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NEWS RELEASE
For Immediate Release
Contact: Steve Halvonik 717 787-1381

Auditor General Wagner Says Schools, Local Governments Profiting From Swaps are Still Gambling with Taxpayer Money

Recommends they unwind risky investments before they sour

HARRISBURG (Nov. 25, 2009) – Auditor General Jack Wagner said today that Pennsylvania school districts and local governments that claim they are profiting from interest-rate swaps should still divest themselves of these risky investments, because sudden movements in interest rates and other factors could result in millions of dollars of financial losses.

“This is gambling with taxpayer money,” Wagner said. “As anyone who has visited a casino knows, it's possible to win a game or two, but, in the end, it’s hard to beat the house.”

A swap is a financial contract between two parties betting on which way interest rates will move. The party that guesses correctly gets paid and the party that guesses incorrectly must pay the other party. The amount of cash being swapped is determined by the size of the debt being financed by bonds with variable interest rates. The higher the debt, the costlier the bet.

“Most homeowners have fixed-rate mortgages because they understand that variable-rate mortgages are riskier and that their monthly payments would be more likely to rise over time,” Wagner said. “The same holds true for public debt financed with swaps. It’s time for school districts and local governments to convert their swaps debt to fixed-rate bonds.”

Wagner's recent investigation found that 107 of 500 public school districts and 86 local governments had entered into swaps contracts with at least 13 investment banks doing business in Pennsylvania. His investigators found that the Bethlehem Area School District lost at least $10.2 million in interest-rate swaps when the banking industry collapsed in the fall of 2008. Investigators found that the Bethlehem Area School District had entered into the most swaps during a three-year period (13), and that the Philadelphia School District had the most debt tied to swaps, in excess of $1 billion.

Some schools and municipalities have said that they are profiting from interest-rate swaps. Wagner noted that Bethlehem Area School District initially profited from swaps – until the economy soured. In an appearance Tuesday night on the PCN cable channel, Wagner noted that the Delaware River Port Authority, which operates toll bridges connecting Philadelphia with New Jersey, initially made $45 million from swaps agreements signed in 2000 and 2001; now, the DRPA is saddled with $242 million in liabilities as a result of those same contracts.

“The majority of entities handling swaps in the public arena don't understand them, which is putting public money at risk,” Wagner said.

Wagner’s five recommendations for eliminating public funds from the risks of swaps are:

  • The General Assembly should immediately repeal Act 23 of 2003, which permitted school districts and local governments to use interest-rate swaps.
  • The General Assembly should immediately amend state law to expressly prohibit local government units and municipal authorities from using swaps.
  • Regardless of whether the General Assembly takes action, no local government unit or municipal authority should enter into or utilize swaps from this day forward.
  • Any local government or municipal authority that is an active party to a swap should immediately terminate it and refinance with conventional debt instruments, if necessary.
  • Local government units and municipal authorities should hire their financial advisors through a competitive selection process and periodically evaluate the quality, cost, and independence of the services provided.

“Our recommendation is simple and strong. Because gambling with public money should not be permitted, the use of swaps and other derivatives by local governments should be prohibited by law,” Wagner said. “As Pennsylvania’s fiscal watchdog, I will do all that I can to ensure that taxpayer dollars are protected from risky swap contracts.”

A copy of Wagner's investigation report, which lists the school districts and local governments using swaps, is available to the public at www.auditorgen.state.pa.us.

Auditor General Jack Wagner is responsible for ensuring that all state money is spent legally and properly. He is the Commonwealth’s elected independent fiscal watchdog, conducting financial audits, performance audits and special investigations. The Department of the Auditor General conducts more than 5,000 audits per year. To learn more about the Department of the Auditor General, taxpayers are encouraged to visit the department’s Web site at www.auditorgen.state.pa.us

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