Auditor General Jack Wagner Slams Excessive Bonuses Paid by Wall Street Banks Tied to PA Swaps Losses

Jan 15, 2010, 12:07 ET from Pennsylvania Department of the Auditor General

HARRISBURG, Pa., Jan. 15 /PRNewswire-USNewswire/ -- Auditor General Jack Wagner today repeated his call for the General Assembly to ban local governments from engaging in interest-rate swaps after pointing out that 13 investment banks underwriting swaps in Pennsylvania are expected to award over $60 billion in executive bonuses this year.

"It's unconscionable that greedy Wall Street bankers are rewarding themselves with excessive  bonuses whose profits were derived, in part, by hard-working Pennsylvanians whose elected officials gambled away their tax dollars in risky financial schemes they didn't understand," Wagner said. "Interest-rate swaps have no place in local government and the General Assembly should put a stop to this immediately."

At least seven Pennsylvania school districts and municipal governments have lost an aggregate $34 million in bad interest-rate swaps during the past two years, according to a Department of the Auditor General investigation and media reports.

Interest-rate swaps are legal agreements between two parties, such as a school district and an investment bank, on which way interest rates will move. The party that guesses correctly gets paid, and the party that guesses incorrectly must pay. The payments are determined by the amount of public debt financed with variable-rate loans.

According to Moody's Investors Service, Pennsylvania has the most local government units in the nation engaged in high-risk swaps. Investigators for the Department of the Auditor General have found that 107 of 500 school districts, or 21 percent, and 86 local governments have tied up taxpayer funds in interest-rate swaps.

According to the Department of Community and Economic Development, Pennsylvania school districts and local governments had financed $14.9 billion in public debt between October 2003 and June 2009. The Philadelphia School District had the most debt tied to swaps contracts, in excess of $1 billion.

"Quite simply, the use of swaps amounts to gambling with public money," Wagner said. "The fundamental guiding principle in handling public funds is that they should never be exposed to the risk of financial loss."

Wagner wrote to the General Assembly in December, urging it to ban the use of swaps, after a special investigation completed by his department found that the Bethlehem Area School District lost at least $10.2 million of taxpayers' money in these risky and complex financial instruments.

As Pennsylvania's independent fiscal watchdog, Wagner has urged the General Assembly to immediately prohibit local governments and municipal authorities from entering into swaps. He also urged school districts and other local governments to take the following actions:

  • Stop using swaps and other types of exotic financial instruments;
  • Terminate any active swaps 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 our report; and
  • Hire financial advisers through a competitive selection process and periodically evaluate the quality, cost, and independence of the services provided.

Wagner said that exotic investment instruments like swaps may be perfectly acceptable in the private sector, but they should have no role in government. Public debt should be financed with fixed interest rates that are transparent, reliable and easily understood by the public.

"As most homeowners would agree, a fixed-rate mortgage is preferable to a variable-rate mortgage because the monthly payments are stable, making it easier to plan your budget from month to month. The same rule should apply to school districts and local governments," 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



RELATED LINKS

http://www.auditorgen.state.pa.us