If we have learned anything from the financial crisis, it is this: Those buying or selling complex financial securities need to understand what they’re doing. As many learned the hard way, a lot of money could be lost when events don’t unfold as “assumed” (e.g., the assumption that housing prices will always rise).
Financial contracts such as subprime loans, option ARMs, CDOs, CMOs, credit default swaps, once thought to be “safe” are now recognized as risky. Many of those who bought them lost fortunes, including those who invested in institutions that bought them. And some of those institutions were local governments with Boards that didn’t bother to understand the risks before authorizing the investments.
At Wednesday’s SMART meeting in Santa Rosa, the board will consider issuing “up to” $200 million in complex, risky securities, known as VRDOs, otherwise known as multi-mode variable rate demand bonds. The public is being told that they are “safe.” Public Financial Management, SMART’s financial adviser, claims, “The recommended financing structure accomplishes SMART’s goals, offers strong security to investors and insulates SMART from any adverse impact on revenues.”
Hmmm. Are these bonds free? Has SMART discovered a financial free lunch?
These bonds are anything but free and they are so risky that the Fulbright and Jaworski, SMART’s “disclosure counsel,” is asking for additional fees.
Taxpayers of Marin and Sonoma County, wake up! You are about to be fleeced. Here’s why.
The bond issuance is unnecessary and it is certainly not free. It could cost SMART millions of dollars in interest payments.
In the very documents that most board members won’t read because they’re too long and filled with legal disclosure language, Public Financial Management states that proceeds raised by the bonds won’t be spent and that, instead, the proceeds will be escrowed until the repeal process is resolved. Fulbright and Jaworksi then disclose that resolution of the repeal process may not occur until December 2012, 13 months from now, after voters have a chance to vote on a repeal measure for local sales tax revenues.
And while the repeal process continues and voters await the outcome of a repeal measure, SMART will have to pay a much higher interest rate on the bonds than it earns on the invested proceeds. How much more? PFM doesn’t know, which means the board doesn’t know, which means the public doesn’t know. But it could be millions of dollars if the board issues $200 million next month and the RepealSMART organization turns in 15,000 valid signatures in January.
In other words, SMART is proposing to knowingly pay interest on potentially $200 million for up to 13 months, risking even higher interest costs over that time because they will be paying a variable rate.
And since they can’t use the funds during this period, why are they taking on this cost? Why are they willing to incur the risk of even higher interest rates some time in 2012? The documents don’t say. The public is in the dark as to why the board would propose such a costly and risky financial transaction.
Whether one is for or against the rail proposal, whether one is for or against efforts to repeal the sales tax, voters and taxpayers ought to be clear: The SMART board is proposing to gamble with our money by issuing a very complex security that it doesn’t understand. It doesn’t know what it will cost. It doesn’t even know what it could cost.