Auditor General Jack Wagner Calls for General Assembly to Ban Municipal Authorities from Using Interest-Rate Swaps

HARRISBURG, Pa., March 3 /PRNewswire-USNewswire/ -- Auditor General Jack Wagner today urged the General Assembly to ban municipal authorities in the state from attaching risky interest-rate swaps to new debt financed by bond issues.

At a hearing before the House Finance Committee, Wagner said that the Municipality Authorities Act should be amended to expressly prohibit authorities from entering into swaps. Wagner also repeated his call for the General Assembly to ban Pennsylvania school districts and local governments from entering into swaps agreements.

"Most Pennsylvanians would be upset if members of their school board or municipal government gambled away their hard-earned tax dollars at the local slots casino," Wagner told the committee. "They should be just as upset if their school district or council has tied up local funds in interest-rate swaps, because these exotic financial instruments are tantamount to gambling with public money."

Swaps are financial bets between two parties, such as a school district and an investment bank, on which way interest rates will move. The party that guesses right wins and gets paid; the party that guesses wrong loses and must pay the other party. How much money is won or lost is determined by how much interest rates fluctuate, and other factors. The bigger the swing in interest rates, the higher the potential losses.

A recent investigation by the Department of the Auditor General found that 107 of 500 school districts and 86 municipal governments had almost $15 billion in public debt tied to interest-rate swaps with at least 13 investment banks between October 2003 and June 2009. The Philadelphia School District had the most debt tied to swaps contracts, in excess of $1 billion.

According to Wagner's Office of Special Investigations, the Bethlehem Area School District lost at least $10.2 million in interest-rate swaps when the banking industry collapsed in the fall of 2008. In addition, the Delaware River Port Authority is facing $240 million in liabilities on its swaps contracts.  At Wagner's urging, the agency's board members recently voted unanimously against entering into future swaps agreements.

One reason Wagner urged the finance committee to ban municipal authorities from entering into swaps agreements is because the Bethlehem Area School District used a local municipal authority as a go-between in a swap agreement before the General Assembly gave school districts permission to enter into such transactions directly in a bill passed in 2003. Wagner said that provisions to prohibit local governments and authorities from entering into swaps should be added to the Local Government Unit Debt Act and the Municipality Authorities Act in order to expressly prohibit local governments from entering into swaps ever again, either directly or indirectly.

"Exotic financial instruments like swaps may be perfectly acceptable in the private sector, but they should have no role in government," Wagner said.

In addition to banning future swaps agreements, Wagner also recommended that school districts, local governments and municipal authorities should:

• Terminate any active swaps as soon as is practicable and refinance with conventional debt instruments;
• Assess the financial consequences if they were to suffer the same negative experience with their active swaps as discussed in the auditor general's report;
• Hire financial advisers through a competitive selection process and periodically evaluate the quality, cost and independence of the services provided.

A copy of Wagner's report, which lists the school districts and local governments using swaps, is available to the public at www.auditorgen.state.pa.us.  The report does not list swaps by municipal authorities because, unlike swaps for school districts and other local governments, such swaps are not required to be reported to the state.  

SOURCE Pennsylvania Department of the Auditor General