The Herald, Sharon, Pa.

Local News

November 19, 2009

Officials stand by ‘toxic’ swaps

AG warns against risky financial tool

MERCER COUNTY — Pennsylvania Auditor General Jack Wagner this week warned those managing public money against interest-rate “swaps” that he says are “toxic products” and shouldn’t involve public funds.

But Mercer County and West Middlesex Area School District have used these complicated financial deals to make or save taxpayers’ money, officials from both entities said Thursday.

“I do not believe we have entered (into) a risky transaction,” county fiscal administrator John Logan said.

As the steward of the county’s asserts Logan said he “wouldn’t make a transaction that was betting on anything.”

West Middlesex Superintendent Alan Baldarelli also disputed Wagner’s assertions.

“For us, it was a good deal,” Baldarelli said.

Swaps theoretically provide a hedge against large increases in certain interest rates, but Wagner likened the complex financial deals to gambling and called them “toxic products”. He said local governments and school districts should terminate any such swaps now in place and pursue other forms of financing.

“The risk outweighs the benefit,” Wagner said. “It’s not a minor risk, it’s a significant risk and public officials are no match for investment bankers.”

The study of swaps — officially named “qualified interest rate management agreements” — was prompted by a $12.3 million payment Bethlehem Area School District made to an investment bank earlier this year.

Wagner said that, in two deals, the district was hit with excessive fees and other payments and was subject to what he described as deceptive marketing tactics. In Bethlehem’s case, the use of swaps cost taxpayers $15.5 million more than if the district had simply not used them at all, Wagner said.

Wagner said local governments should use a competitive process to pick financial advisers and then monitor their performance.

Dave Davare, director of research services for the Pennsylvania School Boards Association, agreed with Wagner that swaps carry substantial risk and that districts should get independent financial advice.

“By independent, I mean the person that they hire works for the district and is not making any other revenue on this transaction from anybody else involved in the transaction,” Davare said.

But he said there are plenty of examples of swaps helping Pennsylvania school districts.

“For every district that you can point at like a Bethlehem ... you can turn around and point out a district that has been successful with it,” Davare said. “This is not a situation where every district has lost money. Some districts have lost money primarily because they’re trying to get out of them too early.”

Locally, West Middlesex began a swap agreement after entertaining proposals from several investment firms and “took a conservative approach to make the most for our taxpayers,” Baldarelli said.

By doing the swap, the district received an upfront payment of about $450,000 and has made another $300,000 since because of falling interest rates, Baldarelli said.

“I hope it stays that way,” he said.

The county has used swaps to take advantage of lower interest rates and refund bonds to save money, Logan said.

“The idea is to reduce our interest expense,” Logan said. “We’re looking at an interest cost that we have to pay and looking for a way to reduce that cost.”



The Associated Press contributed to the report.

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