Ethics Jurisdiction Over Those Doing Government-Approved Work

Individuals and companies doing the work of government or work approved by government, even when they do not have a direct financial relationship with government, should be within the jurisdiction of a government's ethics code. This controversial position is strengthened by what happened to many Tennessee local governments, according to a front-page article in today's New York Times.

These local governments, in Tennessee, lowered the interest rates on their bonds by entering into interest-rate swaps. They did not understand that, should economic conditions worsen, these interest rates could rise a great deal. That is, the swaps were riskier than they thought.

Why did they not sufficiently understand the risks? The reason appears to be that the state allowed a serious conflict of interest to occur. The conflict of interest did not involve government officials or even contractors. It involved individuals the state comptroller appointed to a board to establish guidelines for derivatives and to devise a curriculum for a class to teach local officials about interest-rate swaps. That board included two lawyers from the firm that did most of the state's interest-rate swap work, as well as a banker from the firm that advised and underwrote most of the state's interest-rate swaps.

Then the state approved the law firm and the bank to teach the course. And, unlike many states, Tennessee allowed the same firm to both advise and underwrite bonds. In other words, the state permitted the lawyers and bank officers to wear four hats:  they wrote the rules, taught the course, advised the towns, and underwrote the bonds.

The new state comptroller said that, in hindsight, it "may not have been the best idea." A Nashville city council member, and former bond trader, called the firms' course materials "nothing more than an infomercial."

One lesson to be learned is not only that local governments shouldn't take risks they don't understand (things are risky enough without manufacturing new ones), but that when you meet someone wearing multiple hats, even if the state or federal government has approved everything, you should just say No!

The government ethics lesson to be learned is that it is important to give a local government's ethics program jurisdiction not only over officials, but also over contractors, consultants, and people doing government work or approved to do work effectively for the government, even when they have no direct financial relationship with the government. The fact that they are volunteering their time or getting their money some other way (the law firm and bank were making far more from interest-rate swaps than from regular bond deals) does not mean that they should not declare their conflicts and deal with them responsibly. It's important for public trust, and it may end up being important to the bottom line, as well.

For other blog entries on local government bonds, see here and here and here and here.

For another blog entry on ethics jurisdiction over people who have no financial relationship with government, see here.

Robert Wechsler
Director of Research-Retired, City Ethics

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