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CDR: April 2009

The Pension Scandals: Six Degrees Of How "Toxic Waste" Lands In Teachers' Retirement Funds

Moe Tkacik | April 29, 2009, 3:31PM

LATE UPDATE: An earlier version of this post misidentified New Mexico State Investment Council portfolio manager Kay Chippeaux as being Frank Foy's replacement; Foy had held various titles including chief investment officer at the state's Education Retirement Board.

In June 1997 Tom Flanigan, the chief investment officer of the California State Teachers Retirement System, wrote a letter to his old mentor, then-SEC chief Arthur Levitt. He was under political pressure, he said, to gamble with teachers' savings. The state comptroller was demanding he allocate a bigger portion of the fund to venture capital firms and hedge funds in what he thought to be an overheated market.

Meanwhile, hedge funds and private equity firms were hiring politically connected "placement agents" to descend upon his board of directors, who had final approval over his investment decisions. He had just watched the Texas investment firm Hicks, Muse, Tate and Furst secure a $100 million investment from the state employees' general retirement fund CalPERS after paying a $750,000 "finders fee" to a former board member and longtime Los Angeles politico named Alfred Villalobos. Villalobos had a questionable history with Hicks -- as a board member he'd already approved another $100 million investment in the firm on the advice of the fund's paid adviser Chris Bower. Nine months later, Bower sold his two-year-old yacht to Hicks founder Tom Hicks for a $45,000 profit. And there was other smoke around the deal, if no clear fire: Villalobo, for one had just filed for personal bankruptcy over gambling debts. And the board had initially rejected the deal -- when another LA politico on the board, a labor leader named Jerry Cremins, changed their minds. There was something "unseemly if not unethical" going on, Flanigan wrote. The SEC proposed rules regulating the placement agencies.

A few months later, Flanigan was sacked.

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Topics: Bill Richardson, CDR, Calpers, pension scandals

CDR

The New Mexico Corruption Probe: CDOs, Swaps And "Inappropriate Clothing"

Moe Tkacik | April 10, 2009, 12:27PM

The SEC has stepped into the corruption probe in New Mexico that saved Gov. Bill Richardson the hassle of amending years of tax returns. The new angle involves one of those enticing "toxic derivatives" deals we can't stop reading about, although there's a sexual harassment component, too.

Frank Foy used to manage the state teachers' pension fund, and in 2007 he says he got a call from a guy from a Chicago investment adviser -- and soon-to-be Richardson donor -- named Vanderbilt Capital Advisors. He told the Santa Fe Reporter he was too swamped to meet with him:

"This guy calls me up and says, 'I want to talk to you about a CDO.' I said, 'Call me back in a month. I don't have time to screw with it, dude,'" Foy recalls. "He didn't like that answer."

Soon after, Foy told the Reporter, he got a call from [Foy's Richardson-appointed boss Bruce] Malott. "He said, 'You were very rude to Pat Livney. I think he has a good investment and you ought to talk to him.'...I'd never been called by the chairman before. I thought, 'This stinks.'"

The investment was the lowest-rated slice of a collateralized debt obligation -- called the "equity tranche", presumably because like a stock its value can go all the way to zero. (Which it -- surprise! -- essentially did, after paying out about $4 million in interest payments to the fund, according to State Investment Officer Gary Bland.) Vanderbilt's CDO was the most toxic brand of the sort of "toxic" securities dragging down bank balance sheets right now; most banks, according to this handy primer on CDOs, didn't attempt to sell them to investors. But Livney, a former head trader of asset-backed securities at JP Morgan, nabbed a $90 million investment from the teachers' pension fund, despite what Foy claims were his strenuous objections. Malott, Foy says, told him the investment had been ordered by Bill Richardson's chief of staff. Shortly thereafter, a female employee accused Foy of sexually harassing her, and he was demoted.

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Topics: Bill Richardson, CDR, Rod Blagojevich

Morgan Keegan

"What The Hell Are Alabama Residents Doing Trading Swaptions?" Just Ask Tennessee...

Moe Tkacik | April 8, 2009, 12:24PM

A day after the credit rating agency Moody's issued an unprecedented blanket negative outlook report on the debt of all American cities and towns, a fascinating New York Times story today further illuminates the process by which so many small municipalities signed on to risky derivative securities contracts that exploded on them last year, in some cases quadrupling their interest payments.

