PA auditor to Philly schools: How'd you lose so much?

Pennsylvania Auditor General Jack Wagner says Philadelphia School District finance director Michael Masch has ignored his requests for "detailed information regarding its use of swaps, including all costs, commissions, and other fees incurred from active and terminated swaps."

Wagner, who's running for governor, has been questioning towns' use of interest-rate swaps and other derivative securities sold by JPMorgan Chase & Co., Goldman Sachs, and other Wall Street firms to schools and school districts across the state under a law approved by Gov. Ed Rendell in his first term.

The swaps obliged clients like Philadelphia to trade interest-rate obligations with other investors - for example, fixed-rate interest payments from my bonds, for variable-rate interest off your bonds. The swaps purchased by Philadelphia schools and many other PA towns were supposed to protect them from higher borrowing costs, in case U.S. interest rates rose. But they have lately ended up costing towns millions, as interest rates hang near record lows.

This time, Wagner demanded the information by April 30, he told Masch, or "I will assume that the district is refusing to provide the requested information and we will proceed accordingly."

No immediate response from School District officials. As I wrote last December (here and here), Masch said the district's $1 billion-plus in swaps contracts "have worked as advertised, earning the schools a net '$12 million since 2004,'" and that the district believes swaps also made its debt "cost lots less than fixed-bond rates would have cost."

"Masch based his savings claim on the net $17 million in up-front cash that banks paid the school district when it first bought swaps in fiscal 2004, plus gains in 2006 and '07.

"But the gains reversed as interest rates fell. For the past two years, the city has had to pay the banks an average $8 million a year under terms of the swaps. Not much protection there.

"Still, Masch expects it's cheaper to wait for interest rates to rise, reducing what schools would owe, than follow Wagner's suggestion and pay to 'unwind' the swaps all at once," which would cost over $100 million, by his estimate.

What will Wagner do if the school district won't cooperate? “I’m not sure," he told me. "We have legal options. It’s costly and it’s time-consuming.

"We’re not asking for a lot here. Simply another pair of eyes, looking at swaps. The (Delaware River Port Authority) lost $60 million in swaps. It has another $150 million at risk. We’re finding virtually every public entity has some derivatives at risk with swaps.

"We are doing an audit of the Philadelphia School District. We are of the opinion some of these instruments are not done professionally. We are not placing blame on the local entity. Our concern is more at Wall Street. We know some municipalities can handle this. We hope that’s the case with the Philadelphia School District. But we’re not sure."