School districts across Pennsylvania, including Bethlehem Area, have paid millions of dollars in hidden, hefty fees by getting involved in bond deals that gamble on interest rates, according to a report by a financial news organization.
Bethlehem Area has paid $7.9 million on at least eight of the swaps, sophisticated financial transactions that Gov. Ed Rendell says might need more state oversight.
In 15 Pennsylvania school districts, officials entered into interest-rate swap deals worth $28 million since 2003. Of that amount, the schools took in $15 million and banks and advisers got the rest as fees, according to documents analyzed by Bloomberg News.
"The school districts are getting fleeced," Rendell told Bloomberg Markets, the news group's monthly magazine, which was published Friday.
Bethlehem Area's business manager, Stanley J. Majewski Jr., said the district has taken in nearly $6 million from the transactions. He said the story, which also appeared on Bloomberg's Web site, ignored how the district has used the swaps to drop its interest payments on long-term debt to under 4 percent.
Majewski said he is preparing documents and a statement he hopes will be ready for Monday's Finance Committee meeting. He wants to show the school board the district's records.
"It is saving the district many millions over the life of the financing," Majewski said. "I know at the end it will save my taxpayers money, and that should be what is important to them."
The Bloomberg investigation found that many of the districts lost the bet on which way interest rates would go.
The Pennsylvania transactions involve interest-rate swaps, called derivatives. Derivatives are financial contracts whose value is based on other securities or indexes; interest-rate swaps are tied to future changes in lending rates.
In a swap, two parties agree to exchange payments over a period that can last as long as 30 years. Typically, one agrees to pay a fixed rate and the other to pay a variable rate that changes with a benchmark index or formula defined in the contract.
Using state and local school district records, Bloomberg found that since 2006, at least 27 school districts gambled that the spread between two interest rate indexes would widen. The opposite happened. Spreads narrowed as long-term interest rates fell. The schools had to pay banks, or they could pay a steep exit fee -- the Erie School District paid $2.9 million to cancel its deal.
Aside from losing on the interest rate bet, school districts routinely lose by paying fees to banks that are as much as five times higher than typical rates, and overpay advisers by as much as 10-fold, according to Bloomberg News. That means banks often underpay schools on upfront amounts, public records show.
Derivative deals can bring banks fees three times higher than the traditional selling of municipal bonds, public records show. School districts don't know whether they're getting fair market values with swaps because the contracts are private; they don't know how to compare their deals with those done by other districts, according to Bloomberg News.
Christopher Cox, chairman of the U.S. Securities and Exchange Commission, said he's concerned that municipalities and school districts are taking on more risk than in the past, when they raised money primarily from bond sales.
"It's a serious issue, not only in Pennsylvania but across the country," Cox said. More often than not, the municipalities aren't configured to have financial sophisticates in charge of these offerings -- and the result is that the firms are the only ones who know what's going on."
Bloomberg News reporters Martin Z. Braun and William Selway and Morning Call reporter Steve Esack contributed to this story.
In Bethlehem district, some financing costly
Report finds $7.9 million paid on at least 8 interest rate swaps.
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