Bond Advisers: Pay-to-Play, Phantom Bonds, and a Serious Lack of Transparency
<a href="http://www.nytimes.com/2009/02/17/business/17muni.html" target="”_blank”">An
article in yesterday's New York <span>Times</span></a>
points to yet another clever end run around ethics laws involving
municipal bonds. Bond underwriters are not allowed to make campaign
contributions, to prevent a pay-to-play environment. However, financial advisers, the people who hook local
governments up with bond underwriters, are allowed to make campaign
contributions. And so they do, in large quantities, it appears, even
though they work closely with underwriters as a team.<br>
<br>
In fact, it was contributions such as these that led to New Mexico Gov.
<a href="http://www.cityethics.org/node/599" target="”_blank”">Richardson's withdrawal</a>
from his nomination as Commerce Secretary (the <span>Times</span> article focuses on the
financial adviser involved in New Mexico).<br>
<br>
Another scheme this article points out is the failure in some cases to
use bond proceeds for legitimate government works, which is required by
law (such bonds are referred to as "phantom bonds"). Why would the proceeds of government bonds not be used for
government works? Because then money managers can invest the proceeds
at higher rates and make big money for themselves, as well as money for
the local governments. If making money is what local governments are
supposed to be doing.<br>
<br>
In Gulf Breeze, FL, a local housing authority issued $200 million in
bonds, $12 million of which went to pay financial advisers and
companies. The rest sat in an account making money. Not one cent was
spent on housing. Only a little was spent on housing in a similar deal
in Pulaski County, AR.<br>
<br>
The most serious problem here is a lack of transparency. Citizens have
little idea what bonds are being used for (unless, say, there's a
school or stadium built with them) or who's getting paid what in the
deals. The article's most frightening paragraph is about transparency:<br>
<br>
<p>When challenged by the I.R.S., a local
government typically hires lawyers and works out a settlement,
sometimes quietly paying restitution. That protects the buyers of the
bonds from having to pay tax on their interest. It also keeps the
problems quiet since the I.R.S. is generally barred from discussing tax
cases.<br>
</p>
<p>“If this had been visible to the marketplace, we wouldn’t have had
these problems,” said Christopher Taylor, former director of the
<a href="http://www.msrb.org/msrb1/" target="”_blank”">Municipal Securities Rulemaking Board</a>. The MSRB is now asking Congress
for the authority to cover consultants and other advisers in the
municipal bond business as well as bankers and brokers. Let's hope it
gets this authority.<br>
</p>
<p>And let's hope the I.R.S. changes the rules so that local government
settlements with it are required to be made public. Governments are not
individuals, who have a right to privacy. Governments should have no
right to hide any misconduct, or its cost to taxpayers.<br>
</p>
See my 2007 <a href="http://www.cityethics.org/node/203" target="”_blank”">blog entry on
the federal investigation</a>, and these two related blog
entries: <a href="http://www.cityethics.org/node/575" target="”_blank”">Birmingham
gift</a>s, <a href="http://www.cityethics.org/node/504" target="”_blank”">local
government fiduciary duties</a>. <br>
<br>
For more info on what he calls "black box deals," with a partisan
angle, see <a href="http://46in08.blogspot.com/2009/01/cdr-david-rubin-bill-richardson.html…; target="”_blank”">Robert
Verdi's blog</a>.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
<br>
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