Trick Exotic Loans Surfacing to Government and Business Chagrin

From Gretchen Morgenson, NY Times Today. 06denver.html?dbk=&pagewanted=print
Editor’s Note: OKAY so let’s say you are ideologically of the position that anyone who signed a bum deal to finance their house should suffer the consequences. You signed the note, didn’t you? You borrowed the money, didn’t you? Why should you get any relief when the guy down the block played by the rules and doesn’t get any relief. Blah blah blah.

So fast forward to that guy down the block, in fact that city he lives in. And he finds out that the same deals that caused this ridiculous financial crisis where Wall Street ran off with all the money not only got the little guy, but his own city, which is going to make his taxes rise, services decline and cause a mess in his city and county for decades to come. How now, brown cow?
And fast forward to the mid sized and small companies that got sucked into the same exotic deals believing that these experts from Wall Street knew more than they did and that even if they didn’t understand the deal, it had the stamp of approval from JP Morgan Chase, so it must be good. They wouldn’t do anything bad would they?
This fight isn’t over. As government becomes aware that their own finances have been turned upside down by these follies, as companies become aware that their own pension and operating accounts are being hit by these tactics, the chorus of people signing from the same hymn book on the same page will grow.
August 5, 2010

Exotic Deals Put Denver Schools Deeper in Debt


In the spring of 2008, the Denver public school system needed to plug a $400 million hole in its pension fund. Bankers at JPMorgan Chase offered what seemed to be a perfect solution.

The bankers said that the school system could raise $750 million in an exotic transaction that would eliminate the pension gap and save tens of millions of dollars annually in debt costs — money that could be plowed back into Denver’s classrooms, starved in recent years for funds.

To members of the Denver Board of Education, it sounded ideal. It was complex, involving several different financial institutions and transactions. But Michael F. Bennet, now a United States senator from Colorado who was superintendent of the school system at the time, and Thomas Boasberg, then the system’s chief operating officer, persuaded the seven-person board of the deal’s advantages, according to interviews with its members.

Rather than issue a plain-vanilla bond with a fixed interest rate, Denver followed its bankers’ suggestions and issued so-called pension certificates with a derivative attached; the debt carried a lower rate but it could also fluctuate if economic conditions changed.

The Denver schools essentially made the same choice some homeowners make: opting for a variable-rate mortgage that offered lower monthly payments, with the risk that they could rise, instead of a conventional, fixed-rate mortgage that offered larger, but unchanging, monthly payments.

The Denver school board unanimously approved the JPMorgan deal and it closed in April 2008, just weeks after a major investment bank, Bear Stearns, failed. In short order, the transaction went awry because of stress in the credit markets, problems with the bond insurer and plummeting interest rates.

Since it struck the deal, the school system has paid $115 million in interest and other fees, at least $25 million more than it originally anticipated.

To avoid mounting expenses, the Denver schools are looking to renegotiate the deal. But to unwind it all, the schools would have to pay the banks $81 million in termination fees, or about 19 percent of its $420 million payroll.

John MacPherson, a former interim executive director of the Denver Public Schools Retirement System, predicts that the 2008 deal will generate big costs to the school system down the road. “There is no happy ending to this,” Mr. MacPherson said. “Hindsight being 20-20, the pension certificates issuance is something that should never have happened.”

A spokesman at JPMorgan, which led the Denver deal, declined to comment. Royal Bank of Canada, which acted as the school system’s independent adviser even though it participated in the debt transaction, declined to comment. Denver school officials said that they had agreed to sign a conflict waiver with Royal Bank of Canada.

Denver isn’t the only city confronted with budgetary woes aggravated by esoteric financial deals that Wall Street peddled in the years before the credit crisis. Banks have said the deals were appropriate for the issuers and that no one could have predicted the broad financial collapse that put pressure on the transactions.

Still, some municipalities have found such arguments wanting and are pushing back.

Last March, the Los Angeles City Council told its treasurer and city administrative officer to renegotiate interest-rate deals the city had used to try to lower its debt payments with the banks that sold them. “If they are unwilling to renegotiate, then those financial institutions should be excluded from any future business with the City of Los Angeles,” noted a report by the City Council.

