Most expensive sewage system in history

If you say “Jefferson County” to a professional in muniland, you will likely get a shudder of mild revulsion. This Alabama county is the biggest example of Wall Street aggression towards a public entity since Orange County, California declared bankruptcy in 1994 after buying too many interest-rate derivatives. Dodd-Frank, the financial-reform law that’s been in effect for a year, changed the rules for municipal bonds and derivatives.  But did it change them enough to avert a repeat scenario?

First, a little background: Jefferson County was ordered by the federal EPA to build a sewer system at an estimated cost of $1.2 billion. The construction went over budget and was rife with massive corruption that has ensnared 17 people. The funding of the sewer project was equally corrupt. JP Morgan was under investigation for bribery in 2009 and eventually reached a settlement with the SEC. The Washington Post reported this at the time:

J.P. Morgan Chase agreed to a $722 million settlement with federal regulators over accusations that the bank and two former executives made illegal payments to win municipal bond business from Jefferson County, Ala.

The Securities and Exchange Commission said Wednesday that J.P. Morgan and former managing directors Charles E. LeCroy and Douglas W. MacFaddin paid $8 million to friends of Jefferson County commissioners who voted to hire the bank to carry out municipal bond offerings and other transactions to finance a new sewer system. The friends worked for local financial firms, but did not work on the deal.

The financial deals arranged by J.P. Morgan ultimately resulted in millions of dollars in losses and pushed the county to the brink of bankruptcy, causing residents to pay much higher rates for water and sewer services.

Two strikes against JP Morgan

Can too-big-to-fail banks be restrained from engaging in fraudulent and manipulative practices? Or should we expect large, global banks to keep breaking the rules over and over again?

Today JP Morgan Securities reached a settlement with 25 state attorneys general and five federal regulators regarding their practice of using “sham bids” in the municipal market. The global bank will pay $211 million to settle federal and state charges, according to Reuters.

The details of the settlement are a little mind-numbing if you don’t follow muniland, but they mirror charges of “sham bids” in the auction-rate securities market that JP Morgan first settled in 2006. After violating that SEC’s “cease and desist” order, the bank had to settle for the second time with the North American Securities Administrators Association (NASAA), the Illinois Securities Department, the Florida Office of Financial Regulation and the New York Office of the Attorney Genera in 2008.

Quis custodiet ipsos custodes?

Quis custodiet ipsos custodes? Or “who watches the watchmen?” Credit-rating agencies are the main watchmen of the financial system.  But can we judge their performance, or are they just black holes filled with “opinions?”

The credit-rating agencies continue to make headlines as they try and keep pace with a slowly sinking Europe and the efforts there to rescue bondholders. European banks, the ECB, and officials from the EU are trying desperately to concoct some kind of structured investment vehicle that will solve the Greek sovereign debt crisis without requiring a default. So far, the rating agencies are not eating their “inventive” cooking, and they have yet to bless any new “solution.”

Many observers believe that credit raters completely mis-rated mortgage bonds and that this caused the global financial crisis. Meredith Whitney implies that credit raters are vastly underestimating the riskiness of municipal bonds and have overlooked pension and other liabilities when judging state and local governments’ creditworthiness. But do we have any statistical evidence of any this? Are credit raters getting the ratings wrong on every type of bond?

Green shoots?

Green shoots?

Reuters reports on recent data from the U.S. Census Bureau that shows how tax revenues are improving:

State and local governments brought in record first-quarter revenues this year, according to a Census Bureau report released on Tuesday that offered a sign their budget crises may be abating.

Total state and local revenues for the first quarter reached $321 billion, a 4.7 percent rise from the first quarter of 2010 and the highest level on records going back to 1988. It marked “the sixth consecutive quarter of positive year-over-year growth,” the Census said.

The declining welfare rolls

The ever-shrinking welfare rolls

Stateline has done some very good reporting on the decline of the welfare rolls. Welfare funding was switched to block grants in 1996, and the funding level has remained the same since then. From Stateline:

Welfare is not a big budget item for most states, taking up less than 2 percent of all state spending, according to the National Association of State Budget Officers (NASBO)…

…When Congress overhauled that system in 1996, it changed welfare from an “entitlement program” guaranteeing coverage to everyone who was eligible and instead created the Temporary Assistance for Needy Families (TANF) block grant that hands out lump-sum payments for welfare. States are essentially given a set amount of money and allowed to use it as they wish. The amount has stayed level since 1996.

Standardizing AAA

For many years, a AA-rated municipal bond did not have the same risk of default as a AA-rated corporate bond. In fact, the corporate bond was about 6 times more likely to default.

Over the last two years, credit rating agencies have standardized the municipal and corporate rating scales. This was a substantial change for the municipal bond market and had the effect of raising the credit rating of thousands of municipal issues. Many don’t understand why this large structural change was made, so I thought it would be helpful to share the history.

Many professionals within muniland have said that a substantial amount of “granularity” was lost in the municipal rating scale when it was equalized with the corporate bond scale. A municipal bond previously rated A2 was likely moved four notches up the rating scale to Aa1. This has the effect of “bunching” municipal ratings into a tighter band than they had previously been in, and it obscured the prior “granularity” that the muni scale had.

Muni sweeps: California’s first budget veto

Some thorny action in California on the state budget:

California Governor Jerry Brown, who failed to win Republican support of tax extensions in six months of negotiations, said he’d “move heaven and earth” in another attempt after vetoing a budget without the provision.

Brown, a Democrat who pledged to solve California’s fiscal malfunctions without gimmicks, didn’t say how he’d get the Republican backing needed to pass his plan. His budget veto was the first in state history.

Rocking back and forth

Chip Barnett of Reuters brings us the weekly numbers on muniland flows:

U.S. municipal bond funds posted $172 million of net outflows in the week ended June 15, according to Lipper data issued on Thursday.

Wall Street drives a truck through mile-wide hole in the rules

The Wall Street Journal and my fellow Reuters blogger Felix Salmon have both addressed the issue of the Bank of New York Mellon giving off-market or false prices on foreign-exchange trades to one of their clients, namely California pension fund Calpers.

Morally the actions of BONY, if true, are reprehensible. But are they illegal?  Felix describes the specific problem:

BNY Mellon’s clients put in FX orders, the bank executed those orders and reported back a price. Only it lied to its clients about the price it was getting, padding its own profits while so doing. This is doubly evil: not only did the bank lie, but it lied while serving as a fiduciary to its clients, with an affirmative duty to give them “best execution.”

Whitney’s new gloomy doomy

Mark Gongloff of the Wall Street Journal‘s Marketbeat blog wrote this today about Meredith Whitney:

Professional scary person Meredith Whitney took to the op-ed pages of The Wall Street Journal this morning to sprinkle some more of her fear dust on the muni-bond market:

Municipal bond holders will experience their own form of contract renegotiation in the form of debt restructurings at the local level. These are just the facts.

Muni sweeps: ‘How-to’ primer for bid-rigging

UBS finally comes to the table

In November, 2009 the Wall Street Journal reported that Swiss bank UBS was in talks to settle with the SEC on their role into the three year investigation in municipal bid rigging.

After two years they’ve finally reached agreement to pay $160 million in restitution and fines.

From the SEC announcement:

“Our complaint against UBS reads like a ‘how-to’ primer for bid-rigging and securities fraud,” said Elaine C. Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit.

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