Thursday, June 21, 2012

Local Bond Issue Price Fixing


The brilliant Matt Tabbi has a piece up about a widespread Wall-Street scam on local governments.   It appears that the big bond houses have engaged in a form of bid-rigging connected to the use of proceeds on local government debt.  Basically local governments back a bond issue with a stream of funds from, for example, a tax increase.   But the money generated by the bond issue is not spent all at once.  It could take years.   What should be done with the money in the meantime?   Cities and counties hire brokers to conduct auctions to sell the right to use the parked money for an interest rate.  Basically they are bidding for the right to invest the money.  

The winners get the right to invest the money , and as long as they pay the state or local government the return that they promised in the bid, they can keep the excess.  What Tabbi has learned is that there has been collusion.  The brokers are bribed.    Instead of getting the best interest rate possible for the locality, they have been taking turns tipping off their favorite bidders so that they can win the bid using the lowest interest rate possible.

Every fraction of a percent difference between what the local governments should have gotten and what they actually get can mean tens of thousands of dollars.   We may never know how much taxpayer money has been scammed in the last decade by some of the largest and most respected financial institutions in the country, but Tabbi points out that just four of the many banks involved in the scam have agreed to pay restitution of $637 million dollars in order to avoid prosecution!

That brings me to Arkansas, but it likely applies to whatever state you are in.   Politicians from both parties seemed determined to use debt for all manner of public works, even when they could pay cash.     There seems to be an allergic reaction to Pay-as-You-Go.    With the last issue of debt against our federal highway money there was a big emphasis from pro-debt politicians like Republican Representative Nate Bell of Mena on how investment programs like this one greatly lowered the effective cost of borrowing.   

Well, there is no doubt that investing a huge pile of borrowed money in CDs or something will reduce your net borrowing costs verses not investing the waiting money at all.    But that was never the real question. Back then the fiscal debate was whether this would be more cost effective than not borrowing at all.     Now I see that there is another issue we should consider in all this- is the rate the state and localities are getting on their sitting money really the best rates they could get?

In other words, this trial showed that bid-rigging had been occurring all across the nation for a long period of time.   The question is, has this state been an island of propriety in a sea of scam?   I don't have any proof that the same thing has been going on here, but my credulity threshold has been breached.    The revelation of this scam is yet another reason the people should vote down the routine use of debt.

Look, the math that debt proponents use is flawed anyway.   I don't want to bore readers with the intricacies of cost accounting, and if he was willing Jason Tolbert would be better at it anyway, but here it is in a nutshell:  The proponents are counting all the benefits of using debt, but not subtracting out the opportunity costs and especially the risks.   This gives a false picture that makes it seem like more debt is a better deal for the taxpayers than it really is.

Say for example you borrowed $600 million on a ten year income stream of which $80 million a year would be for loan payments, and that your interest for that loan amounted to $200 million.  That is to say, your income stream equaled principal plus interest.    So far so good.   But since you got the $600 million all at once but took three years to spend it you hired someone to invest the parked money for you.  If they got you 5% and you spent $200 million year one but took two years to spend the rest that would be  ( $400 million X .05) + ($200 million X .05) =  $20 million + $10 million = $30 million.    That would lower the effective amount of interest paid on the loan from $200 million to $170 million.    That's where proponents usually stop the math.

What they should include is the opportunity costs of the lost money that is collected to pay that interest.  IOW, governments are not the only ones who can invest money.  Us regulars can too.  When they take money from us to park it and invest it, there is no assurance they will do a better job than we will.   If Tabbi has it right there is reason to believe they will do worse.    

If one is going to count investment returns of parked money as a plus, one should also count the lost opportunity cost of money collected to pay interest rather than plowed back into the state's economy.    Once your tax stream matches all principle you spent, the stream of money you spend repaying interest represents money that the citizens could have parked that is instead diverted to interest repayments.  After 7 1/2 years your tax stream equals all the principle of the bond.   The rest of the time you are just paying interest.  

At $80 million a year it takes two and a half years to pay $200 million in interest.  So the first $80 million you lose (as something you can invest) for 2.5 years.  That costs you (at .05%) of roughly $10 million dollars.  The second $80 million, which you lose for a year and a half costs your around $6 million.   Losing the investment use of the last $80 million for the last half year would be worth about $2 million.     That's a total opportunity cost of $18 million.

So the $30 million we "saved" in interest costs by investing parked money must be reduced by the amount of money we could have made if we could have spent the money we spent on interest on investing instead.   Instead of $200 million being reduced to $170 million, it was shaved only to $188 million.     And if private investors are better at investing their own money than government bureaucrats are at investing other people's money through a financial system that has just been revealed as a scam in federal court, then it is possible that leaving that money in the public's hands as long as possible would produce an even higher return on the invested funds.     That would reduce the "savings" from the whole complicated deal even more.

But of course, investments you make with your own money, whether in your home, your health, your retirement, your family, or whatever, don't seem to mean much in political accounting these days.   Only the returns they make on the money they take from you counts.   The return you would have made if they had waited to take your money (funding a bond issue with future tax revenues is equivalent to taxing you early) until they really needed it does not seem to figure in their calculations. 

They really think pre-taxing, that is using a promise of future revenue to get a big pile of money at some cost before they even need it, is a conservative way to govern!   To hear some of them tell it, if they taxed us every dollar above subsistence and used it to fund a mega-bond issue whose parked proceeds were invested by some of the criminal banksters caught in this scam, why we'd be better off than ever!  And the sick thing is, these are some self-declared conservatives that are trying to sell us this stuff.


9 Comments:

Blogger Mark Moore (Moderator) said...

This trial showed that bid-rigging had been occurring all across the nation. The question is, has this state been an island of propriety in a sea of scam?

5:54 PM, June 21, 2012  
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