News Briefs
Schools caught up in derivatives lose millions
Feb 14, 2008 12:33 PM
When the Erie City School District in Pennsylvania, deep in a financial hole, couldn’t repair its buildings or buy textbooks in the 2003-04 school year, JPMorgan Chase & Co., the second-largest bank in the United States, made it an offer it couldn’t refuse. All the school district had to do was sign papers that would benefit it if interest rates increased in the future. The bank would also give the district $750,000.
But what JPMorgan Chase didn’t tell the Pennsylvania school district was that the bank would get more in fees than the district would get in cash: $1 million. Three years later, as interest rate benchmarks went the wrong way for the district, the Erie board paid $2.9 million to JPMorgan Chase to get out of the deal. School officials called it a sucker punch.
“It’s not about the district and the superintendent,” the school board chair said. “It’s about resources being sucked out of the classroom. If it’s happening here, it’s happening in other places.”
And it is happening in other places. During the past four years in Pennsylvania alone, banks have secured at least 500 deals totaling $12 billion like the one JPMorgan Chase sold to Erie. Most were made without public bidding.
The Pennsylvania transactions involve interest-rate swaps, which are derivatives, or financial contracts whose value is based on other securities or indexes.
The Pennsylvania deals show that school districts routinely lose when making derivative deals. They pay fees to banks that are as much as five times higher than typical rates and overpay advisers by as much as ten-fold. That means banks often underpay schools on upfront amounts, as JPMorgan Chase did in Erie.
“The school districts are getting fleeced,’’ Pennsylvania Governor Ed Rendell said.
There’s also a lack of transparency and competition in what are essentially private deals. “If you don’t know how much you’re paying, you’re going to be paying too much,’’ one financial watchdog said.
Forty states give government bodies explicit authority to make derivative deals. That’s up from none 20 years ago. Derivatives face no federal or local regulation, while local officials put faith in financial advisers who are paid by banks.
Once an iron and steel center, Erie is now left with shuttered factories and an aging population. Seventy-six percent of students in the district are eligible for free or reduced-price lunches.
Bloomberg Business News, Feb. 4
