Gretchen Morgenson is often a target of heated criticism on the blogosphere, which I have argued more than once is overdone. While her articles on executive compensation and securities litigation are consistently well reported, she has an appetite for the wilder side of finance, and often looks a bit out of her depth. Typically, she simply runs afoul of finance pedants, who jump on misapplication of industry jargon or minor errors when those (admittedly disconcerting) errors fail to derail the thrust of the argument.
But I’ve also seen Morgenson be wrong in the premise of an article. Her weakness is falling for prevailing narratives and it appears that skillful operatives can spin her by making their accounts align with prevailing prejudices. For instance, it isn’t hard to get people to believe an account that depicts Goldman as a bad actor. And while I’m plenty critical of the firm, it really is possible, upon occasion, that Goldman wasn’t the bad guy, particularly when the other party (in this case, AIG) is far from a paragon of virtue. Morgenson jumped on the “Goldman engaged in predatory marks of credit default swaps to bring down AIG” account, a story clearly pushed by AIG employees. The problem was that if you looked at the data (as Tom Adams did) and contemporary accounts (as I had during the crisis) overly generous marks of illiquid paper and complex exposures was widespread (NC had repeated stories on how collateralized loan obligations, less opaque and bespoke than CDOs, were being valued at unrealistically high levels because dealers were stuck with inventory and didn’t want to report losses.). So if you had bothered to do your homework, the assumption would be that AIG and other dealers did have unrealistic marks, and Goldman’s marks were proven to be correct. So if there was a story here at all, it would need to have been a far more nuanced and detailed one than the Goldman-slamming account that Morgenson produced.
I am in no position to say definitively, but Morgenson may have been spun in her report yesterday on a Denver public school financing that turned out worse than initially planned due to financial upheaval. Superficially (and the story presents quite a few general comments and analogies that encourage readers to make the association) this story fits into conventional narrative of “municipality meets banker, banker sells derivative, banker wins and municipality loses, each big time.”
But as with the AIG/Goldman case, an interested party is pushing a story, and while that could easily have been inferred in the AIG/Goldman matter, it isn’t obvious to most readers of the Denver story, which puts them at a disadvantage in assessing it. Michael Bennett, then the school board superintendent, now a US senator, is facing a challenge in the Democratic primaries, and former school board members who are aligned with the opposition are the main (and unnamed) sources for the substantive details in this account. What is particularly sus is the New York Times taking up this story now, shortly before the primaries, when this financing was covered in the Denver media over the past few years.
A buddy of mine (former investment banker turned financial writer, no soft touch, and not a Colorado resident) contends the Morgenson account is off base and forwarded a message from another member of the school board from the time of the financing who lists numerous errors in the Morgenson account. I’m in no position to verify them independently, but the list is long and specific enough to be troubling. The most serious charge is that first, Morgenson got the fundamental impact of the transaction wrong, that even after allowing for its tsuris (and the extra fees involved), the deal still saved the school district money, $20 million to date. In addition, Morgenson claims the school board foolishly entered into a variable rate + swap transaction instead of a “plain vanilla bond,” thus exposing itself to more risk and unnecessary fees. The board member contends that no such “plain vanilla bond” existed for their situation, and the available fixed rate option, after allowing for fees, was more costly than the floater swapped into fixed that the board chose.
The text that follows is from Denver public school board member Jill Conrad:
The Truth of the Matter
I’m all for raising important questions (as I and other board members did in 2008) about major financial and other policy decisions. What disappoints me is the ways in which the facts have been intentionally distorted in many of the blogs and articles I have read on the subject in the last several months. Despite the great reputation (and my own respect for the NYT), I am shocked by the lack of attention to detail and contextual information in the Morgenson article. Here is my take…and an account of at least 18 factual errors in the article…
A. DPS achieved three critical goals with this transaction: we funded the pension in order to allow us to merge with PERA, by merging with PERA we achieved portability, and we added back $20M to schools (previous cuts had been over $80M)
B. Last Friday (7/30) PERA released the CAFR (independent audit) of current funding levels and projected funding: DPS is funded at 88% as of 12/31/09 and will achieve full funding in 2031, 22 years. PERA/school division is funded at 70% with full funding at 2040. Clearly this has had the right effect, financially for DPS employees and academically for today’s kids and teachers.
