Tuesday, March 10, 2009

"SWAPTIONS": The Water Authority Bond Scheme

In addition to the blistering statement mayoral challenger Patrick Dowd released to government officials and to the public yesterday, as well as his press conference, he also circulated a little slide show and some correspondence.

Let's examine some of it. Our comments will appear in italics after each slide.

NOTE FOR NORMAL PEOPLE: Slides #3 and #6 are the sexy ones.


Not much to look at here. Aside from "children".


Whatever. Looks like a cover page.


WHAT??? That's not good. I don't own any Water Authority bonds. I pay water bills, or at least I do through my monthly rent. Is that really the fundamental distinction? Am I really on the hook instead of willing, clear-eyed investors?

I inquired with the Dowd campaign if he could clarify how exactly this distinction exists. I received no response as of press time.


Okay, okay, just don't call me a loser.


Variable rates mean the interest we pay depends on the market. It's a gamble. If the market does well, it's a good deal. If the market does poorly, we can get really soaked.

Mayor Ravenstahl defended the deal yesterday by saying it was the "the best available at the time" (best looking to him), and nobody knew the markets could come down. Spoken like someone who hasn't lived through or had cause to notice any bear markets, and by someone who doesn't do his own homework. The "experts" at the investment banks were looking out for us, after all.

At the critical juncture, Controller Michael Lamb warned the City about this, and we are now aware he was far from alone. But to no avail.


Yeah, baby! Eckert Seamans called this financial vehicle swaptions, and advised Pittsburgh's oversight bodies explicitly against them. I like how our "remarketing agents" are churning the butter.


Yeah I don't have that much money, at least not since Lehman Bro.'s went down. My portfolio took such a beating!


In which Patrick Dowd calls out Mayor Steelershizzle as a reckless tool of unscrupulous businessmen. It should be noted that not all of these firms participated equally: Dexia Credit Local bowed out of the affair with the following statement:

While this comes as a difficult decision for the bank to make with our customers, the recent disruptions in the market lead us to the necessity of implementing a reduction in the amount of our market exposures at this time.

Pittsburgh had no such option. In fact, because of this, its market exposure went up.


Okay so we actually have TWO major problems. Number one is variable rates. Number two is that we allow our financial institutions to make endless "transactions" on our behalf, piling up almost as many associated fees in one year as we had in the previous twelve.

Way to go, establishment!!! I'm sure you are really enraged that Patrick Dowd is "grandstanding" on this issue and bringing this unfortunate state of affairs into light. It's terribly rude and uncouth of him.


Um, okay. $20 million up-front to perform this fanciness. I'm sure that J.P. Morgan Chase & Co. really needed the money.


The fact that P-Diddy called for an audit was widely reported, but as to his whole "Call for Action" we are a bigger fan of...

"How do we get out of this situation?" Direct and to the point.

It appears from my understanding of the plan that we are locked in until about 2047. That is unfortunate. The Comet suspects that eventually, after a frank and open discussion, Pittsburgh is going to reach a consensus that ultimately we will have to plead that these financial institutions hornswaggled us (I'm sure we can find something legitimate), and push for a settlement.

What we should not do is sleepwalk deeper through the deal because it's embarrassing to anybody who was implicated in it. Let's take politics out of it and confront the situation head-on. There are hands-off individuals who might rather unfurl a little blue-ribbon commission to look at it, and report back in 6 or 9 months time ... but let's just call ourselves the commission for once. This is a matter of great public import and immediacy. The political climate to confront investment banks has never been better.


  1. Good post, Bram. A lot more important than college background on Dok. But I am not sure that this is a good time to confront investment banks. Unless maybe we get the State involed (an audit from the Auditor General?). We might need a big gun standing with us if we are knocking at the door of a bank.
    Just a thought.

  2. Thanks. I can barely understand some of that stuff. I will have to reread about a hundred times, but 2047 and $20 million up front are the zingers.

    my verification word--shmedath!

  3. Ed you suggest:

    But I am not sure that this is a good time to confront investment banks. Unless maybe we get the State involved (an audit from the Auditor General?).

    Um, worth a shot. Perhaps the federal government? Perhaps Casey and Specter? Maybe Doyle?

  4. So Pittsburgh is locked into weekly financial transactions (which incur fees for each transaction) until 2047? And the vendor got that business without competition? Hello, US District Attorney!

  5. Slides #9 and #10 look like the real punchline to me. That Dowd was the one to call attention to this is enough to sell me on him.

  6. Bram, this is an excellent post. I agree with MH on Dowd blowing the whistle on this; he should get all the credit.

    I wouldn't be so quick to absolve Eckert Seamans of there role in these transactions though. Both ALCOSAN and PATransit did these five or six years ago and they'll be paying that off for the next twenty-five years. Eckert Seamans is the solicitor for both of them and was heavily involved in both deals. Who knows, maybe they found religion.

  7. On the ther hand, Eckert Seamans was one of the two entities that wrote the original five year Act 47 plan. Will they write then next one this year? Will they take into consideration that they warned against this deal, and limit Pittsburgh's ability to independently make such deals in the future, forcing us to obtain the approval if the ICG and Act 47 team thingies?

    Did anyone see 60 Minutes on Sunday? Besides a report on the proven unreliability of eyewitness testimony in criminal trials that all our candidates *should* be scrambling to comment on, there was a report on the involvement of transit authorities with certain debt deals. Basically the arrangement was for transit agencies to borrow money from banks, buy light rail cars and then sell the cars t the banks. The Banks would then lease the cars to the transit agencies, and the banks would take the tax write-off from depreciation. Banks, of course, are for profit entities (not so much these days) and the transit agencies are non-profits. The banks would split the benefit f the tax write off, so everyone would win. Except … the fine print of the agreements called for an insurer, and specified the insurer had to be solvent. In the case of Washington DC, San Francisco and some others, the insurer was AIG, which has not remained solvent. So the banks are demanding full payment of the leases immediately. It is entirely legal, but pretty nasty. Are we sure nothing like that is in the PWSA debt package agreement?

  8. FYI, you can get official statements for municipal bonds from the website of the Municipal Securities Rulemaking Board, and after a cursory look on my part, I think that this is it.

    I don't fully understand the distinction between this form of variable-rate bonds on the one hand and auction-rate securities on the other, which blew up in late 2007/early 2008 to the consternation of UPMC and many other obligors on munis. In any case it is clear that many of the principles are the same, and that the downturn in the markets means that the supposed bargains for municipal debtors -- sold to them by the "financial services" industry -- are not bargains after all. It's not only the downturn in the averages of other swaps, it's the decision of one of the firms not to guarantee the sales; is this not very similar to the auction-rate securities problem?

    Dowd has done good work in exposing this, though it's a stretch to single out Ravenstahl for this. Corruption is rampant in muni world. Negotiated sales -- as distinct from competitive bidding -- are almost standard now when it comes to munis. If Dowd is serious about changing this way of doing things, then I am pretty impressed, but I am less impressed if it amounts to a campaign stunt exposing just one deal among many.

    Also, it is my understanding that there are some legal restrictions on the cost of issuance, or at least on the fees paid to underwriters. These rules are rarely enforced though. 5% seems pretty damn high to me.

  9. The insurance premium is pretty standard for a municipal bond that is not backed by general obligation revenue or someone's full faith and credit.

    Now onto your question regarding Slide 3. The risk that is being referenced is valuation risk which is the opposite of interest rate risk. As interest rates go down, the value of a fixed rate bond increases and vice versa. Under the VRS scheme for the PWSA, the PWSA and thus City residents are ultimately taking on the valuation risk while under a fixed rate system, the bond holders would be the ones who locked in a thirty year payment off of a variably valued asset.

  10. My head just exploded.

    This conversation needs to move to a classroom at Carnegie Mellon.

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  12. John:

    You amaze me with your insight and knowledge. Lets make Internet money bond whoopie!