In Pennsylvania, some school districts have unwound interest-rate deals, and the state’s auditor general, Jack Wagner, has urged other issuers to follow suit. “For the sake of Pennsylvania taxpayers, I call on the other school districts that have entered into similar swaps contracts to get out of these risky agreements as soon as they possibly can,” he said in a statement in February.

Financial stress from these deals could not come at a worse time for cities, towns and school districts already saddled with high costs and falling revenue. Although it is difficult to tally how many public entities entered into interest-reduction deals, a recent analysis by the Service Employees International Union estimated that over the last two years, state and local governments have paid banks that arranged these transactions $28 billion to get out of the deals, seeking to avoid further crushing payments.

Many transactions remain on public issuers’ books. S.E.I.U. estimates that New Jersey would have to pay $536 million to get out of its derivatives contracts, while California faces $234 million in such payments. Chicago is looking at $442 million in termination fees to unwind its transactions, and Philadelphia would have to pay $332 million.

Both Mr. Bennet, whom the White House has praised for his innovative approach to education, and Mr. Boasberg defend the deal they recommended in Denver back in 2008. They say that it has saved the school district $20 million it would have otherwise had to pay to cover the pension shortfall, and they maintain that no one could have predicted the credit crisis of 2008 that elevated the deal’s costs.

But the savings cited by the two men do not take into account termination fees associated with the complex deal. And had the school district issued fixed-rate debt, Wall Street would not have received the cornucopia of fees embedded in the more complex deal.

While the expenses associated with more complex transactions vary depending on the terms of the deal, Denver offers an example of the additional costs they can impose. So far, Denver has paid about $9.7 million more in fees for its deal than it would have had it chosen a simpler transaction.

Joseph S. Fichera, chief executive of Saber Partners, a financial advisory firm that specializes in structured finance, said that the type of transaction pursued by the Denver schools was a false solution for what the issuers want to achieve — lower long-term costs — because the banks selling the deals rarely quantified all of the potential risks involved.

“The issuer made a simple financing highly complex and took on substantial risk without knowing how large its downside could be,” he said, referring to the Denver deal. “The advisers and bankers may have disclosed that there were risks, but apparently did not help the issuer truly understand them. They typically present economic outcomes to the issuer only on projected savings and assume away any chance of the risks happening.”


$400 Million Gap

In a Pension Fund

The Denver public schools needed to do financial contortions because, like many other public agencies nationwide, its pension plan did not have enough funds to meet the payments due to retirees. And for years, the school system had not met its required annual pension payments to ensure a fully funded plan; by 2007, the school system faced a $400 million gap.

The school system solicited advice from several banks on how to handle this problem and ultimately decided to issue bonds that allowed it to refinance its existing debt of $300 million, which had a fixed interest rate. It also raised an additional $450 million, most of which went into the pension to fill the gap in that plan. Together, $750 million was raised using the riskier pension certificates.

The Denver certificates contained debt issues that had variable rates and were to be resold to investors in weekly auctions; the arrangement carried an annual interest rate of around 5 percent, not counting fees and costs associated with that type of debt. Fixed-rate debt would have cost 7.2 percent.

Denver schools had issued pension certificates before, but this time the banks added a little spice to the recipe: an interest-rate swap that made the variable debt mimic a fixed-rate instrument. If prevailing rates fell, the school system would have to make up the difference to the banks. But if interest rates rose, the swap would protect the school system from having to pay higher debt costs.

It was a heady brew, one that required an unusual amount of financial expertise to assess. In that regard, Denver had an apparent advantage: Mr. Bennet and Mr. Boasberg.

Unlike many school district officials, both men were financially sophisticated and had worked together in the private sector. Mr. Bennet handled investments and structured financial deals for the Anschutz Investment Company, a private concern owned by the billionaire Philip Anschutz that has stakes in telecommunications and oil. Mr. Boasberg, meanwhile, was a deal maker in mergers and acquisitions at Level 3 Communications, a telecommunications concern.

“We looked at what the risks were,” said Mr. Boasberg, who has been superintendent of the Denver public schools system since early 2009.

But according to several members of the board of education, the bankers’ presentations for the 2008 debt deal outlined its risks only in broad terms, discussing, for example, what would happen if interest rates shifted or the economy weakened a bit. The banks provided no full-blown worst-case situations to the board, focusing instead on the transaction’s upside: lower debt costs and a potential saving of $129 million in pension costs over the next 30 years.

