Mary Williams Walsh of The New York Times recently dove into the issue of pension obligation bonds (POB), and she came up empty-handed. In her piece on bankrupt Stockton, CA’s POBs, Walsh relied on the analysis of an academic, Jeffrey A. Michael, with little background in municipal bonds, to claim that Stockton was duped into issuing $125 million of these bonds in 2007. Michael contends that the POB underwriter, Lehman Brothers, did not adequately disclose the risks associated with issuing POBs. Walsh writes:
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.
This “analysis” fails on so many levels that it is hard to know where to begin. The Stockton City Council special meeting on August 31, 2006 where Lehman made a presentation about issuing the POBs contains a broad discussion of the risks by the Lehman representatives, city council members and city officials starting. It starts at about minute 25 of the video here.
Lehman representatives made it very clear that issuing POBs is a method of swapping one liability – unfunded pension costs owed to CalPERS, California’s statewide pension system – with taxable municipal bonds issued to investors. Furthermore, and most crucially, the Lehman representatives explain that issuing POBs at an interest rate of 5.81% will replace payments due over 30 years to CalPERS that would be charged a 7.75% annual penalty rate to catch up. There was a discussion that the rate of return that CalPERS earned on its investments was a separate issue from Stockton catching up its outstanding unfunded liability.