A Giant Shell Game Snares Taxpayers

“Have I got a deal for you!” For many municipalities throughout the United States--not just Orange County--they are the words of Wall Street.

The Orange County investment pool disaster is but one in a long history for municipal bonds. The municipal bond industry has been plagued by scandal after scandal. Pay-for-play. Arbitrage bonds. The New York City debt moratorium. Why? Because the industry itself has a simple goal: legalized theft. How can local governments legally steal money from the federal taxpayer? Tax exemption is a subsidy paid for by all of us, and every local government has an incentive to take as much as it can get away with.

Wall Street got caught up in the game of it all: If the local governments can steal money, then why can’t we? In the wake of last week’s Internal Revenue Service ruling, the news media have estimated that major Wall Street firms helped themselves to more than $1 billion from the federal taxpayer during the past few years by charging artificially high prices for securities sold to local governments. The extra markups produced big bucks for the bond firms and often a little extra change for the local officials who approved the deals.

“Bond”--the dictionary tells us it is a relationship based on trust. On Wall Street that means only one thing--they’ll get paid. Funny the things people do for money. Going along with the program. Being part of the team. Lying. Cheating. Condoning theft.

In the high-money world of Wall Street, being part of the team means being well paid, having a posh lifestyle. A $100 tab for dinner is no longer special. Flying first-class is expected. So is a summer house, a fancy car, $1,000 suits. The more the bosses can encourage you to spend, the more money you “need” to earn. And then they’ve got you.

Then look at the setup. Most of an investment bankers’ compensation is determined by a single person once a year. Sure, you deserve 15% of the $4 million in revenues you brought in this year, but the boss may think 5% is more like it. Or 25%--a cool $1 million--if he likes you or you were “integral” to the team.

Once a banker is hooked on the lifestyle, the bosses’ requests begin. Can’t we get a weekend place for this client to use--just put it on your credit card (leaving the boss with deniability).

Speak up? Assert there is an ethical concern? Tell the client that we are making an extra $1 million on the deal? Watch your bonus and your paycheck disappear. (Fifteen percent of revenues? Try 1%.)

And the compromises go on and on: Everyone does it. Why are you objecting? Even the lawyers agree. At $300-plus an hour, did you think they would object? If things blow up, that just means more work and more hours to bill.

The bankers are told to pitch whatever they can that will earn their firm a transaction, a deal. They don’t expect to be working for the same firm five or 10 years later when the problems hit. Their clients don’t expect to be working for the same government agency. A little graft sure helps get a deal. A little complexity justifies a larger fee. And who can understand those tax laws anyway?

Then the guilt begins. You go to work each day dreading the next outrageous request. Speak up and you are not being a team player. You try to talk to your friends. But they work there too and object to your questioning things. It’s their paychecks too.

The pressure grows. Finally you make the phone call. Anonymously at first. But anonymous information doesn’t help the authorities. In a burst, you tell all.

Revelations by me and others may cause the wrongdoers to pause, but it takes official action to get them to stop. Last year, the Metropolitan Transportation Authority accused Lazard Freres and Goldman Sachs of overcharging for government securities sold to the authority; of, in effect, padding prices on investments they sold to local and state governments. No one had bothered to check what a fair price was, even though that price could be found in the daily newspaper.

The $1.2-trillion municipal finance industry has been overlooked for far too long. Orange County occurred because no one cared to question a story that was too good to be true. It was too easy to see the money to be made. And after all, everyone else was going along.

The problem is not political contributions. When the subsidy is big--and borrowing at tax-exempt rates is a big subsidy--greed takes over. All the players--lawyers, bankers, public officials--have an incentive to cheat.

The bad apples have taken over the barrel. This industry needs major reform, not tinkering. A congressional hearing into Orange County is not the answer; we need new laws on public finance. Unlike the IRS approach, it’s not the issuers who need to be gone after, but the bankers.