School board members also said that bankers had not discussed problems in the variable-rate debt market that arose the previous year — a development that would have alerted them to troubles they might have had securing a manageable rate on the debt that they were refinancing.

Nor, they said, had the bankers discussed the outright collapse of trading in auction-rate securities, a $330 billion market that ran aground in mid-February 2008. Auction-rate securities are very similar to the variable-rate debt the Denver schools were considering at the time; both types of securities involve periodic auctions sponsored by financial institutions to determine what interest rates will be paid by the issuer.

Like the structural weaknesses in the variable-rate market, turmoil in the auction-rate market should have been a warning sign for the Denver school system and its financial stewards. But according to board members, its bankers and advisers never sent up warning flares of this sort.

“I think there was discussion around financial markets as a whole,” said Bruce Hoyt, a board member since 2003 and treasurer at the time the deal was done. “I don’t recall specific discussions about the freezing of auction-rate securities.”

In the end, Denver became ensnared in the financial maelstrom that was stirring even before it restructured its debt and that gathered force as the credit crisis deepened through the summer and fall of 2008. Prevailing interest rates collapsed, and the market for the Denver public school system’s debt shrank markedly.

Denver’s funding costs rose further when Dexia, a Franco-Belgian company that had facilitated the transaction and insured the pension certificates, ran into trouble. Worried about Dexia’s financial position, investors fled any securities the company had insured, including Denver’s debt.

In the end, a deal that JPMorgan said would have an interest rate of around 5 percent spiked to 8.59 percent during its first fiscal year, and has since settled down to an average rate of 7.12 percent today.


Locked In for Years

As a Deal Sours

Financial advisers say that deals like Denver’s might work for some issuers. But they say that their complexity can mask the fact that they often require issuers to give up far more than they get in return.

Like a homeowner, Denver essentially started out with the equivalent of a standard, fixed-rate mortgage that allowed it to refinance if interest rates fell. But the 2008 deal gave that up for the equivalent of a 30-year loan with a lower rate but significant penalties and costs if investor interest in the debt declined, as it did once the credit crisis kicked in.

Moreover, refinancing was extremely costly, given the hefty termination fees.

While such deals have become common in public finance circles, they are rare in the private sector. If corporations issue such debt, they will typically limit their terms to five years, which gives them room to maneuver as economic circumstances evolve.

Agreeing to be locked into a 30-year contract, as public entities have done, is especially costly because getting out of it requires paying penalties to the banks for every remaining year of the transaction.

Andrew Kalotay, founder of Andrew Kalotay Associates, a debt management advisory firm, said a deal like Denver’s would be highly unusual among private sector issuers like corporations because they recognized the pitfalls of locking themselves into an arrangement for 30 years.

“I’m not aware of any corporations trying to get a better fixed rate” by issuing long-term instruments such as those used by Denver. “Why would the school district want to do this transaction with all the attendant risks of mispricing and the possibility of unfavorable unwind costs when they could have done a conventional, taxable fixed-rate deal?” he asked.

Bankers, however, love these deals. In addition to the enormous termination fees they can snare, bankers also get remarketing fees and swap advisory fees.

Termination fees, however, top them all. Like the punishing prepayment penalties some homeowners have to come up with when paying off a mortgage early, termination fees on deals like Denver’s are essentially charges levied to rewrite the terms of a contract.

To some issuers, termination fees feel easier to swallow if they pay for it by issuing yet another round of debt, like a consumer using one credit card to pay the penalty charges on another. But even though no upfront cash is paid out, yet another layer of debt is incurred, adding to the cost of getting out of the deals.

Denver is considering paying its termination fees in this fashion, Mr. Boasberg said. It was unclear what the interest rate would be on the new debt, but he maintained that the school system would unwind the transactions only if it were economical and the interest rate on the debt were low enough to offset the termination fees.

Had Denver issued a standard, fixed-rate bond in 2008, it would not be facing termination fees now. While it is possible that the annual costs of the Denver deal will come down in the future, they are now roughly in line with what the school system would have paid in a fixed-rate transaction.

