Denver isn’t the only city confronted with budgetary woes aggravated by esoteric financial deals that Wall Street peddled in the years before the credit crisis. Banks have said the deals were appropriate for the issuers and that no one could have predicted the broad financial collapse that put pressure on the transactions...

Although it is difficult to tally how many public entities entered into interest-reduction deals, a recent analysis...estimated that over the last two years, state and local governments have paid banks that arranged these transactions $28 billion to get out of the deals, seeking to avoid further crushing payments...

In the end, [the Denver] deal that JPMorgan said would have an interest rate of around 5 percent spiked to 8.59 percent during its first fiscal year, and has since settled down to an average rate of 7.12 percent today.
The slicksters just know how to cozy up to governmnet created power centers and influence those who are controlling money [and borrowing power] that is not their own. These kind of deals don't happen in the private sector. As if to prove my point, Morgenson writes:
Andrew Kalotay, founder of Andrew Kalotay Associates, a debt management advisory firm, said a deal like Denver’s would be highly unusual among private sector issuers like corporations because they recognized the pitfalls of locking themselves into an arrangement for 30 years.

“I’m not aware of any corporations trying to get a better fixed rate” by issuing long-term instruments such as those used by Denver. “Why would the school district want to do this transaction with all the attendant risks of mispricing and the possibility of unfavorable unwind costs when they could have done a conventional, taxable fixed-rate deal?” he asked.


  1. wallst famous conduit is "fees", "bonus" nobody can go after them in future.

    where can i find gigs that will convince other parties to both give me the money, AND let me charge "fees" of 10-20% in doing so.

    Complex finance is Robber Baron's wet dream. Municipalities, pension funds, schools etc are the playground.

    we are so screwed.

  2. To "Anonymous": While I strongly agree with your sentiment (and points made in the article), I would ask you to be careful using the term "robber barons" which often refers (like you link does) to people in a specific era that have been MIScharacterized as thieves, monopolists, etc.