Tuesday, March 20, 2012

Abuse of Municipal Finance in Wisconsin

By Tim Husson, PhD and Tim Dulaney, PhD

The Wall Street Journal is reporting that Stifel Financial has settled with five Wisconsin school districts on charges that they misled these municipal investors with their sale of several complex CDOs.  This is just another example of the situation outlined in a previous post wherein a municipality or institutional investor was taken advantage of through the sale of inappropriate investments.  The settlement involves $22.5 million in cash, plus $154 million in debt forgiveness.  SLCG has been involved with this litigation from the beginning, including valuing the CDOs at issue.

The SEC has also filed complaints regarding these same CDOs against RBC, who structured the deals, and Stifel, who allegedly sold them knowing they were unsuitable for the school districts.

As outlined by the article (and by an older post from Zero Hedge), the representations made to the school districts showed a gross misunderstanding of the risks embedded in these products.  Unfortunately, it is common for unknowing or unscrupulous brokers to target municipalities and rural institutional investors for the sale of highly complex and highly risky investments such as swaps and CDOs.  The complex structure of these deals makes them hard for unsophisticated investors to adequately value and therefore easy for financial intermediaries to structure the deals in their own favor.

The combination of relatively unsophisticated investors -- often school administrators and other local officials -- and large investment portfolios (often backed by future tax revenue), can lead to unbalanced deals which saddle the community with debt for decades.  Clearly more oversight and impartial advice is required in the municipal finance arena, but we are happy that the SEC and other regulatory bodies are fighting the good fight.

Kudos to the WSJ for drawing attention to this grossly underreported issue.

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