In California, it’s not just the pension funds that are losing big on Wall Street gambles. The University of California system is also losing $6 million per year as a result of poorly considered interest-rate swaps, and the system’s accountants now believe that the system could lose as much as $136 million.
The details of these swaps are somewhat complicated, but in general they amount to bets with Wall Street banks that interest rates would go up. When the recession hit, of course, interest rates fell dramatically, and these swaps have become a massive liability to the schools, which are stuck in these deals for another 34 years. This looks particularly ugly in light of the fact that tuition across the system has risen drastically over the past decade. The fact that much of the money was raised to finance an “aggressive building spree” doesn’t help either.
Even more troubling, there are some unsavory connections between UC bigwigs and bankers at Lehman Brothers, which was responsible for many of these deals. The Orange County Register reports:
In January 2007, Augustine, the Lehman banker, presented an analysis to the Regents, which concluded the university could issue $11 billion more in debt.
Six months later, the university issued $200 million in bonds related to construction at UCLA’s medical center. Not only did officials decide to pay Lehman to underwrite those bonds, but they also chose the bank for an interest-rate swap on the debt.
At that time, [Peter] Taylor was a managing director at Lehman and head of the bank’s West Coast public financing operations. He oversaw 15 investment bankers, according to his résumé.
Taylor was also then closely connected to top university officials. He was on the board of directors of the UCLA Foundation and had earlier served as a regent.
Although Peter Taylor was not responsible for this deal, he worked with those who were, and was later hired by the University of California as a CFO, where he continues to back the use of these swaps as a cost-saving measure. This may be legal, but it does raise questions about whose interests, exactly, were being served in these deals.
In addition to highlighting the close links between blue state institutions and Wall Street, this episode reinforces one key lesson: public services, especially those funded by taxpayer money, should invest their cash as conservatively as possible. It’s always tempting for politicians and public agencies to raise money through fancy Wall Street investments rather than convince taxpayers that they deserve more cash. But these plans can easily backfire, leaving taxpayers (and, in this case, students) on the hook.