PhillyDeals: Harrisburg City Council's IRS challenge could leave its legal advisers holding the bag

The Harrisburg city financial meltdown is starting to raise broad questions on how Pennsylvania local officials do business with professional advisers, as debt piles up on the taxpaying public.

Counsel for Harrisburg City Council, which has petitioned for federal bankruptcy protection in hopes that will make it easier to negotiate down hundreds of millions of dollars in debt for an ill-advised trash incinerator project, has challenged the tax-exempt status of more than $300 million of city bonds.

The move, if successful, could leave the law firms, financial advisers, insurers, and banks that helped Harrisburg arrange the ill-fated project exposed to legal action to try and force them to help pay the city's costs, says Bryn Mawr lawyer Mark D. Schwartz, who has been representing the council in its Chapter 9 federal bankruptcy filing.

"I question whether there was adequate due diligence" in professional advisers' promises to the city that the bonds would be "self-supporting from money generated by the [trash] facility," and whether there was legally required disclosure on the project's risks, Schwartz wrote in a letter to Internal Revenue Service chief counsel William J. Wilkins and IRS Office of Tax Exempt Bonds director Clifford J. Gannett.

Schwartz says the professionals, from a long list of firms based in New York, Philadelphia, Pittsburgh, and Harrisburg, had an incentive to urge the city to approve the deal - so they could get paid - but that advisers lacked incentive to warn the city the project could fail, leaving taxpayers in the hole. Officials at two firms that advised Harrisburg declined to comment; others didn't return calls seeking comments.

Prolific borrowing for projects and, sometimes, for operating expenses by Pennsylvania's local governments have left public treasuries strained, as property tax collections have fallen in the recession.

Harrisburg's city council majority and controller Dan Miller have proposed local sales tax or property-tax surcharges, as Philadelphia has implemented, to pay the city's debts.

But city tax proposals are unpopular among the suburban commuter workforce. So Gov. Corbett has signed legislation written by suburban lawmakers that would force Harrisburg to accept state financial control. The state's plan would sell city parks and other assets and break labor contracts to save money without hurting the bondholders or bond advisers. A federal bankruptcy judge will hear arguments from both sides later this month.

Schwartz's IRS letter also called for "an investigation into the swaps that were conducted." Harrisburg, like the Philadelphia School District, the Delaware River Port Authority, Philadelphia's Board of City Trusts (which runs Girard College), and other bond issuers, owes millions from interest-rate hedges, or swaps, they bought from New York banks in connection with the incinerator bonds.

The swaps were typically supposed to protect bond issuers - like Harrisburg - from rising interest rates, but ended up costing millions when interest rates stayed low. Somehow the banks ended up on the right side of these bets, with taxpayers left owing.

Wells Fargo & Co., the giant San Francisco-based lender that became the dominant bank in Philadelphia when it took over failing Wachovia Corp. three years ago, is putting the finishing touches on a banking museum in the old Fidelity building on South Broad Street.

Banks are unpopular in a slumping economy. Anti-bank slogans are on display at the Occupy Philadelphia protest camp two blocks away. Wells Fargo's gesture is a reminder that bankers and credit have played a key role in this republic from the start.

Museum manager Candice M. Helgeson, who holds a master's degree in history from American University, has set up displays mixing Wells Fargo's Old West origins and its East Coast predecessors' roots in the trade, plantation, and waterwheel economy.

The collection, scheduled to host its first public, charter and parochial-school visitors Friday, includes two (nonlocal) stagecoaches painted Wells Fargo red, old Philadelphia bank charters signed by slave traders and merchants turned Revolutionary War financiers, and land speculators Robert Morris and Thomas Willing. The display also includes a model of Stephen Girard's bank (he bought the predecessor of today's Federal Reserve when it lost its charter) and items and papers to evoke, if not fully explain, the role of bankers in industrial America.