Jeannie Kaplan, a board of education member for almost five years, supported the 2008 deal but now regrets it because of its costs and complexity. “Bennet and Boasberg had been presented as financial saviors of the Denver school system, and I sat there wanting to believe what they were saying,” she said. “The board probably should have had their own financial consultant.”

Mr. Boasberg said critics of the deal were politically motivated, pointing to the close primary runoff pitting Mr. Bennet, the former superintendent, against Andrew Romanoff, another Democrat, for a place on the ballot for the Senate in the November elections. But Ms. Kaplan said she started questioning the deal before Mr. Bennet was appointed to the Senate in early 2009.

The school system’s 2008 refinancing is one of several issues that have come up in the runoff, including campaign financing, general integrity issues and Washington effectiveness.

Mr. Bennet became superintendent of the Denver schools in 2005 after he left the Anschutz organization to work for the mayor of Denver, John Hickenlooper.

From the campaign trail in mid-July, Mr. Bennet reiterated his support of the deal, saying that it had achieved the school system’s goal of improving its cash flow and merging with Colorado’s Public Employees’ Retirement Association, which meant the schools no longer had to pay 8.5 percent interest on its annual pension shortfall.

“Despite going through the worst recession since the Great Depression, we did that,” he said in a statement.


Another Shortfall,

And Cloudy Future

As Denver weighs its refinancing problems, it faces another conundrum: the money the city raised to shore up its pension fund has turned out to be inadequate because of the stock market’s plunge.

The fund turned in a dismal performance in the credit crisis — as was the case with most such funds — losing almost twice the $400 million borrowed by the school district to plug the pension gap. As a result, the school system’s pension shortfall recently stood at around $386 million, only slightly lower than it was two years ago, and even though $400 million had been funneled into it in 2008.

While the pension’s merger with the state system allows Denver’s school system to avoid paying interest on shortfalls, that benefit is temporary. If a shortfall still exists in 2015, the merger requires that it be closed.

Mr. Boasberg maintains that the deal has allowed Denver to hire teachers while other school districts are cutting back. But Henry Roman, president of the Denver Classroom Teachers Association, said that fewer teachers had been hired this year than in previous years.

Some board of education members fear that the human costs of Denver’s exotic refinancing deal are yet to be fully realized — and when they are, it will be in classrooms.

Ms. Kaplan says she is particularly concerned about the impact of having to fund the Denver school’s pension plan fully in 2015 if investment losses have not been recouped by then.

“How is that going to affect kids and teachers and classrooms?” she asked. “It makes it difficult for board members to do a budget now.”

26 Responses

  1. With regards to the article reposted above, Sen. Benett has come out stating that the NY Times “got it all wrong.” You can read his response to the NY Times article, if interested, here:

  2. Polymath Neil Garfield actually borrowed from Agatha Christie’s “Murder on the Orient Express” when he coined the phrase “Compartmentalized Fraud”.

    Christie’s book is about a capital crime committed on a train: and that train had many many compartments.

    As Christie’s train hurtled West from Aleppo in Syria to Istanbul, somebody hatched that murder, and in the movie, Richard Widmark got it.

    Now Hercule Poirot couldn’t solve the murder. And Mr. Poirot was smarter than Mr. Garfield. Why Hercule was even smarter than I! Why couldn’t Hercule solve the murder and conclusively identify the culprit?

    Compartmentalized Fraud! Read the book. See the movie.

    There really ain’t nothing new.

    Proving he knows how to use highly credible sources, Mr. Garfield now draws on the NYT’s Gretchen Morgenson for further inspiration.

    Brilliant article!

  3. Boots

    “With prejudice” is harsh, especially for pro se. Some courts allow amendment of claims – others do not – luck of the draw. That is why you always have to be prepared to appeal if necessary.

  4. thanks , alina for the comments, however my case was dismissed with prejudice based on the defendants motion to dismissed under fed.rule 12(b). failure to state a claim and the court failed to to disclosed the basis for its ruling. most of this ruling based on defendant’s argument not based if i i plead with specificity on the complained? I did specify the date, time where and how the fraud were committed, i was never given an opportunity by the court to proceeds with litigation of my case. i thinks i plead it specificity. nothing wrong with us Pro -Se,but something wrong with our court system , it is not equipped with knowledge that we have as a pro-se. we studied hard for our case, read law books and cases and with the help of this blog we accumulate wealth of knowledge thanks neil, but i would never give up even we know that being a pro- se is a gamble.

