Confidence Game - Christine Richard [81]
When taxes fell short of covering the bond payments, the issuer looked for ways to tap into the coffers of surrounding communities. One plan diverted money from a program that redistributed funding from wealthy Texas school districts to poorer districts in the state. Another proposal called for selling off some of Las Colinas’s assets to other communities, including its drainage ditches and a flower clock in the middle of a traffic circle. Residents objected, saying the “assets” were just maintenance burdens. In a planned residential neighborhood, the houses had to be so closely packed together in order to achieve the necessary amount of projected tax revenue that the local fire chief warned that it would be impossible to lean ladders against the houses in the event of a fire. But the debt continued to be paid.
In California, the San Joaquin Hills toll road was threatening to default on MBIA-insured bonds. Local authorities worked out their own unconventional solution. The Foothills toll road, a more successful project run by the same authority, agreed to make a $120 million payment to the San Joaquin Hills toll road even though the two toll roads were expressly prohibited from subsidizing one another. In exchange for the payment, the San Joaquin project promised not to sue the Foothills toll road if it built an extension and drew drivers away from the San Joaquin route. Brittany McKee, an employee of the Sierra Club, which opposed the plan, summed it up this way: “It’s a weird concocted financial bailout plan.” That seemed to sum up a lot of what I found going on that summer.
“If you think rationally about it, [bond insurance] sounds a lot like extortion,” said Professor David Schultz at Hamline University in Saint Paul, Minnesota. “The people who are put on the hook are the taxpayers.”
This extortion costs the U.S. taxpayers $2.5 billion a year, Bloomberg News estimated in an article titled “The Insurance Charade” in the fall of 2006. Darrell Preston, a Dallas-based public finance reporter, and I took some ribbing over the article.
“Yes, Virginia, bond insurance does save issuers money,” George Friedlander, Citigroup’s municipal bond strategist, chided in a research report. The Bloomberg story turned reality on its head, he argued. Bond insurance saved issuers more than $2 billion a year.
Sean McCarthy, chairman of the Association of Financial Guarantee Issuers, the bond-insurance trade group, also disputed the idea. “No issuer is forced to buy insurance,” he said. “It is an economic decision based on simple mathematical calculation of whether the borrowing cost is lowered by raising the rating to triple-A.”
But there was nothing simple about this. Why did municipalities have to buy triple-A ratings when they were the ones shielding the triple-A-rated bond insurers from having to cover claims? Richard Nixon’s disgraced attorney general, John Mitchell, knew that if America wanted ever more debt, it was going to have to stretch rules. The bond insurers played by rules that few understood. But perhaps the article had shed some light on those rules.
Rafael Mayer wrote Ackman a quick e-mail the day he read the Bloomberg Markets story: “I had never given this any thought. If it is true that municipal bond defaults are made improbable by implicit (and explicit) state guarantees . . . then what we have is a whole industry that serves essentially no function other than to transfer money from the pockets of the public to the pockets of management and shareholders.”
Chapter Fourteen
When Crack Houses Become Collateral
The Caulis Negris venture was a small-scale example of what eventually sank the subprime market.… Securitization can create value from thin air and assumptions.
—DAVID BOBERSKI, EXECUTIVE DIRECTOR AT UBS INVESTMENT BANK, CDS DELIVERY OPTION (BLOOMBERG PRESS, 2009)
BY THE FALL OF