The American Interest
Analysis by Walter Russell Mead & Staff
Denver Loses Big on Wall Street

WallST

Yet another city is suffering the consequences of hitting up the Wall Street casino to fund its pension system. Bloomberg reports that Denver’s public school system has paid a total of $215.6 million to Wall Street banks related to swaps and bond sales made since 2008—equal to two-thirds of total teaching expenses for one year.

We’ve heard this story before. The problems began when Denver’s public school system, looking to plug a $397.8 million hole in its teacher pension system, turned to riskier Wall Street investments rather than raising revenue or cutting spending. The bets didn’t pay off, and meanwhile the city government has raised property taxes by a whopping 26 percent to fund education. Unfortunately, this comes after Wall Street got its big payday:

Denver schools wound up doing a bond deal in 2011, along with last month’s, to convert the 2008 bonds to fixed-rate and exit swaps. The $215.6 million paid to unwind swaps as well as fees for new bond sales has eroded money the district set out to save for its pension plan. Besides the swap termination payments, the cost includes fees to underwriters and other professionals[...]

“We’ve lost hundreds of millions of dollars on deals we never should have been in,” said Jeannie Kaplan, a district board member who said she voted for the 2008 borrowing and then began pushing to end it in 2010. “Public institutions with elected boards shouldn’t be in these kinds of transactions. Our responsibility is to use the public’s money in a judicious way.”

By their own admission, district board members didn’t know anything about the bond market. This should have been the first warning sign that this may have been a bad idea.

Other cities facing pension shortfalls should take note of Denver’s struggles. Keeping pension plans underfunded in the hopes that future generations will pick up the slack is rarely a good idea; relying on the Wall Street casino to make up the difference is a worse one. Instead, public officials and fund managers should, at a minimum, keep their plans reasonable, adequately funded and gimmick-free. Perhaps the best option, however, would be to make the switch from defined-benefit to defined-contribution plans.

[Wall Street image courtesy of Shutterstock]

Published on May 10, 2013 5:00 pm
  • Anthony

    “By their own admission district board members didn’t know anything about the bond market” or where to seek credible counsel. That just about sums it up WRM (100s of million dollars loss later). Best option would be to understand Municipal finance and Bonding intricateness.

  • http://www.facebook.com/corlyss.drinkard Corlyss Drinkard

    Just wait till the results of all those Californians flooding into Colorado in search of cheaper housing and better business climate come in. Their generosity with Colorado taxpayers’ money will make this pension story look like a comic strip.

  • Steven Walser

    I do not know the details of the Denver swap position that they recently, so expensively, unwound but they would not be the first and certainly won’t be the last group of board members to guess wrong on the future direction of interest rates.

    It sounds like these people had to make a decision, one way or another, on what direction they thought bond prices would go from 2008 onward. Many others would also have erred in thinking they would go higher so it is no big surprise that they would have tried to insulate themselves from this possibility and now seek to unwind a position that proved wrong. How many who read these pages would, in 2008, have predicted the current nearly record low interest rates courtesy of “The Bernanke”?
    To now unwind a losing position is probably wise, at this point.

  • http://www.facebook.com/people/Luke-Lea/579129865 Luke Lea

    Aren’t there fiduciary responsibilities here that prevent Wall St. even doing deals like this? I mean it should be illegal for public officials to gamble with the public’s money, and, ipso facto, it should be illegal for Wall Street to accept such bets.