<p>Interesting reportage. The Scam Wall Street Learned From the Mafia</p>
<p>Read more: [The</a> Scam Wall Street Learned From the Mafia | Politics News | Rolling Stone](<a href=“The Scam Wall Street Learned From the Mafia”>The Scam Wall Street Learned From the Mafia)</p>
<p>Comments?</p>
<p>I am actually pretty confused reading the article. With very, very limited exceptions, issuers of tax-exempt municipal bonds aren’t supposed to make any profit at all on reinvesting the proceeds of the bond issues while they wait to spend them. There was a time, starting in the 1960s and continuing to some extent into the 1980s, when some issuers (including Guam, I think I remember) were issuing hundreds of millions of dollars of tax-exempt bonds, reinvesting the proceeds in taxable investments, and then never actually doing anything (or doing it only very, very slowly) with the money borrowed except pocketing the (not inconsiderable, especially back then) spread between taxable and tax-exempt rates. Starting with the big tax exemption reform legislation in 1969, and continuing through the Reagan Tax Reform Act of 1986, Congress progressively ratcheted up the rules intended to stop that from happening. </p>
<p>Since 1986, the centerpiece of the rule is that municipal issuers essentially have to pay a 100% tax on any net arbitrage spread they earn by investing the proceeds of tax-exempt bonds, except for small amounts held for a very short time. So municipal issuers essentially have no interest at all in getting the highest rate possible for their temporary bond-fund investments, as long as they are at least covering the interest on the bond issue, since they can’t keep anything above the bond interest.</p>
<p>So the IRS and Congress essentially created a system that was prone to price-fixing and kickbacks. Banks could make excess profits by investing these funds, so of course they were willing to route other benefits to municipal issuers (or their decisionmakers) for the opportunity to do so. And municipal decisionmakers have no incentive for reducing the excess profits, because the cities don’t get to keep any additional interest they earn, and if there are no excess profits then there won’t be any kickbacks to the cities or to them personally.</p>
<p>At one point, the U.S. Treasury was in on the deal (and it may still be), offering to let municipal issuers invest pools of bond funds in special Treasury bonds that would pay exactly the right amount of interest (but no more). Now THAT’s price-fixing! “We’ll pay you x on your investment, and if you get x + y from someone else that’s fine, but you have to pay us y.”</p>
<p>I think the phone conversations show that price fixing, and bribes were occuring. </p>
<p>Actually, I don’t think, I know. </p>
<p>Was the money that was invested after the munis were issued at rates higher than what the municipals were paying?</p>
<p>Are we talking about profits? Or smaller losses?</p>
<p>Wasn’t it Al Capone who said of Wall Street “It’s a racket. Those stock market guys are crooked.” What’s changed?</p>
<p>It should have been profits here, not smaller losses. At least until recently when short-term rates have been close to 0%, generally the rates on investment grade tax-exempt bonds were significantly below top-grade taxable rates, so that even with a maturity difference there should have been some spread. That’s why the rules were necessary in the first place. Maybe I’m wrong about that, but it’s hard to believe cities were issuing bonds at a time when they were going to lose money by issuing them.</p>
<p>It’s true that muni bond rates used to be much lower than taxable rates. </p>
<p>And the article is a little confusing.</p>
<p>The bottom line is Wall Street engaged in bid rigging.
And the taxpayer was the loser. With the banks, the taxpayers are losers, plenty.</p>
<p>As far as borrowing money and then receiving less for the money, when it is invested in the short term, if that happens, that just increases the cost of capital to the municipal. Those costs should be in the total finances of the project. And the costs are higher if the money invested
from the muni offering has a lower return.</p>
<p>I don’t think there is a dispute that the taxpayers were ripped off.</p>
<p>This is a little more clear and a little less angry.</p>
<p><a href=“JPMorgan Chase settles bid-rigging charges for $228 million”>JPMorgan Chase settles bid-rigging charges for $228 million;
<p><a href=“Ex-JPMorgan banker admits role in municipal bid-rigging scheme”>Ex-JPMorgan banker admits role in municipal bid-rigging scheme;
<p>[Ex-GE</a> Bankers Convicted of Municipal Bond Bid-Rig Scheme - Bloomberg](<a href=“Bloomberg - Are you a robot?”>Bloomberg - Are you a robot?)</p>
<p>The Libor fiasco, I like Jon Stewart’s July 18th show on this. First 5 minutes or so of the show. Can be watched on OnDemand.</p>
<p>Similar bs. I think some of the bankers involved are going to be sorry they communicated by email. :)</p>
<p>Great articles Dstark, thanks. JHS that is very intersting; I don’t know what to make of this news given what you say. It is confusing. What was the big tax exemption reform legislation of 1969?</p>
<p>Hugcheck and Dstark, thanks for the articles - very interesting. And JHS, that info really puts a different spin on it. Clearly these guys were breaking the law by fixing prices and getting kickbacks, but if excess positive arbitrage is subject to a 100% federal tax, then their crime was not stealing income from municipalities, they were stealing potential tax revenue from the federal government. The Rollingstone article in particular stated (and quantified) an artificially low interest rate deprived the city of earnings. </p>
