Confidence Game - Christine Richard [77]
“I am sorry?” Ferreri said.
“Can you tell us what the par value of the bonds that have had reserve funds hit to date has been?” the analyst repeated.
“Par value of the . . . ?”
“Of the bonds where the reserve funds have been tapped?” the analyst repeated, sounding a little exasperated.
“No,” Ferreri said.
The analyst gave up. “Okay. All right.”
Despite MBIA’s 30-year track record of insuring municipal bonds, its executives seemed reluctant to discuss the most fundamental questions about why or when a county or town might turn to an insurer to cover their bond payments.
A letter written by Louisiana Treasurer John Neely Kennedy to Governor Kathleen Blanco made the situation a bit clearer: “Wholesale defaults on debt of this size, or even a portion of it, would destroy the credit ratings of our local governments, the state of Louisiana, and the bond insurers themselves,” Kennedy wrote. No one could afford to stop believing in the no-loss illusion.
IN THE SPRING OF 2006, I left Dow Jones for Bloomberg News, taking with me a pile of articles, credit-rating reports, and interview notes. Many of these papers were about municipal debt issuers that appeared to be on the verge of defaulting and filing claims on their bond insurance. When I dug in further, it seemed a number of these issuers had been on the verge of collapse for years. So why didn’t they default?
The first place I went was Oklahoma to follow up on a story about the Grady County Jail.
It was built in the late 1990s when Oklahoma’s rural counties were told their dilapidated Depression-era jails weren’t up to code. Inspectors cited leaky pipes, crumbling walls, and faulty wiring, and they gave the counties an ultimatum: Fix your jails or empty them. Without a jail, Grady County would have to pay someone else $100,000 a year to house its prisoners.
That’s when a Missouri architect named Lawrence Goldberg entered the picture. In the “law and order” state of Oklahoma, where incarceration rates are high and sentences long, the business of housing prisoners was both expensive and potentially profitable. Goldberg pitched the Grady County commissioners on the idea of building a new jail that would be big enough to house the county’s prisoners and still have space left over to rent cells to other counties or the federal government.
The county put the question of selling bonds to finance the construction of the jail to a vote. It was overwhelmingly rejected, not once but twice. In the state of Oklahoma the sale of long-term bonds requires voter approval. Safeguards against local governments’ taking on excessive debt are part of every state constitution.
Grady County proceeded with plans to build the jail despite voter objections. Rather than owning the jail, the county decided to lease it. And instead of selling bonds backed by the full faith and credit of the county, the Grady County Industrial Authority sold certificates of participation (COPs). The securities were backed by the county’s annual lease payments on the jail. The stream of payments Grady County expected to make were no different under the lease arrangement than they would have been under the terms of a bond financing. But COPs aren’t considered long-term debt and therefore don’t require voter approval. So while voters in nearby Mayes County sold $3.2 million of debt with voter approval to build their new jail, the Grady County Industrial Authority sold $12 million of COPs over the objections of its citizens. Due to cost overruns on the project, the Grady County Industrial Authority later sold another $5 million of COPs, bringing the total cost of the jail to $17 million.
Almost immediately, the jail had trouble covering payments on its $17 million of debt. Four years after the builders broke ground for the project, a 15-member grand jury found that “officials built a jail that was too big for the county’s jail needs, yet too small to produce enough revenue to sustain the [bond] payments.” Charged with investigating the construction, financing,