  5. boots,

    I am sorry that your claims were dismissed. Fraud is the hardest claiim to prove even for attorneys. There are certain elements in a fraud claim that must be pled. If you do not plead fraud wtih specificity, you have a great chance that the fraud claim will be dismissed.

    This in not just something that applies to pro se parties, but applies to any party in any type of case where fraud is pled.

  6. Regarding requests for judges to recuse: They should have to recuse if they have any investment in the banking, trust company or servicing companies or the parent firms of any of them. This must also extend to the judge’s retirement accounts. No immediate family members should work in the financial companies that might be affected by the judges’ rulings on these cases. This is similar to the way potential members of a jury are challenged before they are accepted as the jury.

  7. as Neil said A LONG TIME AGO THE SYSTEM IS BROKEN WITH NO WAY TO FIX IT NEIL IS A VERY SMART MAN …. but i truely believe despite the huge adversity we face, it is better to do something than nothing because ya never know and people keep searching there are a few good men and women left in the legal feild find someone that you feel owes no favors and is GOD FEARING and understands when he meets hios maker he will not hang his head in shame. i think i found one after going through a few schiasters…well see and ill keep ya posted, see ya cant kill hope

  8. we are all systematically eliminated by the court system as a Pro Se, no matter how you pleaded your case, it is not what the merits of your case is to be, but being a Pro – Se is a big disadvantage for all of us. the court systems don’t want to deal with us . they viewed us a low life person who is ignorant and don’t understand the law. I just received dismissal of my case with prejudice. the only cause of action it survived is to to amend ithe FDCPA and The Rosenthal Act claims against the defendant and my Fraud claims were dismissed with prejudice. how could you dismissed a Fraud Claim when you specify that the the substitution of trustee document were fraudulently signed by an employee of a law firm? how do you called that? how do you explained that the employee who notarized the sub – of trustee is also the trustee itself.? but according to the judge decision i still failed to claim for Fraud. In other word it is easy to commit a Fraud than to prove a Fraud. hahhaha. crazy thinking. this decision doesn’t make a sense , our court system is CROOKED’ , the court knew that all the pro se litigants have bases for cause of actions, but the court stop us from there. so being a pro-se litigant is a right but no right afforded to us when it come to litigate our case. i will appeal this dismissal in the court of appeal. i spent so much time and energy doing my homework on this case and i would never give up the fight no matter what.




  11. THE A MAN
    Which is better Pro Se or Sui Juris?
    Pro Se is a deviation of Pro Se Cutor.
    Would that be a disadvantage?

    Abby in CA,
    Truth in plain sight. Little Shop of Horror…there’s a lot of shops of horrors with deadly, damaging, and killer secrets behind their doors.

    I see you searching for that mortgage, when it gets into court, its as basic as do you have an agreement, who failed to perform.
    Really it kind of boils down to that. When they do an eviction, they say your landlord wants to evict you, and ‘the other side’ makes it look like you failed to perform by failing to vacate the premises. If it’s a foreclosure, then the ‘lender’ (term used loosely) says you promised to pay, and failed to perform.

    The Note is specific as to who you promised to pay. There’s all this junk about a note holder, but really if you read it, really does it tell you, you ‘have to pay the note holder’? Or does it spend a lot of time telling you about the note holder and what he’s doing with the note? There’s a lot that’s just NOT SAID, and I find that “one” (used intentionally) would infer something from what was NOT SAID. I make no assumptions. I read what was said, and if it didn’t say something, it didn’t happen, or it wasn’t meant to be said.

    The other day, I was in a court, and a guy comes in with a warning ticket for going 2 miles over the speed limit, but also for not having proof of insurance. He takes the proof to the court clerk. She tells him to fill out the plea form.

    I watched, as this guy, decided whether he was guilty, not guilty or nolo contender (sp?). I realized that the guy actually decides what the purpose of the ticket is.