<p>I think a responsible reporter should have included that in his story. The activity is illegal either way, but it may not have deprived the issuers of any money directly.</p>
<p>JHS is speculating.</p>
<p>I think many of these settlements state explicitly that
municipals were affected by the banks bid rigging.</p>
<p>"In Illinois, 23 entities will share more than $2.2 million, said state Attorney General Lisa Madigan. They include the cities of Chicago, Evanston and Elmhurst; Midway and O’Hare International airports; the Chicago Transit Authority; and Northwestern Memorial Hospital.</p>
<p>“JPMorgan Chase concocted a scheme to enrich themselves by cheating hospitals and schools out of much needed resources,” Madigan said in a statement. “Today’s settlement will restore funding to agencies throughout Illinois for use as they originally intended — to improve services in their communities.”</p>
<p>Municipalities and other tax-exempt issuers typically invest proceeds
from bond sales in a variety of investment vehicles offered by financial institutions because the money usually is not spent right away. These investments are collectively known as municipal bond derivatives.</p>
<p>That was JPM…</p>
<p>This is Wachovia. </p>
<p>"Wachovia agreed to settle the charges by paying $46 million to the SEC that will be returned to affected municipalities or conduit borrowers. Wachovia also entered into agreements with the Justice Department, Office of the Comptroller of the Currency, Internal Revenue Service, and 26 state attorneys general that include the payment of an additional $102 million. The settlements arise out of long-standing parallel investigations into widespread corruption in the municipal securities reinvestment industry in which 18 individuals have been criminally charged by the Justice Department’s Antitrust Division.</p>
<p>“Wachovia won bids by playing an elaborate game of ‘you scratch my back and I’ll scratch yours,’ rather than engaging in legitimate competition to win municipalities’ business.” said Robert Khuzami, Director of the SEC’s Division of Enforcement.</p>
<p>Elaine C. Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit, added, “Wachovia hid its fraudulent practices from municipalities by affirmatively assuring them that they had not engaged in any manipulative conduct. This settlement will result in significant payments to municipalities harmed by Wachovia’s unlawful actions.”</p>
<p>Wachovia Bank is now Wells Fargo Bank following a merger in March 2010.</p>
<p>When municipal securities are sold to investors, portions of the proceeds often are not spent immediately by municipalities but rather temporarily invested in municipal reinvestment products until the money is used for the intended purposes. These products are typically financial instruments tailored to meet municipalities’ specific collateral and spend-down needs, such as guaranteed investment contracts (GICs), repurchase agreements (repos), and forward purchase agreements (FPAs). The proceeds of tax-exempt municipal securities generally must be invested at fair market value, and the most common way of establishing that is through a competitive bidding process in which bidding agents search for the appropriate investment vehicle for a municipality.</p>
<p>According to the SEC’s complaint filed in U.S. District Court for the District of New Jersey, Wachovia engaged in fraudulent bidding of GICs, repos, and FPAs from at least 1997 to 2005. Wachovia’s fraudulent practices and misrepresentations not only undermined the competitive bidding process, but negatively affected the prices that municipalities paid for reinvestment products. Wachovia deprived certain municipalities from a conclusive presumption that the reinvestment instruments had been purchased at fair market value, and jeopardized the tax-exempt status of billions of dollars in municipal securities because the supposed competitive bidding process that establishes the fair market value of the investment was corrupted."</p>
<p><a href=“http://www.sec.gov/news/press/2011/2011-257.htm[/url]”>http://www.sec.gov/news/press/2011/2011-257.htm</a></p>
<p>Actually, it is all becoming a little bit more clear to me now. It is exactly those IRS rules that provided the incentive for this fraud. The municipalities didn’t care because it didn’t make any difference to them. <- This may not have been true in every case, but where it didn’t made a difference to them financially, I can see how there was an incentive to commit fraud and share the difference with Wall Street, or let Wall Street have most of the profit.</p>
<p>Finally found a clue in this article:</p>
<p>
</p>
<p>[Bond</a> Buyer Online - IRS Tackles Mispricing In Market](<a href=“http://www.bondbuyer.com/issues/121_10/irs-mispricings-muni-bond-market-1035268-1.html]Bond”>http://www.bondbuyer.com/issues/121_10/irs-mispricings-muni-bond-market-1035268-1.html)</p>
<p>That’s a great link, njres.</p>
<p>Looks like JHS was correct in many cases, maybe most.
That was a good catch by JHS.
Post number 2 was an excellent post.</p>
<p>Having said this, it is obvious that local governments were screwed too.
"“Wachovia agreed to settle the charges by paying $46 million to the SEC that will be returned to affected municipalities or conduit borrowers. Wachovia also entered into agreements with the Justice Department, Office of the Comptroller of the Currency, Internal Revenue Service, and 26 state attorneys general that include the payment of an additional $102 million. The settlements arise out of long-standing parallel investigations into widespread corruption in the municipal securities reinvestment industry in which 18 individuals have been criminally charged by the Justice Department’s Antitrust Division.”</p>
<p>I guess JHS was not speculating. :)</p>