There was a time when the Harrisburg, Pa., incinerator was a successful waste-to-energy plant. Then, with the stock market rising and every American looking like a sharp investor, politicians hooked up with Wall Street in a series of exotic financial deals designed to finance plant upgrades.
After a decade, they’ve incinerated not just trash—but cash.
Through finance and refinance, the Harrisburg Authority and city officials multiplied the facility’s $80 million debt more than four times into an astonishing $340 million. Despite the rising debt, the improvements failed and the facility earned nowhere near what experts forecasted, leaving no way to pay down the massive debt, save pending sale of the facility. The only winners appear to be the Wall Street dealmakers who collected some $40 million in commissions and fees over a decade of transactions.
Now state lawmakers are scrambling to produce legislation to keep other Pennsylvania municipalities from sinking hundreds of millions of dollars into debt.
Ban on Swaps
State Sen. Mike Folmer (R-Lebanon) has introduced a proposal to ban the kinds of financial swaps that contributed to the Harrisburg fiasco.
“There’s so much market dislocation and so much volatility that, in today’s market, I can’t imagine a Pennsylvania municipality that I would recommend get into one,” said third-party auditor Steven Goldfield.
Swaps allow borrowers to bet against future changes in interest rates on existing bond issues. For example, borrowers can agree to a fixed-interest rate instead of a variable one, or vice versa, in an attempt to earn a more favorable rate.
Entering a swap agreement with a lender can provide up-front cash in exchange for making the deal. But quitting the deal early for any reason can cost borrowers millions.
Swaps are complex. They are controversial. And they’re relatively new to Pennsylvania’s local government borrowing rules, allowed by law since 2003 as a way to manage interest rate costs.
But after Harrisburg, Folmer and others have said swaps are a risk not worth taking with public dollars.
“They’re very risky, and all you have to do is have one mistake,” Folmer said. “If a private company wants to do this, that’s fine. They’re risking their own money. But when you’re dealing with taxpayer money, it’s other people’s money. It should not happen.”
Tales of swaps gone wrong are not hard to find in Pennsylvania, as they’ve been called out by government watchdogs and policy analysts.
Auditor General Jack Wagner found in 2009 that 107 school districts and 86 local governments had $14.9 billion in debt tied to swaps. In the city and school district of Philadelphia alone, taxpayers are facing $331 million in debt because of swap deals, according to a Pennsylvania Budget and Policy Center report from 2012.
Elsewhere, officials used swaps in financing deals that led to two of the largest U.S. municipal bankruptcies ever—in Jefferson County, Alabama and Orange County, California.
Officials in Harrisburg entered into multiple swap agreements on incinerator bonds since 2003. A third-party project audit showed three of these swaps involved payments by the Harrisburg Authority to the Royal Bank of Canada well above market prices.
Add this type of financing to the fact that the incinerator never made nearly as much money as it was supposed to.
It’s not that managing interest rates is a bad decision, for private or public monies. But some believe the complexity of swaps may be more than a local government can handle.
State Sen. Rob Teplitz, D-Dauphin, was elected in November to represent the Harrisburg area. He previously worked in the Auditor General’s office studying swap deals throughout the commonwealth, Teplitz said.
‘Not Sophisticated Enough’
He supports banning them for all local governments and school districts.
“What you have, particularly at the local level, are very well-meaning, very dedicated public servants who are not sophisticated enough in these financial instruments in order to make the appropriate decisions,” Teplitz said. “Compounding that problem is that they have to rely on financial advisers who will only get paid if the swap deal goes through.”
Goldfield notes larger cities with a team of independent, intelligent advisers may be able to effectively use swaps to help keep payments under control.
State Treasurer Rob McCord said Monday he was not familiar with the details of a proposed ban or of Harrisburg’s particular swap deals.
McCord, a Democrat who worked in finance before he ran for public office, cautioned against overregulating financial management or villianizing the idea. Swaps can manage interest rate risk over time, which can be valuable for long-term debt, he said.
“If these are well-used, they actually reduce risk in the long-run,” McCord said of swaps.
But officials can get into trouble when they don’t fully understand the financing that’s going on. Sometimes, that’s a case of “sophisticated sales people,” working on commission, who put the deals together, he said.
Worth the Risk?
Despite proven value in certain arenas, the question just becomes whether or not swaps are a risk worth taking in the public sector.
David Unkovic, the former state-appointed receiver for the city of Harrisburg, also testified about swaps during Senate hearings last October. He said local governments, as well as municipal authorities, should be banned from entering new swaps altogether.
The nine years of legal swaps in Pennsylvania have been a failed experiment, he said.
“If you continue to allow the use of swaps, even with additional protections, I believe it is inevitable that there will be more multimillion [dollar] fiascos that result for local government and authorities,” Unkovic said in his testimony.
Melissa Daniels ([email protected]) reports for PA Independent. Used with permission of PAIndependent.com.