Talk:Government budgets

From Sunshine Review

Talking Paper At the SCASD School Board Meeting September 14, 2009 Don E. Gordon

I want to make a statement about the Qualified Interest Rate Management Agreement (QIRMA) initiated in 2006. You call it a fixed interest rate swap. In my opinion. It’s a $58 million contract involving bond rate hedging and derivatives, it’s gambling with taxpayer money.

The April 2009 SCASD Financial Update shows a cost of $8.4 million to terminate that contract. Unofficially the cost may be lower today $6M, higher tomorrow $12M. Who knows? Nobody.

Here is my first concern. We have a $58 million debt obligation but no debt. Why? The previous school board approved a $58 million bond obligation two years prior to the Act 34 approval of the high school project. At that time the project was estimated to cost $68 million, increased to $112 million, overbid by another $17 million, then cancelled.

A debt obligation is normally cancelled when a project is cancelled. So why wasn’t the debt cancelled at that time when the termination fee would have been very low? That’s a rhetorical question. We all [board members] know the answer.

Because, also in 2006, Pennsylvania passed the Taxpayers Relief Act, called Act 1, which imposed a requirement for public referendum on large budget increases. Because the $58 million was obligated before Act 1 it could be spent without referendum. The board tried to carry the $58 million forward to evade referendum. I think that action is contempt of taxpayers.

About 111 School districts got involved with over 400 swaps and about a third of them are terminated. I can’t find another QIRMA involving carry forward financing. Swaps are not intended for carry forward financing. [See: Pennsylvania Department of Community & Economic Development, Qualified Interest Rate Management Agreements – DEG can provide a copy]

Here is my second concern. Where did the idea originate that a school district should get involved with hedges, derivatives, and swaps. Competitive bids were not sought. Second opinion was not sought. The rates were derived (hence a derivative) from a ten currency arbitrage index called the London Inter-Bank Offer Rate (LIBOR) rather than a traditional bond index. Arbitrage is the highest kind of investment risk. It’s a bet on future currency markets. It was international financing involving a London arbitrage index and the largest bank in Canada versus a school district. Risk exceeded knowledge. The district’s risk mitigation plan required by the state would receive a D – at any business school.

Who planted this seed? I can trace the introduction of this idea to January 2006 and the former business manager and Lou Verdelli of Public Financial Management, your financial consultant. By the way after Verdelli sold you the hedge he went to work for the Royal Bank of Canada. Remember Richard Wood of Rhoads and Sinon your legal consultants, he’s involved too and all of them pass through the Pennsylvania Association of School Business Officials acting as a focal point. Gov Rendell refers to swaps as fleecing school districts.

Pennsylvania law requires these consultants to be totally independent. Yet the board agreed to have the Bank of Canada pay them and the district solicitor’s firm, directly or indirectly $233,000 (total) (1/4 $ million) in fees. To me that’s a conflict of interest.

Where was the due diligence? Did your legal advisors report that the Bank of Canada paid a $1.5 million SEC fine for deception and has two federal court cases pending for similar allegations?

Here is my third concern: In 2006 the school board closed Citizen Advisory Committee for Finance meetings to the public. The board president, Susan Werner, opined at the time that CAC meetings were too complex for average citizens to understand. Apparently too complex for the board too. Independent notes of working sessions show some CAC members questioned the use of public funds for such high risk nitwittery. Unfortunately, consensus triumphed critical thinking, the CAC recommended the hedge. The district’s own charts show the index was almost never favorable to the school district.

The index went the wrong way. The dollar lost 40 percent. The arbitrage index tanked 62.5 percent. The district is upside down. We have to pay big to get out.

Even the district’s financial advisors suggested terminating the swap in July 2007, at a loss of $300,000. Were you aware that the termination fee increased 290 percent in only 30 days during that period [June 29 to July 31, 2007]? Didn’t that set off loud alarm bells? By October 2007, the loss was $2 million. But the same board refused, insisting on a zero loss. By April 2009, the termination fee increased to $8.4 million. This particular arbitrage index is about devaluation of the dollar caused by growing national debt. Don’t expect a zero loss. I do understand that the largest effect on the swap termination fee is long term municipal bond rates, but don’t dismiss the arbitrage index.

Hedge financing for local government was prohibited, rightfully so in Pennsylvania until 2003 because of high risk.

The current board is left with a giant lose-lose mess. Any choice will cost the district’s taxpayers and not one dollar of it will go to education.

All of this because of contempt for open records and meetings and public referendum. The lesson will be very expensive. Hopefully your priority will be to terminate the swap at the lowest cost and not to extend the swap in order to evade public referendum.

Given this track record, I strongly recommend that you hire a truly independent hedge expert, for a second opinion, to guide you through your hard choices ahead. Use the district’s public relations department to do something useful and explain all this in plain English using classical mathematics to the public who will pay this bill.