    He has proof, why say guilty? He has insurance, it just wasn’t on him with he was stopped, why say not guilty? Why even choose nolo contender (sp?). Seemed to me all of them were N/A, since he wouldn’t have to decide if he wasn’t stopped. The clerk actually called the insurance company and asked if he was insured two days before he had arrived, which was the date of the ticket. I would never get into the obligations of his private contract with the court. I just listened to the interaction take place. It was interesting.

    If one (used intentionally) goes to court as a pro se, what rights are protected, and if the court does not recognize those rights and makes a judgment in violation of it, can’t one just notice the court that they made an error in fact in denying due process, and inform the court that they have lost the jurisdiction to settle the dispute since they made a gross error in fact to settle the case?

    One (used intentionally) that is sui juris; there should be no reason to appeal if the court lacked jurisdiction to judge a case in the separate capacities and standings of the parties, right?

    Is an appeal an entrapment to get you to accept the jurisdiction of the lower court that was not there before in your pro se or sui juris status; but by the fact that they issued a judgment ignoring your standing, you rush to reverse it and thus confer jurisdiction without realizing it? I’m just asking.

    If a court does not see a man or a woman, and has no jurisdiction over a man or a woman, is there really a way to ‘appear’ as yourself for a case and be heard or is all that communication only in writing?

    If two people are not in a contract and one sues another can a court enjoin them as if they were in a contract and then rule for one over the objection of the other who was never in a contract with them? Is that legal? Can that be binding? Is it smoke and mirrors, and you have to correct the court in their error to enjoin two unknowns?

    I’m just curious. Thinking out loud. Ignore if it doesn’t make sense, and give it some thought if it does.

    I know nothing and if I think I know something, I know nothing.
    I don’t give legal advice because I DON’T KNOW legal things, really I don’t.

    Light and Love,

  12. Be A Patriot, Stop Payment !
    Tar and Feather these S.O.Bs
    Teach em’ a lesson,
    They can not foreclose on everyone !

  13. After further research, I found some of the certificates from my mortgage trust included in one of the “shitty deals” like Abacus called “LOCHSONG” (CDO^2). It’s funny how these Goldman deals all end up with ownership in the CAYMAN ISLANDS.

  14. *There’s plenty more… this is standard practice for the Wall St wrecking & demolition crews!

    More Than a Dozen Banks Suspected
    Co-Conspirators in Muni Case

  15. Black Box Deals, AIG, J.P Morgan Chase, and CDR Financial Products: A Summary of Corruption

  16. Little Shop of Horrors opens with:

    words read by Stanley Jones:

    “On the twenty-third day of the month of September,
    in an early year of a decade not too long before our own,
    the human race suddenly encountered a deadly threat to its very existence.
    And this terrifying enemy surfaced, as such enemies often do, in the seemingly most innocent and unlikely of places…”

  17. I think we need to all take time to see that 1986 movie
    called ‘Little Shop of Horrors’ with that giant plant Audrey who keeps saying ‘FEED ME!’.

    Doesn’t it seem like Wall Street is like Audrey? ‘FEED ME!’ and the more it is fed the bigger it gets and the louder it gets.

    Rick Moranis was Seymour.

    How did it end?

  18. *Oh there’s plenty more (a lot more). This is standard practice for the Wall St wrecking & demolition crews!

    More Than a Dozen Banks Suspected
    Co-Conspirators in Muni Case

    Black Box Deals, AIG, J.P Morgan Chase, and CDR Financial Products: A Summary of Corruption






  21. To A-Man,
    Why not ask attorney’s to start filing a “recuse” order for every judge who has a mortgage? How do we know if the judge isn’t being contacted by their mortgagor and being bullied??

  22. This article needs to be sent to every nay-sayer in your contact list. Every single one of them that tell you, “it’s the homeowner’s fault.” Really? REally??


    If these are the minimum requirements to go on a Game Show than what about our Economic Lives are at stake.

    You are not eligible to be a contestant on Wheel of Fortune if you work for, or are related to, anyone who works for Sony Pictures Entertainment Inc., Sony Pictures Television Inc., Sony Pictures Television International, Quadra Productions, Inc., CBS Television Distribution Group, game show prize suppliers, or any TV station (including its advertisers and affiliated radio stations), or networks broadcasting Wheel of Fortune or Jeopardy!.




Contribute to the discussion!

%d bloggers like this: