Link to article here.
Remember this is written by a toll road industry advocate, so the tone is pro-toll. It’s enlightening as to the financial chicanery being played with taxpayer money regarding interest rate swapping and other tricks with public debt that are not only risky, they’re downright malfeasance!
State auditor hits Penn Pike for “gambling” with $2.23 billion in interest rate swaps
Toll Road News
Posted on Fri, 2010-04-09
The state auditor-general in Pennsylvania, Jack Wagner has criticized the Turnpike for “gambling” with $2.23 billion variable interest rate debt tied to 26 different interest rate swaps. He said his office calculated the cost to terminate the swaps could be $146m – the equivalent of around three months toll revenues.
Wagner wrote in a letter to Turnpike CEO Joe Brimmeier: “Swaps are tantamount to gambling with taxpayer money and they have no place in the public sector. With drivers already paying higher tolls mandated under Act 44, the Turnpike Commission must do all that it can to show Pennsylvanians that it is handling money wisely.”
In his letter to Brimmeier, Wagner urged the Turnpike Commission to:
– stop using swaps,
– conduct a financial assessment to determine the financial impact of its swaps, and
– hire financial advisers through a competitive selection process.
He asked Brimmeier to provide more detailed information about the Turnpike Commission’s swaps giving a deadline of April 19.
Wagner is quoted: “The fundamental guiding principle in handling public funds is that they should never be exposed to the risk of financial loss. Swaps have no place in public financing and should be banned immediately.”
Carl de Febo spokesman at the Turnpike said the commission is “reviewing that correspondence, and we have no comment at the moment.”
Wagner is a candidate for the Democrat Party’s nominee in the state governor election this November, since the incumbent governor Ed Rendell is term-limited out.
Critics of Wagner will say he’s engaging in populist politics and pandering to people’s prejudice against complex financing instruments. Economists argue that all borrowing is risky. It is, they say, a gamble because future revenue streams to pay the interest and repay capital are uncertain, and because prevailing interest rates are unpredictable.
Interest rate swaps can – at a price – reduce the risk of interest rate volatility and such ‘hedging’ will make variable interest borrowing less of a gamble. Properly used they can be an insurance against big increases in interest rates on variable interest debt or on refinancing debt as debt matures.
To prohibit public authorities from hedging, they will say, could increase the “gamble” they take when they borrow – like prohibiting insurance.
But interest rate swaps that shielded borrowers in the boom turned out to be big lossmakers in the great financial crisis from 2008 on. Engineered to protect against rises in interest rates they turned into major lossmakers when interest rates plunged.
Carelessness and fraud
And many theoretically defensible swaps and auction rate securities seem to have been carelessly written, some were fraudulent. In addition many contracts just fell apart when the bond insurers lost their required credit rating. That risk had not been properly explained or considered.
Brian Chase an investment consultant and former Nossaman and Carlyle Group staffer says: “Frequently, we have seen that the public sector does not in fact understand the financial risks it has taken through its use of interest-rate swaps and auction-rate securities.”
Elaine Greenberg, top SEC official in Pennsylvania, has said there is widespread pay-to-play corruption and bid fixes in bond underwriting and derivatives transactions in that state.
Small cliques seem to get the great bulk of the profitable work of underwriting and legal and financial advice.
Size of debt may be biggest issue
But the biggest question of all may lie not in hedging via interest rate swaps but in the absolute size of the Turnpike’s borrowing relative to its income stream and its obligations.
How sound is the basis for the Turnpike’s huge borrowing – $6.11 billion at end December last year? Can the Turnpike realistically deliver on the fixed Act 44 obligations it has assumed to support unpriced and loss-making transportation elsewhere in the state?
Public authorities held to lower standard of liability disclosureGreenberg of the SEC told Business Week recently that public authorities like the Turnpike have not been required to fully disclose the liabilities they are taking on nearly as fully as investor owned companies.
So while they provide sexy subject matter for gubernatorial campaigning the interest rate swaps may turn out to be a trivial side issue compared to the fundamental question of whether the borrowing of these many billions is justified. Some say it isn’t clear that the proceeds of the borrowings been productively invested to generate cash flows five and ten years off to service that huge debt.