For space reasons we had to leave a few interesting bits out of my latest magazine piece, "The Scam Wall Street Learned From the Mafia," about widespread corruption in the municipal bond markets. The odd thing is, we might actually have undersold the damage done by this sort of cartel-style corruption.
When we called around to towns and cities affected by the rigged auctions discussed in the trial, many of the local officials were quiet, mainly because there’s still pending civil litigation in many of those cases. But a few of them pointed out a little-discussed flip side to the damage caused by Carollo-esque bid-rigging.
Bid-rigging skims from towns after they’ve already borrowed money through bond issues. But some communities insist they’re being skimmed before they borrow as well. The central complaint is that the credit ratings of municipalities are excessively low, compared with counterparts in the corporate market who have the same risk of default. If true, this would artificially hike borrowing costs for cities and towns.
"Municipals virtually never, never default," says Rebecca Kaplan, a city councilwoman in Oakland, one of the cities listed as a victim in the Carollo trial (the defendants rigged an auction for a Port of Oakland bond deal). "And yet munis receive ratings that, if you were comparing them to corporate ratings, you would think you were talking about a significant risk of default."
The statistics bear this out. If you look at this report prepared by the House of Representatives four years ago – look at page 5 in particular, in the table for "Cumulative Historical Default Rates" – you’ll see that munis consistently receive significantly lower ratings than comparable corporate bonds.
The ostensible reason for this is that ratings agencies like Moody’s use different methodologies for rating munis versus corporate bonds. Muni ratings are based upon the financial strength of the issuer, while corporate bond ratings are based upon risk of default. And who knows, maybe that makes sense. But the end result is that towns, when they borrow money, get clipped coming and going: they pay more to borrow the money in the first place, and then – thanks to rigged auctions for bond service – they earn less on the money they borrow.
A few other notes on the piece. The muni bid-rigging investigation described in the article, as large as it is in scope, is likely just the appetizer for an even broader and more serious investigation into another cartel-style corruption scheme, the manipulation of LIBOR, the interbank exchange rate often used to determine variable interest rates for things like mortgages.
Regulators in at least four different countries – the U.S., Canada, Japan, and the U.K. – are conducting a probe into the manipulation of LIBOR. At least one bank, UBS, is cooperating with authorities, and Wall Street has been abuzz with rumors in recent months that another major cooperating witness has come forward. That, coupled with news this winter and spring of dismissals of rate traders at several major banks in connection with these probes, suggests that these investigations are gaining momentum.
Many of the bigger banks have been targets. J.P. Morgan Chase, for instance, has been targeted by the Canadian probe (not that you would have heard about that in the recent congressional hearings with Jamie Dimon), along with Deutsche and HSBC. Barclays, the Royal Bank of Scotland, Citigroup, and a host of others are also being investigated.
There have been a number of major civil lawsuits filed over the LIBOR issue, and as in the muni bid-rigging scandal, the list of defendants in these civil cases (see here for example) reads like a Who’s Who of the top banks in every major western country: Bank of America, Citigroup, Chase, Bank of Tokyo-Mitsubishi, Barclays, Lloyds, Rabobank, Credit Suisse, and Royal Bank of Canada, among others.
If the allegations of LIBOR manipulation turn out to be true, it would present governments with the mother of all regulatory dilemmas: when virtually all the top banks in all places have been fixing something as elemental as interest rates, what do you do? Issue more fines?
In any case, anyone who wants an even more in-depth look into the bid-rigging business should check out some of the primary materials in the various cases. The second consolidated class action complaint in the major civil suit on the bid-rigging case, led by Hausfeld LLP (whom some readers may recognize as the firm that is leading the brain damage suit filed by over 100 retired NFL players), is a good place to get an overview of the problem, and to see a list of defendants.
There are also a number of government settlements with private companies worth checking out. There’s the $160 million settlement with UBS, the $137 million deal with Bank of America, the $148 million settlement with Wachovia/Wells Fargo, the $228 million settlement with Chase (again, not mentioned in the recent Dimon hearings), plus lesser settlements with GE Funding Capital Markets Services and CDR, the two firms discussed in the article.
To me the most disturbing thing that came out in the Carollo trial was how easy it is for financial companies to rip off cities and towns once they start cooperating. Municipalities really have no defense against this sort of behavior; it’s not like they can arrange the bond issues themselves. So it surprises me that there hasn’t been more of an uproar from local officials over this behavior. One can hope the only reason for that is that they don’t know about it.