by Alex Taliadoros
The Chicago Tribune followed-up its investigation of the Chicago Public Schools’ toxic finance deals with three new articles that point to how we can start to reverse the trend of financial abuse that our communities have suffered from Wall Street. The way forward begins with cities and states promptly taking legal action to recover funds lost due to misleading or deceptive behavior from banks. In addition, the federal government needs to properly oversee the municipal finance market if it hopes to prevent other local entities from falling victim to unfair lending practices in the future.
Chicago officials have thus far rejected calls to win back the money lost in predatory deals. Despite Mayor Emanuel’s insistence that his hands are tied by these costly financial deals, the Tribune found ample evidence of municipalities successfully recouping millions of taxpayer dollars after challenging the same type of problematic auction-rate debt. The article highlights cities as small as Pittsburg, California (population 63,264) that have won substantial amounts to cover their losses from auction-rate securities. Most settlements between public entities and financial institutions remain secret, but the paper cites a conservative estimate of more than $25 million in payouts to municipal issuers. Cities have recovered taxpayer money both by filing claims with the Financial Industry Regulation Authority (FINRA) and by bringing banks to court. They were successful because they were willing to take action against the fraudulent lending practices that have impoverished their schools and hospitals.
The Tribune also examines how the Securities and Exchange Commission (SEC) has failed to protect local governments after banks duped them into issuing auction-rate debt. The SEC is tasked with enforcing laws to protect municipal borrowers from Wall Street. Its own investigation revealed that banks made the auction-rate securities market appear more stable than it actually was so that they could sell more of these deals. When the market collapsed, it cost borrowers millions of dollars. Although the SEC secured a $6.7 billion settlement in connection with this scandal, local governments only got a fraction of that amount. The city of Chicago, which lost nearly $100 million when the auction-rate securities market collapsed, did not receive a cent. In response to a Tribune request for instances where the SEC took action against banks for dealing unfairly with municipal borrowers, an agency spokesperson was only able to find one case involving a single bank official in Florida that took place more than two decades ago. The SEC’s reluctance to punish bad actors has encouraged banks to bend the rules and exploit cash-strapped municipalities for profit.
The paper also shed light on a planned certification exam for municipal advisers that many experts believe is inadequate. The test was instituted by the 2010 Dodd-Frank Wall Street Reform Act after many local governments received bad advice from unqualified practitioners that led them to make disastrous financial decisions that will burden them for decades to come. Chicago Public Schools was no exception; its costly debt deals were endorsed by a well-connected consultant whose analysis did not account for their riskiest component. Nevertheless, many industry specialists quoted in the piece believe that the curriculum being developed won’t test someone’s ability to evaluate complex instruments such as interest rate swaps or auction-rate securities. Thus, the exam would do little to safeguard taxpayers from the kind of predatory deals that spurred Congress to set new standards in the first place.
There are clear lessons to be drawn from the recent Tribune pieces. Chicago should emulate smaller cities that have confronted Wall Street’s predatory behavior and successfully recovered taxpayer money. In a compelling report detailing how banks raid our public coffers, Saqib Bhatti from the ReFund America Project lays out several steps municipalities can take to hold banks accountable for their conduct and reduce the millions of dollars they pay to Wall Street each year. Yet it is not enough for our localities to stand up for themselves. The SEC also needs to fulfill its dynamic regulatory mission of preventing fraud and abuse in the municipal market and punishing the perpetrators when it does occur. Otherwise, more cities and states could find themselves in financial peril.