The story focuses on Tennessee and the Memphis-based investment bank Morgan Keegan, which recently celebrated its rise to top underwriter status in the state and the south central U.S., managing a whopping 39% of Tennessee bond issuances last year.

Tennessee is one of few states with laws requiring public officials charged with approving derivatives deals to attend "swap school" to learn about the risks and complexities of the contracts. The state comptroller says he asked business professors to write the swap school textbooks, but when they declined the task was left to...Morgan Keegan, which had also been retained as an adviser to many of the state's towns.

In many corners of Tennessee, the first anyone heard of interest-rate swaps was from C. L. Overman, a vice president of Morgan Keegan who assured officials that the deals carried little risk, city and county officials said.

"He told us it would be a good thing and there wasn't much downside," said Mayor Duncan of Claiborne County.

Then a few months ago, according to the Times, Overman called to tell county officials they had a few weeks to refinance an $18 million bond or pay a quadrupled quarterly payment of $700,000. Perhaps unsurprisingly, Morgan's swap school curriculum understated such risks, and the Times has the textbook to prove it. The big risk factor they missed? It's a familiar one:

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Topics: CDR, Morgan Keegan, Municipal finance

CDR

Blago's Risky Bet On Derivatives

Moe Tkacik | April 6, 2009, 2:51PM

The Rod Blagojevich pay-to-play scandal may seem like an anachronistically simple big city machine politics scandal next to the ever-widening web of inscrutably interrelated financial scams comprising the on-going financial crisis. But in brokering deals with public coffers, at least, Blago liked "exotic" derivatives as much as the next hedge fund guy.

In January 2004, the Illinois pension obligation program was $36 billion in the hole, the most indebted state pension program in the country. So Blago decided to refinance, taking advantage of the era's superlow interest rates to float $10 billion in "exotic" new bonds in the country's biggest pension bond offering on record. Bond Buyer named it the Midwest Deal of the Year at the time -- not just for its "complex" pricing but its use of derivatives, which had just been legalized by the state legislature the year earlier. It was the start of a new trend, the trade publication noted:

Since Gov. Rod Blagojevich took office in January 2003 faced with a nearly $5 billion budget deficit, his finance team - which includes former financial advisory professional John Filan and quantitative analyst and investment banker David Abel - has turned to more sophisticated techniques to manage state finances. Supporters have called them creative, while critics have labeled them dangerous.

The deal alone netted investment banks $35 million in fees, including $8 million for the lead underwriter Bear Stearns, which in turn delivered a $809,000 consulting fee to a firm called Springfield Consultants run by lobbyist Robert Kjellander. The fee caused much furor in the Illinois statehouse when Bear Stearns disclosed it in an SEC filing, especially after initial probes launched by the state Inspector General revealed the firm could not produce any evidence that Kjellander, a prominent GOP lobbyist and friend of Karl Rove, had done anything to earn the fee.

The investigation swung into high gear when a hospital president named Pamela Davis got an unsettling phone call at her house from a Bear Stearns executive:

Back in 2003, Davis was trying to get approval for a new medical office building from the Illinois Health Facilities Planning Board. A night or two before a hearing was to be held, Davis recalled, something strange happened. A business acquaintance of hers, Nicholas Hurtgen, then a managing director of the Chicago office of Bear Stearns, called her at home and told her that unless she agreed to use a certain contractor she should pull her building request, because it wasn't going to be approved.

She ignored the warning and went off to the board hearing, where she was surprised to find that her request was denied. "I was humiliated," she said. "They were mean. So I walk off, and then a different guy comes up to me and he says, 'We told you to pull your project. Call me.' And right then I decided to call the F.B.I."

The FBI wouldn't confirm or deny Davis' story to the New Yorker, but she says she spent seven months secretly recording conversations with Hurtgen and his cronies, eventually filing a sealed federal whistleblower lawsuit alleging that Hurtgen, a former protege of former Wisconsin governor and Bush cabinet member Tommy Thompson, was part of a massive pay-to-play scheme that somehow linked the bond offering to the hospital.

The details are still unclear, but some of that $809,000 allegedly made its way back to Tony Rezko, who in turn split the bounty with three friends -- one of whom was Blago, according to last week's indictment, which refers to Kjellander as a "lobbyist" according to the Chicago Tribune: