Auditor General Jack Wagner Says Taxpayers on Hook For Lost Transportation Funds from Interest-Rate Swaps

Turnpike, DRPA, SEPTA could lose millions if transactions sour

HARRISBURG, Pa., May 5 /PRNewswire-USNewswire/ -- Auditor General Jack Wagner said today that Pennsylvania taxpayers could end up paying hundreds of millions of dollars to bail out transportation agencies that have financed billions of dollars of public debt with risky derivative contracts known as interest-rate swaps.

Wagner's representative, chief counsel and policy director Robert Teplitz, told the Senate Finance Committee this morning that a recent review of the latest financial statements found that the Pennsylvania Turnpike Commission had about $2.3 billion tied to swaps agreements. If the Turnpike Commission had to terminate all of those swaps, it would lose $145.7 million, which is equivalent to almost three months of turnpike toll revenues.  Just last December, the Turnpike Commission made eight payments, totaling over $52.6 million – the equivalent of over one month of toll revenues – to investment banks to terminate swap deals that had turned sour.  

In addition, the Delaware River Port Authority, a bi-state agency that operates toll bridges linking Pennsylvania and New Jersey, entered into seven swaps in 2000 and 2001 related to over $1 billion in debt.  Although it collected $45 million in upfront payments, it has now paid out $65 million so far to terminate several of those swaps.  The remaining active swaps have a net

negative fair value of $200 million, which is the equivalent of a full year of tolls on all four bridges the agency operates.  Wagner, who joined the DRPA board as an ex-officio member several years after it entered into its swaps, succeeded in passing a unanimous resolution last December to prohibit the agency from entering into future swaps agreements and to begin a process of terminating its current swaps.  

The Southeastern Pennsylvania Transportation Authority reported three active swaps with a net negative fair value of $52.4 million, which is an amount equal to approximately six weeks of fare revenues. Those swaps related to $345.5 million in debt.

Noting that taxpayers in the Bethlehem Area School District were required to pay higher property taxes to cover the district's $10.2-million loss in interest-rate swaps, Teplitz said, "Auditor General Jack Wagner's position is clear and unambiguous. Interest-rate swaps are tantamount to gambling with taxpayer money, and they have no place in the public sector."

A swap is a contract between a bond issuer, such as a school district or other public entity, and an investment bank, in which the parties bet on which way interest rates will move.  In theory, swaps allow government entities to enter into variable-rate debt financing in order to take advantage of low interest rates and, at the same time, hedge against the possibility of those same interest rates going up.  

However, as Wagner has explained, swaps are actually nothing more than a form of gambling with public funds.  The party that guesses right wins and gets paid; the party that guesses wrong loses and must pay the other party.  How much is won or lost is determined by the size of the underlying debt, how much interest rates fluctuate, and other factors.  

A special investigation by Wagner last year found that 107 school districts and 86 local governments had $14.9 billion in public debt tied to swaps agreements.

The Senate Finance Committee heard testimony on two pieces of legislation that would ban the use of swaps by school districts, local governments, and municipal authorities.  

Teplitz expressed Wagner's support for Senate Bills 1277 and 1278, introduced by Sen. Lisa Boscola (D-Lehigh/Monroe/Northampton) and Sen. Patrick Browne (R-Lehigh/Monroe/Northampton), which implement the recommendations of Wagner's special investigation by prohibiting swaps for school districts, other local governments, and municipal authorities and requiring competitive selection and regular oversight of their financial advisors.

Regardless of whether or not the General Assembly takes action, Wagner has urged local governments and school districts to stop using swaps, terminate their active swap agreements, determine the financial impact of their swaps, and hire financial advisers through a competitive selection process and periodically review the quality, cost, and independence of the services provided.

Teplitz said that Wagner is equally concerned about the use of swaps by other public entities, especially transportation agencies, as the General Assembly grapples with the issue of transportation funding in the aftermath of the federal government's rejection of tolling on Interstate 80.    

"With Pennsylvania facing a funding deficit for its critical transportation infrastructure needs, agencies must stop gambling with public money and sending it to Wall Street instead of investing it here," Wagner said.

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.

SOURCE Pennsylvania Department of the Auditor General