Wednesday, March 17, 2010

Ban Local Governments from Using Interest Rate Swaps?

HARRISBURG, Pa., March 16 /PRNewswire-USNewswire/ -- Auditor General Jack Wagner today joined Sen. Lisa Boscola (D- Lehigh/Monroe/Northampton) and Sen. Patrick Browne (R- Lehigh/Monroe/Northampton) to promote legislation that would ban school districts, local governments and municipal authorities from risking taxpayer money in interest-rate swap agreements.

Wagner recently called for legislation banning the use of swaps, after his special investigation determined that 107 of 500 Pennsylvania school districts and 86 local governments had tied up at least $14.9 billion in public debt to swaps. As a result, a sudden movement in interest rates could cost taxpayers hundreds of millions of dollars, said Wagner.

"Swaps are tantamount to gambling with taxpayer money, and they have no place in the public sector," Wagner said at a press conference in the Capitol Media Center. "I commend Sen. Boscola for bringing this problem to the attention of the Department of the Auditor General, and I commend her and Sen. Browne for sponsoring this important taxpayer-focused legislation that implements the recommendations of our report."

Swaps are legal contracts between two parties, such as a school district and an investment bank, that bet on which way interest rates will move. The party that guesses correctly gets paid and the party that guesses incorrectly must pay; the amount of money changing hands is determined by the amount of underlying public debt financed with variable-interest rate bonds "hedged" with swaps, how much the variable rates change, and other factors.

Wagner, who urges the passage of the legislation, has also recommended that school districts, local governments and municipal authorities:

  • Refinance with conventional debt instruments;
  • Assess the financial consequences to taxpayers if they were to suffer the same negative experience with swaps as the Bethlehem Area School District and others; and
  • Hire financial advisers through a competitive selection process and periodically evaluate the quality, cost, and independence of the services provided. This recommendation was also included in the legislation discussed at today's press conference.

The Delaware River Port Authority, which operates toll bridges linking metropolitan Philadelphia with New Jersey, faces $199 million in liabilities because of interest-rate swaps that have soured, said Wagner, who became an ex-officio board member several years after DRPA entered into those swaps. At his urging, DRPA recently passed a resolution to ban using swaps in future financial transactions and to begin a process of unwinding its current swaps. Nevertheless, DRPA was required to pay the Swiss investment bank UBS $3.6 million in January and February – the equivalent of six weeks' tolls on the Betsy Ross Bridge – to hedge interest rates on bonds that have not yet been refunded. In addition, DRPA has lost a total of $65 million from swaps that turned sour.

"It's unconscionable that greedy Wall Street bankers are rewarding themselves with excessive bonuses whose profits were derived, in part, by hard-working Pennsylvanians whose elected officials gambled away their tax dollars in risky financial schemes they didn't understand," Wagner said. "Interest-rate swaps have no place in local government and the General Assembly should put a stop to this."

Auditor General Jack Wagner is responsible for ensuring that all state money is spent legally and properly. He is the Commonwealth's elected independent fiscal watchdog, conducting financial audits, performance audits and special investigations. The Department of the Auditor General conducts more than 5,000 audits per year. To learn more about the Department of the Auditor General, taxpayers are encouraged to visit the department's Web site at www.auditorgen.state.pa.us.

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