How a Plan to Help Stockton, Calif., Pay Pensions Backfired

The following is an excerpt from an article in 

The New York Times
Tuesday, September 04, 2012

How a Plan to Help Stockton, Calif., Pay Pensions Backfired

By MARY WILLIAMS WALSH

Jeffrey A. Michael, a finance professor in Stockton, Calif., took a hard look at his city’s bankruptcy this summer and thought he saw a smoking gun: a dubious bond deal that bankers had pushed on Stockton just as the local economy was starting to tank in the spring of 2007, he said.

Stockton sold the bonds, about $125 million worth, to obtain cash to close a shortfall in its pension plans for current and retired city workers. The strategy backfired, which is part of the reason the city is now in Chapter 9 bankruptcy. Stockton is trying to walk away from the so-called pension obligation bonds and to renegotiate other debts.

After reviewing an analysis of the bond deal, underwritten by the ill-fated investment bank, Lehman Brothers, and watching a recording of the Stockton City Council meeting where Lehman bankers pitched the deal, Mr. Michael concluded that “Stockton is entitled to some relief, due to deceptive and misleading sales practices that understated the risk.”

“Lehman Brothers just didn’t disclose all the risks of the transaction,” he said. “Their product didn’t work, in the same way as if they had built a marina for the city and then the marina collapsed.”

Financial analysts and actuaries say essentially the same pitch that swayed Stockton has been made thousands of times to local governments all over the country — and that many of them were drawn into deals that have since cost them dearly.

Since virtually all pension obligation bonds turn on the same basic strategy that Stockton followed, Mr. Michael’s research could be a road map for avoiding more such problems, or perhaps for seeking redress. His analysis was part of his August economic forecast for the region, which he prepares as director of the Business Forecasting Center at the University of the Pacific.

There are about $64 billion in pension obligation bonds outstanding, and even though issuance has slowed, more of the bonds are coming to market, even now.

Officials in Fort Lauderdale, Fla., are scheduled to vote on a $300 million pension obligation bond on Wednesday, for instance. Hamden, Conn., has amended its charter to allow for the bonds to rescue a city pension fund that is wasting away. Oakland, Calif., recently issued about $211 million of the bonds, following the lead of several other California cities and counties.

For more, visit www.nytimes.com.

Schools Pass Debt to the Next Generation

The following is an excerpt from an article in 

The New York Times
Friday, August 17, 2012

Schools Pass Debt to the Next Generation

By FLOYD NORRIS

The deleveraging of America is well under way, as individuals and companies recover from the excess borrowing that helped to produce the boom and left many people vulnerable when the bust arrived. Household debt is down nearly $900 billion over the last four years, partly from repayments and partly from defaults.

During the crazy times, homeowners could get mortgages that allowed them to pay less than the full amount of interest being charged, with the rest added to the principal. Commercial property owners generally paid the full amount of interest, but did not have to repay any principal until the loan matured in five or 10 years. For both homes and commercial properties, lenders were willing to rely on extremely optimistic appraisals.

For property buyers, those days are gone,

But for some borrowers, it is still possible to borrow now and pay nothing for decades.

There is a furor in California because the Poway Unified School District, in San Diego County, borrowed money last year on terms that even Countrywide would have laughed at during the boom. It will not pay a dime of interest or principal for more than two decades. Only then will it begin to service the bonds.

It is paying a high price. Although it has a good credit rating — Aa2 at Moody’s and AA– at Standard & Poor’s — it will eventually pay tax-exempt interest of up to 6.8 percent for the borrowings. When it issued more conventional bonds last year, it paid rates that were much lower, ranging up to just 4.1 percent.

For borrowing $105 million in 2011, taxpayers — or perhaps it would be more accurate to say the children and grandchildren of today’s taxpayers — will pay $877 million in interest between 2033 and 2051.

For more, visit www.nytimes.com.

Irresistible Mortgage-Backed Securities

Excerpt from an article in The New York Times
Sunday, February 19, 2012

Prices of Mortgage-Backed Securities Prove Irresistible

By AZAM AHMED

Some Wall Street investors made money as the mortgage market boomed; others profited when it fell apart.

Having reaped big gains during both of those turns, Greg Lippmann, a former star trader at Deutsche Bank, is now catching the next upswing: buying the same securities built from mortgages that he bet against before the financial crisis erupted.

Mr. Lippmann is joined by other big-money investors - mutual funds like Fidelity as well as hedge funds - in riding a wave of interest in the same complex loan pools that nearly washed away the financial system.

The attraction is the price. Some mortgage bonds are so cheap that even in the worst forecasts, with home prices falling as much as 10 percent and foreclosures rising, investors say they can still make money.

"Given its significant underperformance in 2011, we believe the product is as cheap to broader markets as it has been in a long time," Mr. Lippmann, whose portfolio is heavy with subprime mortgage securities, wrote in a recent letter to investors.

More broadly, the nascent recovery in the mortgage bond market supports a view that the housing slump may have bottomed out. Sales of existing homes are picking up. State and federal authorities have reached a $26 billion settlement with the big banks that is expected to provide some mortgage relief. And the Federal Reserve Bank of New York has been able to auction off billions of dollars of mortgage securities that it acquired as part of the financial crisis bailouts.

"There is light at the end of the tunnel," said Kenneth J. Taubes, the head of United States investment for Pioneer Investments, a global investment manager that owns these securities. "The mortgage crisis is getting behind us, and things are getting back to some semblance of normality."

That optimism is an about-face from 2006 and 2007, when Mr. Lippmann and others told investors that housing was a bubble ready to burst. On Wall Street, Mr. Lippmann became known as "Bubble Boy," and one of his traders wore a joking T-shirt that read, "I Shorted Your House."

His exploits were chronicled in Michael Lewis's best seller "The Big Short," which described him as somewhat brash and crass. He was known for maintaining a sushi spreadsheet, where he ranked the top Japanese restaurants in Manhattan on ambiance, quality and cost. (He still maintains the spreadsheet.)

These days, industry competitors describe Mr. Lippmann, who runs LibreMax Capital, as a more mellow presence. And he is much more positive about the market, telling investors that his fund is reducing its hedge against a potential market crash. Through a spokesman, Mr. Lippmann declined to comment.

European Zombie Banks

Excerpt from an article in The New York Times
Monday, February 13, 2012

Help in European Financial Crisis Could Spawn ‘Zombie Banks’ 

By JACK EWING

FRANKFURT — Few would begrudge Mario Draghi his boast last week that he and the European Central Bank had prevented a disastrous credit crisis by showering banks with cheap loans in December.

But beneath the gratitude toward Mr. Draghi, the president of the central bank, lurks a fear that the easy money could simply be creating the conditions for another banking crisis several years from now.

Because of the central bank’s cheap financing, some economists warn, sick banks now face less pressure to confront their problems — to clean out bad loans and other impaired assets, or even wind down operations if there is no hope of a turnaround. The European Central Bank, they say, could inadvertently spawn a cohort of “zombie banks,” burdened by nonperforming loans and assets that remain on the books, like the ones that helped make the 1990s a lost decade for Japan.

“It’s a huge bet,” said Charles Wyplosz, a professor of economics at the Graduate Institute in Geneva. “If the crisis ends up well, the E.C.B. will have pulled off a miracle. If things go wrong, then commercial banks will be in a much worse situation than they were before.”

Professor Wyplosz said the central bank might be making the banking system more fragile by encouraging institutions to load up on risky assets, especially government bonds from troubled euro zone countries like Spain or Italy. Banks can use those assets as collateral for more loans from the central bank.