By Joel Thurtell
I was sipping coffee and reflecting on the ignorance displayed for all the world to read in a New York Times article.
It was January 9, 2009. The Times story claimed to offer “a rare glimpse into a long-simmering investigation of…wrongdoing throughout the municipal bond business.”
The Times neglected to mention that such glimpses are rare only because newspapers like The New York Times CHOOSE to make them so.
There’s a school bond scandal brewing as California schools load taxpayers with horrendous debt for the next generation of taxpayers.
The blight is called CABs — short for Capital Appreciation Bonds.
It hit Michigan in 1988. Within four years of the first CAB issue, Michigan public school debt had doubled to reach more than $4 billion. That was just principal. The interest on the CABs amounted to 200 percent — 300 percent — even 575 percent of principal, depending on the terms of the individual bond issue.
Nineteen years ago, I delved into this fascinating but arcane world with its private argot strewn with obscure words like “zeroes” and “basis points” describing fairly simple things in language you need a special dictionary to comprehend. It’s an industry with specialized documents that seem encrypted so that people like you and I will have trouble understanding them.
Because most journalists are lay people not indoctrinated into these clubby ways, and because municipal bonds are not well known as the powerful economic motors they are, journalists don’t look closely at this business that accounts for trillions of spending with virtually no accountability and the lightest of pseudo-regulation.
Suddenly, the Times in 2009 had discovered the shady world of munis.
But only because, as the story says, “three federal agencies and a loose consortium of state attorneys general have been gathering evidence of what appears to be collusion among the banks and other companies that have helped state and local governments take approximately $400 billion worth of municipal notes and bonds to market each year.”
When Authority speaks, it’s Page One news.
Where do I begin?
Collusion is what it was all about when I studied Capital Appreciation Bonds, a particular form of muni being foisted on Michigan school taxpayers in the late 1980s and early 1990s.
Reporters encounter the lingo of munis at election time, when governments propose that voters approve borrowing sums of money to build schools, city halls, fire and police stations, sewers, water works and so forth. Finding someone in local governments who actually understands what voters are endorsing with their “yes” votes is hard. States collect information on bonds and to some extent monitor their issuance, but archiving data is not monitoring. I found people in Michigan’s state government who were aware of the shakiness of these deals, but felt they lacked the power to prevent what amounted to a colossal screw job. Even on those rare occasions when state financial overseers ordered special precautions, the state’s demands were ignored.
In Michigan, there was a cartel of businesses that controlled school bond issuing, with — in the early 1990s — two bond underwriters sharing nearly all the business; two law firms were also cut into the deals, as was an Ann Arbor financial advising firm. I learned of lavish trips to New York ostensibly paid for by the supposedly independent financial adviser, who introduced school officials to bond rating officials in Manhattan, although those meetings produced nothing of benefit to the schools; the cost of the trips, together with Broadway plays, was eventually billed by the “independent” adviser right back to the schools. School officials were being bribed and their taxpayers — already on the hook for huge unnecessary interest costs — were made to pay for their officials’ personal spending sprees. Another word: bribes. You will read about this particular abuse in Story 7 of my forthcoming series, which is a re-run of a package of stories I wrote for the April 5, 1993 Detroit Free Press.
Because of my Free Press stories, one school superintendent who went on such a junket lost his job. Tip of the iceberg. Also, the state Legislature banned future issues of Capital Appreciation Bonds and ordered that future bond issues be competitively bid rather than rigged through a process the underwriters euphemistically termed “negotiation.”
It was huge that CABs were banned, because as you will read in these stories, schools were piling up enormous debt to be paid by future taxpayers. Imagine the predicament schools would have found themselves in had such debt been allowed to continue accumulating into today’s depressed economy. Debt payback was predicated on rosy assumptions called “present value” that predicted large increases in real estate valuation ad infinitum. Today, we easily perceive the folly of that notion, but in the early 1990s, boundless optimism about the economy engendered a credit card mentality that led to over-borrowing.
The stories were widely read among bankers, bond underwriters and bond attorneys as well as by Michigan school officials. They won the 1994 Michigan Education Association School Bell Award. They had important statewide impact, but they failed to spark a national movement towards regulating the industry.
In 2009, I decided to post these then 16-year-old news stories in hopes of showing that what’s being discovered today about abuses in the municipal bond industry is not new. This story has been with us for a long time, and despite some prosecutions which may or may not occur this time around, the system is likely to keep on with its old clubhouse collusion and profiteering unless really strong steps are taken to stop it cold.
Now, it turns out, what is an old story for Michigan is about to break in California.
Please stay tuned. I will be re-posting my 1993 CAB stories as I write about unbelievable –except they are true — CAB abuses in California.