To members of the Denver Board of Education, it sounded ideal. It was complex, involving several different financial institutions and transactions. … 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 question before the Denver school board was how to finance a gap in its pension fund. Denver agreed to a bond deal with JP Morgan in which the interest rate Denver paid on the financing would fluctuate, rising in the event of an economic downturn, falling in the event of an upturn.
The Denver school board agreed to this four weeks after Bear Stearns collapsed. The same week that the price of a gallon of gasoline hit a record high. If the school board couldn't foresee that recession was in the wind in April 2008, well, there were other warning signs about the deal.
For instance, Denver knew that JP Morgan was an adverse party in the deal. That JP Morgan was betting against Denver. No problem: Denver hired the Royal Bank of Canada to act as its independent advisor, then allowed Royal Bank of Canada to participate in the deal, also as an adverse party, waiving the conflict of interest.
Look, Denver. When a guy offers to trade you six magic beans in return for your cow, your goose, and your chicken, it's certainly a good idea to be skeptical. Hiring a magic bean appraiser is the right thing to do.
But when your independent magic bean appraiser tells you that these are wonderful beans, and that he'd like to put up a couple of additional beans himself, for which he'll take an interest in the goose, and, Oh by the way, would you mind signing this form acknowledging that I've informed you that I have a conflict of interest in the transaction, and that you knowingly waive the conflict and will allow me to stay on as your magic bean appraiser? …
Don't walk away. Run.
So far the magic beans have not produced a single stalk, but they have produced an angry man-eating giant, in the form of higher interest rates than Denver would have paid on a standard bond. Unfortunately this giant carries no gold. He does carry an $81 million termination fee, payable to JP Morgan, in the event that Denver tries to get out of the deal.
Denver's school superintendant Thomas Boasberg, who was one of the prime movers behind the magic bean trade, dismisses critics as "politically motivated." That's code language. It means "My conduct was wrong. It was indefensible. Since I have no defense, I'll use ad hominem to attack those accusing me, who are politically motivated doodoo-heads."
And while Boasberg has no defense, he can at least console himself that there are others with whom to share the blame. There's the rest of the school board, and there's Boasberg's former boss, who left the school system to take a different job in November 2008.
You might think the old boss's "new job" was a euphemism for "resigned in disgrace," but in fact it was a promotion. Boasberg's old boss, who pushed the magic bean trade through the school board, is United States Senator Michael Bennet.
Senator Bennet's webpage, as of this writing, features a large banner with a Wall Street sign, and the words, "PAY IT BACK!" A good sentiment, one that Senator Bennet ought to follow as well.
But of course anyone suggesting that Colorado voters should remember Bennet's job performance, as a Senator or as a magic bean trader, come this November (Bennet was appointed to the office shortly after the bond deal)
2014 would be "politically motivated."
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