C. The article is full of inaccuracies and misleading uses of data: I count at least 18 factual errors in this poorly researched and highly slanted article:
1. “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.” – Actually, the district has realized $20 million in savings to date compared to not having done the transaction.
2. “While it is possible that the annual costs of the Denver deal will come down in the future, they are now roughly in line with what the school system would have paid in a fixed-rate transaction.” Not true. Fixed rate debt cost 7.25%. DPS is now paying 6.1%
3. “In the end, a 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.”
4. To the contrary, the all in cost including all fees of the transaction was projected and budgeted at between 5.75% and 6%, not 5%, at the time the deal was approved. DPS is now paying 6.1% inclusive of all fees, not 7.12% . The cost did spike to 8.59%, inclusive of all fees, during the 2008-09 fiscal year.
5. “And for years, the school system had not met its required annual pension payments to ensure a fully funded plan; by 2007, the school system faced a $400 million gap.” False. With very few and not economically material exceptions the district had made all required annual payments for years. The pension was underfunded because of the 2000 – 2002 market crash.
6. “The Denver schools essentially made the same choice some homeowners make: opting for a variable-rate mortgage that offered lower monthly payments, with the risk that they could rise.” To the contrary, the rate was fixed via the interest rate hedge or “swap” transaction the article later criticizes. The transaction structure is the opposite of a variable rate mortgage where the homeowner is subject to rises and falls in interest rates.
7. “Rather than issue a plain-vanilla bond with a fixed interest rate, Denver followed its bankers’ suggestion and issued so-called pension certificates with a derivative attached. Together, $750 million was raised using the riskier pension certificates.” This is inaccurate and misleading. Regardless of whether the pension debt was fixed or variable rate, the debt would still have been in the form of pension certificates of participation. There was no option of a “plain vanilla bond”. In 1997, we issued fixed rate pension certificates of participation. In 2005 and 2008, we issued variable rate pension certificates of participation, in both cases with a very commonly used interest rate hedge, the “derivative” the article refers to.
8. “To avoid mounting expenses, the Denver schools are looking to renegotiate the deal.” False. Expenses are not mounting. Expenses have declined considerably. Our current all-in costs, including interest and fees, is 6.1%.
9. “And had the school district issued fixed-rate debt, it would not have paid Wall Street the cornucopia of fees embedded in the more complex deal.” Actually, the fees up would have been the same whether the debt was fixed or variable. Ongoing fees were budgeted from the beginning and are all included in calculating the $20 million in savings thus far.
10. “Unlike many school district officials, both men were financially sophisticated and had worked together in the private sector.” False. Bennet and Boasberg have never worked together in the private sector.
11. “Like a homeowner, Denver essentially started out with the equivalent of a standard, fixed-rate mortgage that allowed it to refinance if interest rates fell.” False. Denver’s 1997 fixed-rate pcops could not be refinanced. There were no call provisions in the 1997 pcops or ability to refinance if interest rates fell.
12. “Moreover, refinancing was extremely costly, given the hefty termination fees.” False. There are no termination fees per se. There is a make-whole provision that runs both in favor of and against the banks (and DPS). DPS has the sole option to terminate the swap, which is priced based on publicly quoted Bloomberg rates. If interest rates rise, then the banks owe a termination fee to DPS should DPS choose to terminate. if interest rates fall, then DPS owes a termination fee to the banks. The make-whole fees are exactly the same in either direction.
13. “Agreeing to be locked into a 30-year contract, as public entities have done, is especially costly because getting out of it requires paying penalties to the banks for every remaining year of the transaction.” False. There are no penalties for remaining years of the transaction. There is a make-whole provision that runs both in favor of and against the banks as described in the previous para.
14. “Like the punishing prepayment penalties some homeowners have to come up with when paying off a mortgage early, termination fees on deals like Denver’s are essentially charges levied to rewrite the terms of a contract.” False. There are no charges levied to rewrite the terms of the contract, only the make-whole provision described above. If interest rates rise, the banks owe a termination fee to DPS.
15. “The pension turned in a dismal performance in the credit crisis – as was the case with most such funds – losing almost twice the $400 million borrowed by the school district to plug the pension gap. As a result, the school system’s pension shortfall recently stood at around $386 million, only slightly lower than it was two years ago, and even though $400 million had been funneled into it in 2008.” Article does not mention that absent the $400 million contribution to the pension in 2008, the current pension shortfall would be twice as large as it currently is.
16. “While the pension’s merger with the state system allows Denver’s school system to avoid paying interest on shortfalls, that benefit is temporary. If a shortfall still exists in 2015, the merger requires that it be closed.” False. DPS must continue to pay interest on the shortfall, which is known as a UAAL payment. Article fails to note that Cavanaugh and Macdonald, the independent auditor to PERA, the state pension fund, have projected the DPS pension fund will be 140% funded at the end of the current 30-year project period. The auditor also found that the district’s pension fund was significantly better funded than the statewide division and all of the other school districts, and would be fully funded years before the rest of the school division would be.
17. “Boasberg maintains that the deal has allowed Denver to hire teachers while other school districts are cutting back. But Henry Roman, president of the Denver Classroom Teachers Association, said that fewer teachers had been hired this year than in previous years.” This is remarkably misleading. All school districts in Colorado are facing severe budget cuts. While it is true we are hiring fewer teachers than in previous years, the savings from the pension debt transaction has allowed us to actually hire teachers while most of our neighboring districts are laying teachers off and instituting furlough days.
18. And finally, the article quotes Jeannie Kaplan. It does not attribute the fact that she is a leading fundraiser for Andrew Romanoff, Michael Bennet’s opponent in the primary, and falsely claims that she raised issues about the pension debt in advance of the primary race. Article offers no substantiation that Ms. Kaplan raised this issue in advance of the primary race since no such substantiation exists. The article does not mention that a second board member, Andrea Merida, who has questioned the transaction is a paid staffer for Mr. Romanoff’s campaign.
The fact remains that this transaction has positioned DPS, its employees, and most of all its students to be better off in the long run than they would have been if we had not taken action. I was proud to be a part of the decision then, stand by it now, and am grateful for the leadership and vision of Michael Bennet, Tom Boasberg, and my fellow board colleagues who are focused on one thing-the most important thing-turning DPS around so that all resources, time, and attention serves to drive increases in student achievement, graduation rates, and college success.
The Denver Post has an article up, with lots of links to old stories they reported about the DPS deal here: http://www.denverpost.com/election2010/ci_15700755
I think Gretchen got punked. This is all about the senate primary.
the denver post endorsed bennet; its the silly season & everyone’s being punked…
Wow, this is interesting, indeed.
Bennet was appointed to fill the seat that Ken Salazar vacated to be in Obama’s Cabinet. Bennet is young, and one of his primary appeals (or so I hear) in CO is his reputation for taking on the Denver Public Schools problems: teachers who weren’t performing, kids who weren’t getting to school, etc, etc. The New Yorker did a fascinating profile on Bennet when he was first appointed to the Senate, and I recall it because of the novel, creative approaches that Bennet devised to connect with… ‘a different demographic’ than his own.
Basically, he sounded like a very talented, non-ideological problem solver.
His opponent is evidently backed by the Clinton wing of the Dem party.
What I find most interesting is that Bennet has been one of the younger Senators, who appears to have had his mind blown by how dysfunctional the US Senate has become.
So it’s a safe guess that whoever punked Morgenson is perhaps someone who likes the filibuster, the ‘secret holds’, and all the other tyrannical, secrecy-imbued shenanigans that are currently allowed in hte US Senate.
Given the timing of this item, and also the fact that his reputation for tackling serious problems in the DPS, it’s almost Rovian: go after a candidate’s strongest talents, and make them sound like foibles.
But this may not be a state-level effort to punk Morgenson; indeed, if I were betting, I’d bet quite heavily that whoever put this out wants to retain their control of special privileges and legislation by their ability to control a single senator, thereby invoking a filibuster to stop the entire Senate business.
From what I’ve heard, Bennet is a reformer.
He has been advocating reforms to outdated, seriously dysfunctional Senate rules — including the filibuster.
It’s a reasonably safe bet that whatever dark forces were plying Morgenson with this story does **not** want any reforms in the Senate rules.
I’d change the title to “Gretchen Morgenson Spun the DPS Financing Story.”
kudos to Jill Conrad – it certainly seems like the school board wasn’t quite the bunch of naive rubes making unsuitable deals and getting robbed by the evil Wall Street Bankers that Morgenson made them out to be. Jill Conrad seems to know EXACTLY what was going on.
I think for readers the most important items are
#4 – DPS is STILL paying less than the 7.25% would have under a fixed rate transaction
and then #12,13,14 – Morgenson tried to make it sound like the Banks had inserted onerous fees to make it impossible for the municipalities to get out of these transactions. Jill Conrad explains it well – the value of the swap changes when interest rates change. THAT is where the “fees” come from – they are just changes in the NPV (net present value) of the trade (fixed/floating cash flow difference)
I just saw Ives Smith discussing economics on CSPAN. I cannot believe the insanity spewing from her mouth… “Even smaller businesses aren’t re-investing so what is the point of allowing them and corporations more cashflow” (paraphrased). This perspective is simply crazy. Most of us small businesses are not sacking away cash, we’re struggling. And if we are able to save any cash wouldn’t it seem like a good idea to build a “nest egg” for our businesses so we’re less vulnerable to economic pitfalls like we’ve seen. Further more, it’s not your business to “allow” us cashflow. Ms. Ives, if you don’t like capitalism please move to a different country. You will not be missed by me.
If there was any lesson to be learned from the financial crisis, it’s that we don’t have capitalism in this country.
It’s amazing how the shills for multinational corporations come out of the woodwork whenever someone has the audacity to suggest these behemoths pay their fair share of taxes. The rules of the game seem to be 1)play fast and loose with the truth, and 2)never explicitly advocate for your own interests, but always dress up your own interests in the garb of small businesses.
Yves pointed out that, when it comes to multinational corporations, the nominal tax rate is not what is important. What is important is the effective tax rate, which hovers around 10% for the multinationals. Small and medium-sized business pay much higher effective tax rates because they cannot move income around to countries with more favorable tax treatment, the way multinationals can. She advocates “leveling the playing field” so that multinationals pay the same effective tax rate as small and medium-sized businesses.
In regards to the tax cuts to corporations that some have advocated, Yves said she doesn’t favor these. There has been a growing trend on the part of multinational corporations not to reinvest their profits, so the money just accumulates at the top and stays there. Making the already rich even richer seems to be the goal of these tax cuts.
But where our corporate shill really shows his true colors is with this line: “Most of us small businesses are not sacking away cash, we’re struggling.” And so it is. Dishonest arguments always result in this sort of cognitive dissonance. For here’s a newsflash for Hal Cooper: If you’re “struggling” as a small businessman, you’re not making any money, and paying income taxes is the last of your worries. It’d be like an unemployed person getting all worked up over the top income tax bracket. It ain’t gonna happen.
It sounds as if you did not listen very clearly to the interview, that you were so upset with the criticism of corporations that you did not hear that I was very clearly singling out big public companies (did you miss the focus on managing quarterly earnings and not investing/disinvesting to please Wall Street?).
I also very clearly said retained earnings should be taxed above a certain reserve level. That allows for the safety margin you are talking about.
And frankly, most small business don’t keep there reserves in the company. For tax efficiency reasons, they take it out in expenses or compensation/bonuses to avoid double taxation. The owners then keep the dough and either lend it back to the company or make an equity investment in bad times. I sometimes work with smaller companies on fundraisings, and have a lot of colleagues who either run, invest in, or advise (as in are lawyers to) small and medium sized private companies (and I do run a small business myself). Most that operate that way.
People in glass houses…
I’m a bit disappointed with Yves for publishing this whole thing while admittedly not being able to verify the details. But I think the bigger problem is with Jill Conrad, who professes real outrage at Morgenson’s “at least 18 factual errors”. Providing a list of 18 paragraphs isn’t the same thing as pointing out 18 factual errors.
Consider, for example, number one on Conrad’s list. The quote from Morgenson says that the fees and interest paid by the school district are at least $25 million more than anticipated. Conrad apparently believes that she refutes this statement by telling us that the district has saved $20 million in comparison to not having done the transaction.
One thing has nothing to do with the other. Both things can be true. Both things can be false. One or the other can be true while the other is false. They have nothing to do with each other!
If we are going to insist on facts and care when writing arguments for one position or another, shouldn’t we insist on that behavior from all participants?
I don’t know who’s right about the Denver school district. But I do know that Jill Conrad is no less biased than Gretchen Morgenson. And I do know that Conrad can’t refute claims made by Morgenson through the use of non-sequitors.
Denver public school board member Jill Conrad writes:
“1. “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.” – Actually, the district has realized $20 million in savings to date compared to not having done the transaction.”
Ms. Conrad seems to cleverly conflate two distinct ideas here, no? Ms. Morgenson wrote about “$25mm more than originally anticipated” in payments thus far, while Ms. Conrad counters by writing about something quite different: $20mm less paid out than if no transactions were done.
If this deception is bullet point #1 in her list then one need read no further, and perhaps Ms. Morgenson did not really ‘get played.’ Judging by the way she writes Ms. Conrad herself might make a good Derivatives marketer…
With all due respect, I think you are missing the point.
No one is denying the deal turned out worse than in a best case scenario. But read the Morgenson piece, and you have quotes from experts (Joe Fischera, for instance) commenting on typical municipality rubedom, and comparisons to other municipalities that were clearly had (Los Angeles). The narrative is that DPS were idiots just like everyone else.
It doesn’t appear to be the case. This deal, per Conrad, still saved money v. doing nothing, even after the incurring extra charges. And the idea that there was the alternative of issuing a plain vanilla bond, also used by Morgenson as a basis for criticism, appears to be untrue.
With same due respect, I think that Conrad is actually trying hard to imply that the deal didn’t turn out worse than the best case scenario. She closes her missive with a very proud defense of the process and the result.
Perhaps as important is the insistence that what we should be considering is how the deal as it occurred performed in comparison to taking no action at all. It seems fairly obvious that taking no action at all would have been catastrophic and so doing better than that wasn’t much of a challenge.
You seem all too willing to take Conrad’s word for the fact that there weren’t better alternatives (something in between doing absolutely nothing and doing the deal that Denver did). Morgenson may be wrong about the availability of the plain vanilla alternative, but we can’t even be certain of that.
I’m curious: why are you so confident of Conrad’s claims? Aren’t you the least bit suspicious that Conrad might be self-serving?
As I said in my earlier comment, I don’t know who’s right, Conrad or Morgenson. But I wonder why you give so much credence to Conrad?
I think Conrad’s key point is that this swap, which Morgenson would have you believe is highly complex, convoluted, and a tool of the Big Bad Bankers to relieve poor municipalities of their educational budgets, is really nothing of the sort – and that despite the fact that the trade didn’t work out as well as it could have for DPS, it STILL worked out better than the fixed rate alternative of 7.25%…
I give credence to Conrad because I understand the products at issue, and I understand that there was nothing complex here, and that Morgenson is trying to write another article inducing populist anger at the banks from those who don’t understand.
Kid Dynamite –
I agree that Morgenson has an agenda (one with which I generally agree). I also agree that Morgenson believes that this kind of swap is highly complex and convoluted.
I think that from Morgenson’s perspective, she’s right: this swap is not one that would be readily understood by lay people. The fact that you understand it doesn’t change that.
While it’s certainly possible (even likely) that Conrad herself was well aware of what she was doing when she voted with the Denver district to go with the swap, that doesn’t mean that all the voters involved were equally aware. It’s also possible that had everyone been aware, they might have been unwilling to accept the associated risks.
Given your expertise, you’re certainly entitled to judge the deal on its merits and draw conclusions about whether or not it was a good deal. But that doesn’t condemn Morgenson, since she’s talking about people who didn’t have your expertise. In general, people with expertise are able to convince lay people without providing them with the necessary knowledge to truly make their own judgments. That happened time and again in the financial industry as it was heading for the current disaster. I don’t see how Morgenson is wrong to suggest that it might have happened here.
I suggest you read the post again. I clearly say I’m not certain who is right here, but Morgeson’s account appears awfully one-sided, and she mixed general quotes with comments from unnamed board members. So this is a “he said-she said” and she appears not to have access to documents or data where she could have made an independent verification.
“No one is denying the deal turned out worse than in a best case scenario. But read the Morgenson piece, and you have quotes from experts (Joe Fischera, for instance) commenting on typical municipality rubedom, and comparisons to other municipalities that were clearly had (Los Angeles). The narrative is that DPS were idiots just like everyone else.”
That’s the message, its always the rubes fault. Its like blaming all of those upside homeowners for not reading the small print.
It deflects from those who intentionally created the crisis and at the same time feeds their intentionally created perpetual conflict agenda. It avoids the really pertinent questions like; Where will we build the gallows to hang these lying bastards? Should we have group hangings? Should the collaborators also get hung or get life in prison?
Morgenson wasn’t spun, she’s a collaborating spinner — this is the New York Slimes, get a grip.
Deception is the strongest political force on the planet.
To Whom It may concern,
I love the thoughts here, but the copy is hard to read. The gray is too light and so is the orange? Can you darken it a tad?
After reading the NYT’s article and the two articles in the Denver Post today which contain no meat whatsover, but just politics and “he said, she said” I am left with this, the only fact in the entire writing:
“The deal means DPS’s interest rate stays at about 6 percent over 30 years. The bank takes the risk if rates go above that mark, but the bank benefits when the rates are lower.”
Now, considering most expect us to be entering a Japanese-like period with zero interest rates for as far as the eye can see, can anybody tell me how I can get in on a piece of this action??? Gretchen had it right when she said that the private corporations would never sign such contracts.
Sorry, the odds are in my favor to go with the stereotypes here. Political spin on the one side, investment banker’s reputations on the other.
As I indicated in the post, I’m not certain where the facts lie either, but Morgenson appears to have taken one side of the story, and I don’t see any evidence that she tried to verify the claims of either side with independent sources. She instead has general quotes from experts. So my belief is this case is probably some shade of grey, when it has been painted in black v. white.
Let me play devil’s advocate. As a borrower, if you are taking floating rate risk, your BIG concern is being exposed to rate increases. You do want a cap. 30 years is a really long time. Not having a cap is what is killing Jefferson County.
Moreover, people NOW are STARTING to see deflation as a serious risk. You are engaging in hindsight bias, big time. How many people then (and quite a few still now) were talking re hyperinflation? I get it on the blog daily, and this is a savvy readership.
Now they might have gotten a bad price on this cap (as in a more common approach is a collar, you trade a cap against a floor), but in concept, a cap is critical. You are insuring against costs moving into an area that will make you broke. Insurance is ALWAYS more costly than going naked, that’s the nature of the beast.
So you are conflating two issues: the cap, which was a sound idea, and whether it was greatly overpriced (and what they could have done to prevent being taken on the cap).
This is for the ‘lay’ people …
This is like screwing someone that may or may not have a venereal disease, your big concern is being exposed to something that will haunt you for the rest of your days. Wear a condom or go naked?
Let me play devil’s advocate. As a screwer, if you must take the risk, your big concern is being exposed to; rashes, brain damage and excruciating pipe bending pain. You do want a condom. A lifetime can be severely shortened without one. Not having one is what killed Al Capone.
Moreover, people NOW are STARTING to see syphilis as a serious risk. You are engaging in hindsight bias, big time. How many people then (and quite a few still now) were talking about plain old gonorrhea?
Now they might have gotten a bad price on this condom (as in a more common approach might have been a baggy or Saran wrap), but in concept, a condom is critical. You are insuring against costs moving into an area that will make you really sick for the rest of your days. Insurance is ALWAYS more costly than going naked, that’s the nature of the beast.
So you are conflating two issues: the condom, which was a sound idea, and whether it was greatly overpriced (and what they could have done to prevent being taken on the high price of the condom).
All of which deflects from the real issue — the wealthy ruling elite and their corruption of government that caused the bubble prices in condoms and their counterfeit derivative products.
Deception is the strongest political force on the planet.
Conrad, herself, makes a statement that is counterfactual: “There was no option of a “plain vanilla bond”.” There is always that option; if the bankers told the board there wasn’t, it was self-serving on the part of the bankers. I’m tending toward scepticism of both Conrad and Morgenson, and would like to see a good outside audit. The picture is far from clear.
Re the plain vanilla issue, again I indicated I don’t know re the muni market, but your assertion that a simple fixed rate bond is always available over the desired target time horizon just ain’t true.
One of the reasons the interest rate swap market developed to begin with was that some issuers could not get fixed rate funding over their desired time horizon (then, some lower rates issuers and/or project finance). They’d fund floating and swap into fixed. The muni market is much less deep and much more fragmented than the corporate market, and a school board has no taxing authority, hence they are not the highest esteemed borrowers in that universe.
Basically, you are assuming the capital markets are deep and liquid everywhere and at all times. That isn’t the case.
I don’t know about the municipal markets either but if you look at the corporate bond market you tend to see the opposite – that is most corporations want to issue long term bonds (generally the longer the term the better it is for your liquidity) however the long term corporate debt market is predominantly a fixed rated debt market. However many corporations would prefer a balance of interest cost – from my experience dealing with Fortune 500 companies I’d guesstimate that the desired fixed rate/floating rate mix is close to 50/50 (there are exceptions clearly). This gives you some benefit if rates fall (as they tend to do when the economy is weak) but not be completely exposed to upward increases. So issuing LTD and then executing a fixed-LIBOR swap to convert, say, 50%, to floating rate debt is not uncommon. When executing the swap in the ISDA there are agreements on what events can allow the swap to be ‘broken’ and how this is calculated (usually be reference to Bloomberg which is correct). Basically the swap breakages is the NPV of the future cash flows.
So that fixed-floating swaps have breakage as implied in the NY Times article is hardly some nefarious creation it is how plain vanilla interest swaps have been dealt more or less since inception.
There ought to be a law preventing any public entity from buying or selling derivatives or swaps. And doubly so for issuing a bond to make up for pension funding. What is worse is issuing bonds to invest in their favoriate pension plan. If they were so damn smart to know an investment scheme that pays better than their bonds they wouldn’t be public “servants”.
I’m not qualified to comment on the swap transaction.
I try to find journalists and bloggers who seem to know what’s going on and hope they are telling some reasonable version of the “truth”.
Conservatives have complained for years about bias in journalism and they have succeeded beyond their wildest dreams in making that meme stick. It is simply impossible anymore for someone like me to know who is spinning whom.
I know that Ms. Smith has certain positions that I fundamentally disagree with and I know where Ms. Morgenson stands on various issues too. I like to think I’m smart enough to know when they are venturing into spin territory.
And since my opinions don’t count for anything in this debate, it really doesn’t matter if they spin me.
What a tangled web!
My gripe with the Times article is that it does not describe the transaction and the aspects of it that created DPS’s problem. I understand that their readers may not be interested in this detail, but its absence makes it difficult to understand what is going on.
At first, I thought that DPS had issued fixed-rate, long-term debt with an embedded option for which it was not adequately compensated. The references to “make-whole” provisions in paragraphs 12-14 of Jill Conrad’s lead me to think that DPS’s problem is that it has an option to terminate its floating-to-fixed swap at an exorbitant premium. My limited experience with “make-whole” provisions is in call provisions of debt. In one case, an issuer with an A or A- rating could call its debt, but the call price was the present value of all of the future payments at the comparable Treasury plus 25 bp. This was described as a “make whole” provision, but the call price was bound to exceed substantially the fair market value of the debt. DPS’s termination option is illusory, and one wonders whether that was understood and whether that was taken into account in setting the fixed rate of the swap.
I think the real gripe here is the decades of economic theory that suggested that if you have bond-like actuarially determined liability (eg future pension obligations) and hedging this with equities was a good idea. Essentially if you are a pension plan you are long equities (assets up if equities up) and short long term interest rates (if rates go up your liability goes down). Essentially every public/private company was some form of operating company with an embedded hedge fund with this position.
We never should have allowed pensions to heavily invest in equity on the ‘theory’ that equities always outperform bonds. It would have been better if pension funds (public and private) had neutralized their liability by buying fixed rate debt instruments to hedge the funding liability ie a pension fund today has a very good idea what its payments will be in 10 years (this approach does not hedge actuarial risk – that your employee life expectency is different – but that is less than funding risk). Since we allowed pensions to assume a higher rate on their assets (eg. whatever the long run rate of return on the S&P 500 was) than their liabilities (the Aa long term bond rate) we created this ficticious accounting arbitrage that moved companies into equity. Basically if you had required that the returns on the plan were the same as the discount rate on the liability you would have made these funds safer – but the costs would have been higher and people would have had to face that rather than rely on the equity market to bail out their underfunding.
Yes, fully agree.
Same thing w/upcoming mid-terms: everything I see about repub gains, especially by “conservative” media & pundits, makes both explicit/implicitly vociferous claims that BO is ruining the country, blowing holes in US economy/budget etc etc, while making argument that we need “conservatives” to fix it all.
But BO didn’t create our mess, BushCo & K-Street congress did. BO just didn’t do anything to fix it.
These ****ers are essentially advocating going to Satan for economic redemption. That eliminates a lot of context, particularly when these guys are wrapping themselves in cloak of morality and godliness.
I’d be wary of any school board who thinks they got a good deal from IBs. It can happen, but for it happen, at a minimum, they need to get 3 to 5 prices from different IBs for the exact same product. And the ideal is to get multiple banks competing and a bid-ask of the product (if this is possible).
Anyway, I’m afraid Conrad’s response to 9 leaves me shaking my head and makes me think she just doesn’t understand:
NYT: “And had the school district issued fixed-rate debt, it would not have paid Wall Street the cornucopia of fees embedded in the more complex deal.”
JC: “Actually, the fees up would have been the same whether the debt was fixed or variable.”
JC’s reply is not a reply. The NYT is talking about “fees embedded”, and JC is just talking about fees. The IB basically gets fees on these things in two ways: upfront fees and hidden fees. A fee can be hidden (embedded using the NYT language) in a interest-rate swap by the level of the interest rates or details of the optionality (if any). The upfront fees may not be much, but if DPS got a worse interest rate than it should have, or worse optionality conditions than it should have, it is paying a hidden or embedded fee. The fact that JC does not even seem to understand this (she would not be speaking with such confidence that the fees are the same in the two cases if she did), makes me think she just doesn’t have an appropriate understanding of the issues, which, I’m afraid, is good evidence that the DPS did not get a good deal.
I don’t see any prior reference to Morgenstern’s Saturday 8/7 attack on Fannie/Freddie (http://www.nytimes.com/2010/08/08/business/08gret.html), just a day or two after Yves reported that 82-83% of subprime lending was *private*. I don’t think Morgenstern is being “spun”…I think that–especially in the run-up to the mid-terms–she’s been told to do her job and write analyses that undermine faith in government and that support the privatization of everything.
Good article Yves, and I’m glad you posted it.
I read original, and bought it hook/line/sinker.
Thing is, current landscape makes Morgenson’s article believable:… eg. general description she provides (incompetent local/state finance decision makers getting “punked” by banks/WS) happened pretty much as described… all over the country.
I’ve read all the comments, and especially those calling your bullet points into question. But as Robert said, Time’s piece does not give proper context to problems these guys inherited.
Beyond that, when author is relying on PR spokesmen for opponent’s mid-term campaign, printing the allegations w/out followup is prettttttttty damn sloppy.
The author never explained why Bennett, who arranged and approved the deal since he was DPS superintendant at the time, would spin details to make himself appear incompetent, almost misfeasant. It flies in the face of reason that he would do this, especially now that he is seeking a higher office. That being said, I have heard more than a few occasions where Morgenson’s due diligence of the facts left quite a bit to be desired, and also brought her subject matter knowledge into question.
So DPS is better off? What is the point?
“We never should have allowed pensions to heavily invest in equity on the ‘theory’ that equities always outperform bonds.
The dishonoring of pension obligations, even if only rhetorically constructing them as a ‘burden’, is the moral heart of the matter. DPS and Bennett in the grip of the crack pot rationality which governs public discussion of our society did not wish to honour an obligation undertaken by previous school boards; in a version of pass the parcel, they were stuck with honouring it. The pension provision promised to all those badly paid teachers was underfunded; a complex financial contract was found which, once again, would leave it to others to pay. Moreover, since no one is required to live in Denver (or Detroit, for that matter), this future obligation can be avoided by moving away to some other low tax frontier city once the bill comes due.