It was 2005, and the recession hadn’t hit yet. Most taxpayers didn’t have opinions on financial derivatives. Few imagined major banks could ever go belly up. Even government agencies began drinking the Kool-Aid.
The San Diego Association of Governments was no different. Looking to maximize the possibilities for TransNet, its newly passed sales tax measure, the public agency did what others were doing: It played around with sophisticated financial arrangements that few understood.
SANDAG bet big that interest rates would go up. Instead, rates went down and stayed down – they’re still down. That unforeseen event – persistent and historically low interest rates – cost the agency millions.
As a result, SANDAG now has a roughly $100 million liability hanging over its head. It’s already spent $3.5 million out of pocket that it didn’t anticipate. And it spent $22 million to get out of a portion of its bad bet using borrowed money that will end up costing $42.5 million to repay.
All of that taxpayer money was supposed to go to regional transportation and infrastructure projects.
But agency leaders say everything is fine. The deal is working as intended.
We Stand Up for You. Will You Stand Up for Us?
As one quoted source said, “You are betting with public money”. Cutting deals for derivatives, swaps and the like is simply outrageous. The public is getting screwed here, just like it did with the county pension fund when they started playing with hedge funds.
Come to think of it, there’s one commonality between the two situations, and it’s called Ron Roberts, the guy who always seems to think he’s the smartest guy in the room. Roberts, as a County Supervisor, approved the machinations of Lee Partridge and his Salient Partners (was that the name?) wheeling and dealing in derivatives. That cost the taxpayers a bundle. Now this. Think it might be time for good old Ron to call it a career in “public service’.
At this point, Roberts is saying nothing. Of course not, there’s nothing he can say that won’t implicate him further in a second fiasco that ends up costing taxpayers money.
Though it sure seems like they may not have negotiated a very good variable rate / swap deal, what is the difference between what they would have paid with fixed-rate debt and what they could theoretically be paying with this swap deal? That's the nut of the bet, and I couldn't see it in here. Variable rate debt and swaps aren't inherently bad, it has to be compared with the fixed-rate option.
@David Lynn In 2005, the board was told they could get 4.58 percent interest for fixed-rate non-callable bonds... however since the bond sale didn't take place until 2008, that percentage could have dropped by then. It's also likely they would have issued callable fixed-rate bonds, which can be refinanced at lower rates without penalty -- something they cannot do with swaps.
@Ashly McGlone Thank you. Paying 4.2 with high risk vs 4.58 with no risk certainly seems to be a bad bet, doubt any of us would do that on our mortgage. If fixed rate was 7, that would have been a different question.
Per your response, is there an element here in that they didn't have to issue a bond? Guessing that also made the deal more attractive to them.
@David Lynn @Ashly McGlone The swaps were agreed to in 2005 with the understanding they would take effect when $600M in TransNet bonds were sold in 2008. In this case, SANDAG knew it was going to issue loads of bonds to get a new round of TransNet projects going after voters approved the sales tax extension.
@Ashly McGlone @David Lynn Ashley, that is most likely not true. In most cases the debt and the swap are two separate instruments. Had the rates gone the other direction, they could have sold the swap for a large profit without touching the bonds. Can't say for sure without seeing the docs but that's the way swaps usually work.
This article states that PFM Financial Advisors recommended the investment and that it is SANDAG's (paid) financial adviser. What is not clear is whether PFM Financial Advisors profited (i.e. received commissions, transaction fees, etc.) from the investments in question. Aside from the inadvisability of exotic investments by public boards like SANDAG, for many different reasons, the paid financial adviser should not separately profit from the advice. That creates a conflict of interest.
@Chris Brewster PFM made $101,200 advising on the 2005 swap deal, then was paid another $60K for advising on the 2009 swap overlay deals, according to SANDAG.
Thank you. My question is whether they also acted as a broker on the deal and made money in that manner. Normally, when buying a financial product, some party acts as a broker and the broker gets a percent of the transaction. For example, let's say I pay Merrill Lynch to be my financial adviser and they charge me 1% of my investments each year to do so. Let's say that as part of this advice, they recommend that I buy X shares of Y corporation. If I agree and they act as the broker, they may charge me additional fees as the broker. I don't know whether PFM is a broker or whether they generated additional fees as part of the transaction. That was what I was asking. To put this another way, who acted as the broker for the purchase of the swaps and what was the cost to SANDAG?
@Chris Brewster Good Qs. I am not aware of any payments like that to PFM, but I am not sure.
@Chris Brewster SWAPs are very profitable to the banks - they build it into the rate - you can bet this was even more profitable for the bank than it was for the advisor.
SWAPS however are hardly an exotic instrument , they are actually a quite conservative financial tool usually used to lock in a fixed rate but the fee's can be hefty.
Mr. Nelson: Thanks for this. Hidden fees for sure and hopefully VOSD can follow up to see what the real cost of this was. As for whether swaps and other derivatives are exotic, that is, I suppose, a question of how you define exotic.
Interest rate Swaps? City Pension short falls? We (by we I mean the City) are expecting a 70% return on pension investments? And yet we offer parachutes like Chief Zimmerman's deal- we can't afford it! Of course at this point these deals are the least of our issues.
No investment returns are going to provide the amount of money needed to be whole. I think many corporate entities, with more experienced actuaries and investment personnel, got caught in the credit swaps. Has anyone thought that if we weren't in such negative financial position combined with astronomical pensions the City and SANDAG would never consider these investment vehicles for funding?