Philly schools reject auditor's demand to dump investments

What should the Philadelphia School District do with more than $1 billion worth of interest-rate swap agreements it holds with various Wall Street banks, at a time when it'd be lots cheaper to borrow at record low bank and bond interest rates?

"Immediately terminate any active swaps and refinance with conventional debt instruments," Pennsylvania Auditor General (and potential candidate for governor) Jack Wagner told the Philadelphia School District in a statement yesterday.

He also wants the schools to "hire financial advisors through a competitive selection process."

I called Wagner's office to ask if he'd thought this through - if he was sure the School District, already committed to swaps at a time when interest rates stand at record lows, might be better off waiting for rates to rise before it buys out more than $1 billion in interest-rate bets with big Wall Street banks.

"Good question," Wagner spokesman Steve Halvonik told me. While interest-rate swaps are "gambling with taxpayer money," and are inappropriate for any town, "the interest rate, we acknowledge, is a factor in determining when, where and how they dissolve these contracts." 

"We're not arguing with the Auditor General whether it's a good idea to enter into more swaps," Philadelphia schools chief business officer Michael J. Masch responded, when I ran that by him.

But: "These swaps were entered into years ago, by a different superintendent and chief financial officer, under very different market conditions. His recommendation is that we terminate the swaps immediately. But his auditors, in our building, know we'd lose $120 million if we did that."

Masch says the swap agreements have earned the schools a net "$12 million since 2004." He acknowledged there's currently a three-percentage-point deficit between market rates and the "synthetic counterparty interest rate," and that the schools are responsible for the difference, which looks like it's costing the city $30 million a year, compared to today's market rates.

But the loss will fall, evaporate, and even reverse as interest rates recover. So it may be cheaper to pay as we go, than to write all the contracts off. It can't get more expensive than it already is, unless banks start paying people to borrow.

Wagner was also out of line to demand the schools hire advisers by competitive selection, Masch added, since the administration already does that. "He could have asked us that," instead of sending out a press release, he concluded. "Give me a break."