Monday, December 14, 2009

Bloomberg Article on Chicago Unit Bond Issue

Bloomberg recently wrote an excellent article about a bond issue by a Chicago public entity (not part of the city, but close), the Metropolitan Water Reclamation District of Greater Chicago. The article is called "Hedge Funds Win on Chicago Sewer Debt at Public Cost".

To summarize, the Federal Government now subsidizes local municipal bond issues through a "Build America" program, which offers a subsidy of 35% of the interest cost to issuers. This is viewed as more efficient than the tax subsidy of municipal bonds, which are tax exempt on the individuals' tax return and also often for state returns if the bonds are purchased by in-state holders.

The MWRDGC issued $600M of debt recently. Customers bought $73M of the issue and immediately sold them in the secondary market. This type of activity generally means that the bonds were mis-priced (priced too low), which the Bloomberg article references.

Per Bloomberg:
Dec. 8 (Bloomberg) -- The “fair and reasonable” price financial advisers recommended to the Metropolitan Water Reclamation District of Greater Chicago for the biggest borrowing in its history cost taxpayers $8 million in unnecessary interest and resulted in a bonanza for bankers, according to documents initially withheld from the public.

The Aug. 11 Chicago sewer bond sale, arranged without competitive bidding like 84 percent of the $354.3 billion of municipal debt issued this year, “was a very lucrative deal for underwriters and investors and a very poor deal for the taxpayers of the district,” Daniel Kaplan, president of Kaplan Financial Consulting Inc., said in a letter read at the district’s board meeting Nov. 5.

Also interesting - later in the article - they mention that in other deals it is rare for hedge funds to be involved in this sort of purchase. An Iowa issuance mentions that they didn't have any hedge funds at all in their initial sale.

I commend Bloomberg for their research and recommend that the local papers, the Sun-Times and the Chicago Tribune, investigate the other bond sales by the City of Chicago, Cook County, and related governmental units. The analysis would probably lead to other types of insider deals and the like.

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