Who is the “muppet” now?
The media is filled with reports and reviews of a book by former Goldman Sachs employee Greg Smith, which disparages his former employer. Smith alleges that traders on his London equity derivatives desk treated their clients harshly and would glibly refer to them as “muppets.” They secretly despised their clients as they ripped them off, according to Smith, especially the “muppet” clients that were mainly pension funds and non-profits. The Guardian reports (emphasis mine):
“Getting an unsophisticated client was the golden prize,” he told the [60 Minutes] programme. “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.
“What Wall Street will do is they will approach one of these philanthropies or endowments or teachers’ retirement pension funds in Alabama or Virginia or Oregon and they’ll say to them: ‘We have this great product that is going to serve your needs’. And it looks very alluring to these investors, but what they don’t realise is that upfront they are immediately paying the bank $2m (£1.2m) or $3m because of their lack of sophistication.”
How fast can you say “muniland muppet”? There happens to be a big derivatives controversy brewing in in the “City of Brotherly Love,” right now. Some background from the Philadelphia Inquirer:
Urged on by private-sector financial advisers, approved by bond lawyers, the city took advantage of a 2003 state law approved by then-Democratic Gov. Ed Rendell and Republican legislative leaders to “swap” interest-rate risk on the next several years’ borrowings with clients of JPMorgan, Goldman Sachs, Wells Fargo, and other big Wall Street banks…
…How much did we lose? City officials have been vague about that. This past spring, the union-aligned Pennsylvania Budget and Policy Center totaled a string of payout and obligation reports by city agencies and announced that Philadelphia’s swaps losses approached $500 million. Auditor General Jack Wagner said towns have no business doing such “complex” transactions.
According to the Inquirer, Philadelphia City Treasurer Nancy Winkler doesn’t know how much interest rate swap exposure the city currently has. She is in a conflicted position because she previously worked at the financial advisor firm – PFM – that advised the city on many of these deals. She has been asked to testify at hearings organized by city Councilman Jim Kenney (D) on losses from these products.
Although Winkler doesn’t know the interest rate swap exposure, the Pennsylvania State Auditor General Jack Wagner reported on it in 2010:
San Bernadino’s coming pension brawl
The bankrupt cities San Bernadino and Stockton, California share similar fiscal woes. Both include very high employee pay and benefits. Both have sought the protection of Chapter 9 municipal bankruptcy and are shielded by the courts from any new litigation. The court protection gives the cities time and fiscal space to negotiate with employees and creditors, and to organize their financial affairs. It’s hard to imagine the difficulty of running a city in bankruptcy with dwindling cash reserves.
Stockton and San Bernardino have taken very different approaches to how they will manage their cash reserves. Each approach will likely have big effects on how their bankruptcy processes play out.
Stockton has chosen not to challenge CalPERS, the statewide pension system, and has continued to pay the monthly pension contribution for its employees. The city’s unwillingness to ask CalPERS to negotiate has caused other Stockton creditors – the bond insurers – to challenge whether the city has met the conditions of a Chapter 9 bankruptcy. The blog Public Sector Inc describes the situation:
Bill Lockyer’s big stick
I wish that I knew how to put on a conference, because we need a muniland event with Bill Lockyer, California’s state treasurer, as the headliner. I would invite all the state treasurers and attorneys general to learn how state officials can wield their power to protect local governments from unscrupulous underwriters, bond counsels and financial advisors.
Here is Lockyer at The Bond Buyer conference in California:
Treasurer Bill Lockyer put underwriters, advisors and bond counsel on notice Wednesday that if they are not willing to renegotiate some of what he called the more egregious capital-appreciation bonds issued by the state’s school districts, his office may cut them off.
“I wish the firms that underwrote those bonds would renegotiate those deals,” Lockyer said. “I have the list, I know the underwriters, financial advisors and bond counsel who did them, and they are going to face constraints with my office when the state issues bonds.”
Lockyer paused, then looked out to audience members and said, “You get to make the choice.”
The 30,000-foot view of muniland
The Bond Dealers of America, an organization representing national middle-market bond dealers, held its national conference in Chicago last week. I did not attend, unfortunately, but the agenda was a good mix of regulatory and legislative perspectives from the buy-side (mutual funds, insurance firms, asset managers) and electronic trading platform executives.
