My dear friends, today’s BEE contained another story about the fools at city hall. Please stay with me, and you will see why I use such a strong term.
Let me explain in a simple, short statement, what we are talking about. Modesto’s finance director, Wayne Padilla, two city managers, Britton and Nyhoff, and most of the sitting council have been duped by the wizard from New York, into the dumbest way to borrow money you can imagine. (Selling a bond is borrowing money.)
Let’s say you go to your banker and say that you want to borrow $1,000,000. You are willing to put up your monthly income as collateral. (The city put up its revenue.) Your banker says, you betcha, and have I got an interest rate deal for you. You say, explain. He says that every week, he is going to re-negotiate your interest rate on the open market. When rates go up, you can pay a little less than market, but when rates go down, you pay a little more than market. (Of course, he makes a profit for each transaction.) If rates get too high for you, you can buy your way out, and refinance the loan. If rates get too low, you will have to put $250,000 (25% of the original loan) into escrow.
(You may read about these “ticking time bombs” in the attached article.)
Please think about this. The banker makes more money if interest rates go up, maybe a little less than he would on a fixed rate loan, but he gets paid. If interest rates go down, he gets paid, too, a little more than market, so he is happy. If rates skyrocket and I want out, all I have to do is pay him $125,000 in a lump sum, and then I can refinance. He is happy as a fly on peanut butter as interest rates go up.
But, if interest rates fall so low that it no longer makes the banker happy, he makes you to stuff 25 % of the loan value into escrow to protect HIM from loss.
What risk does the banker have? The only time he has a risk of earning less than he would if he had made me a fixed rate loan, is if interest rates stay lower than the cyclical market rate fluctuation. But, HE MAKES THE RULES! He will not start you out at such a low rate that he never makes up the difference. The risk you face is that if you make the deal for such a long time as to experience the normal market fluctuations, you will end up paying far more in the aggregate than you would have in a fixed rate loan. Worse, if rates get too high, your get-out costs are horrible, and if rates go so low as to displease the banker, you must liquidate some of your assets to stop the bleeding.
The BEE story quotes the city’s banker, Peter Miller, as saying “...the swap agreement doesn’t put the city at risk.” This is where the “fool” comment comes in. You can only guess at who the fools are. Just read the story headline, which says, “Modesto cuts deal to reduce water bond risk.” OF COURSE THE CITY FACES A HUGE RISK, it is just that the city officials are not the ones to feel the pain! YOU MUST PAY THE PENALTIES IF THE DEAL GOES BAD!
YOU ARE THE CITY, not the council or city manager or his staff. The city made this deal for 25 YEARS!! We have actually had two catastrophic failures of this deal in 5 years.
The actual facts speak for themselves. The original 2005 swap failed because the interest rate the city had to pay rose to 12%; the city was forced to renegotiate the loan 2007. That cost you about $5 Million dollars. Now, you face the prospect of have to collateralize a $77 Million dollar loan to the extent of $18 Million. That represents 23% of the original loan. Who is Miller kidding? The city has no risk? And, where is your mayor, council, esp. K. Olsen who oozed happiness over the wonderful swap deal? Where is the city manager who promised me and the STA leadership that he would not enter into another swap?
Let’s go back to our esteemed city manager’s comments regarding this situation. When asked if the $100,000,000 in the current water fund reflected improperly high water rates, he said words to the effect that, no, we need all that money for specific project that are needed now. Then, when asked that if we transfer $18 Million out of the water fund, won’t he have to raise water rates, he said, no, we really do not need that money now. These are beautiful examples of bureaucratic speak, eh? Right out of “1984”.
This is a tad long, but the rest of the story is somewhat complicated. Suffice it to say, your Stanislaus
Taxpayers Association discussed this swap nonsense with the council and city managers. We warned them. They did it anyhow. They proved just how smart they really are.
As ever, Dave