What interested me most was a presentation by Amy Laskey, managing director of the Public Finance Group at Fitch Ratings, who provided a 30,000 foot view of the current state of muniland. These are the best sections that present a mixed-to-positive picture:
Review of Recent Rating Actions
• Average local government general obligation rating remains ‘AA’ but trending towards ‘AA-’
• 12% downgrade rate YTD
• Upgrades scarce
• Multiple downgrades
• Increasing divide between strong and weak credits
• Expect more isolated cases of default, bankruptcy
Revenue vs. Spending Trends
• Moving in opposite directions
• Flat to declining recent revenue performance
• Property tax
• Sales tax
• State aid
• Natural spending growth
• COLAs [cost of living adjustments], step increase
• Inflationary growth
• Pension, health care increase
Sound Reserve Levels
• Reserves remain strong for most local governments despite some declines during the downturn
• Once the prolonged nature of the downturn became clear most managers turned to recurring budget solutions
• Unrestricted reserves at the end of fiscal 2011 average well over 20% of spending for governments rated in the ‘AA’ category
Broke New York municipalities have more choices than bailouts or bankruptcy
Things are heating up in Albany, New York’s capitol. Someone close to Governor Andrew Cuomo appears to have been whispering into the ear of New York Post reporter Fredric Dicker:
Several of New York’s biggest cities — including Yonkers, Rochester and Syracuse — are “close to bankruptcy’’ and are looking for a bailout from Gov. Cuomo’s administration, The Post has learned.
Mayors of the three cities, all of which face runaway labor, pension and education costs and shrinking property-tax bases, have held secret talks in recent weeks on their financial options, and the possibility of “bankruptcy’’ has been discussed, a source close to the mayors said.
Meanwhile, aides to Cuomo are working on a new plan to link any future aid to the ailing cities to “workout plans’’ that reduce local costs, the source said.
The mayor of Yonkers, Mike Spano, is telling a similar story to the local paper in his city:
Lawmakers and the municipal bond tax exemption
The Joint Committee on Taxation is circulating an analysis of tax reform proposals, one of which includes removing the municipal bond tax exemption for all bonds issued after December 31, 2012. If the tax exemption is repealed or capped so that the federal government can collect more tax revenue, bond prices will fall. The higher yields would repay investors for their loss of tax exemption, nevertheless, groups are forming to oppose proposals to repeal the exemption.
Republican presidential candidate Mitt Romney has not indicated any specifics about how he would treat muniland in his tax reforms. President Obama has proposed changes. The Bond Buyer summed up the President’s position:
Some market participants contend that Obama’s plans to raise tax rates and permanently reinstate the Build America Bond program would help the muni market, despite his plan to cap the value of tax-exemption at 28% for higher income earners.
Danville’s AAA disclosure
One of the most common complaints in muniland is over a lack of disclosure. Public officials often say too little too late about fiscal matters. That is why it was a pleasant surprise to come across the proactive response of Joseph Calabrigo, the town manager of Danville, California, to Moody’s announcement that it is reviewing credit ratings associated with lease-backed and/or general obligation debts issued by 32 cities in California.
Danville is a well-to-do town of 42,000 located about 30 miles east of San Francisco. The city has two sets of bonds outstanding that are included in the Moody’s review. These Certificates of Participation (COP) were issued to acquire and construct public parking in the downtown area. In speaking about it, Calabrigo was separating the review of these bonds from the general credit quality of Danville, which is one notch higher at Aa1.
From the Danville town blog:
States don’t need to take loans from JP Morgan
Jamie Dimon, the CEO of JPMorgan Chase, made headlines this week for an interview at the Council on Foreign Relations in which he said that buying Bear Stearns in March, 2008 was a “favor” to the Federal Reserve, and that JPMorgan had lost money on the deal. But there was another part of his interview where he talked about lending to states that caught my attention:
DIMON: OK, so — (laughs) — this company, JP Morgan and Chase — (inaudible) — went through ’06, ’07, ’08, ’09, 2010, 2011, 2012, never lost money in a quarter, didn’t need TARP and was there for a lot of people when others weren’t. California, New Jersey, Illinois, hospitals, schools, businesses.
I think that Mr. Dimon is inferring that California, New Jersey and Illinois, which have had severe cash flow problems, had had to rely on JPMorgan to tide them over until they completed their next bond offerings. I remember all these financings; there was very little data available about the borrowing costs and terms. Although these loans are for public entities, the current MSRB rules exempt bank loans from disclosure. This is mind-bending when you consider that JPMorgan’s purchase of Bear Stearns required voluminous public disclosure to protect shareholders. There are no such rules to protect taxpayers.
High-taxing states and debt
The Tax Foundation named names in a new report that details the states that have the heaviest tax structures. The report compiled personal and corporate income tax, sales tax, unemployment insurance and property tax rates, and it used this data to rank states by their tax burdens. The Tax Foundation describes the purpose of the effort:
State Business Tax Climate Index enables business leaders, government policymakers, and taxpayers to gauge how their states’ tax systems compare.
Property taxes and unemployment insurance taxes are levied in every state, but there are several states that do without one or more of the major taxes: the corporate tax, the individual income tax, or the sales tax.
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