Swaps a Risky Business for New Orleans Saints

When the New Orleans Saints went to rebuild the Superdome after Hurricane Katrina in 2006, the Louisiana State Bond Commission financed it by using a Merrill Lynch & Co. (NYSE:BAC) plan with debt and interest-rate swaps. The deal kept the Saints in town and paid for a new upgrade to the team’s stadium, but the $42 million cost became so expensive, the state had to repurchase the debt.

The state of Louisiana is not alone in dealing with the this type of financial problem. Public officials from across the country, including then-governor Jon Corzine of New Jersey fell for the same Wall Street  pitch: “auction-rate bonds” would decrease financing costs by allowing holders to pay short-term rates while interest-rate swaps would protect them should markets trade in the wrong direction.

These municipal securities represented about half of the $330 billion auction-rate market when it imploded in February 2008, according to Bloomberg. Taxpayers were also hit hard by these bad investments: in the last fear years, they have paid over $20 billion in fees for the swap agreements in the past five years, explained Andrew Kalotay, chief executive officer of the debt-management firm Andrew Kalotay Associates Inc. in New York.

Now government financial professionals are realizing they didn’t understand that the market controlled by the investment banks that sold the products used to decrease risks would be penalized when the deals fell apart.

Sophisticated Products

So how did all these municipalities lose so much money on these swap products? The public officials involved in the financial investments didn’t understand the sophisticated product. Some also believe they don’t want to admit screwing up while others don’t want to acknowledge the products were too difficult to comprehend.

According to Roger Noll, professor emeritus of economics at Stanford University, “In most cases, the elected political leadership are part- time amateurs. They get a noisy political grassroots movement that wants to subsidize a team, and then they get sold a bill of goods.”

While Louisiana’s treasurer John Neely Kennedy saw that the potential Merrill Lynch swaps plan could backfire in March 2006, others ignored his warnings as everyone wanted to rebuild the Superdome for the home team. Kennedy felt as if he had “a gun to my head.”

For the Saints, they had somewhat of a happy ending as they won the Superbowl in 2010, and the way they’re currently playing, they could see a second one this year, but along the way it’s been an expensive journey.

Louisiana saw its costs rise after the credit crisis after banks no longer acting as buyers of the last resort. Debt rates increased–as high as 20 percent–and the swaps couldn’t cover the investment’s difference. Investors then left the market.

Louisiana Lawsuit

The Bayou’s state Stadium and Exposition District (LSED) sued on the allegations that bond-insurer Financial Guaranty Insurance Co. (FGIC), a unit of New York-based FGIC Corp., sold them worthless protection and investment bank Merrill Lynch committed fraud by not telling them all that they needed to know.

The case’s claims against FGIC were dismissed by the U.S. District court in May 2010, but only seven counts against Merrill Lynch were thrown out.

The counts of breach of fiduciary duty, intentional and negligent misrepresentation and fraud remain. The bank has denied the claims and said in a response by spokesman William Halldin, “LSED and its sophisticated advisers fully understood the risks of the bonds and knowingly accepted those risks in exchange for a lower interest rate.” Louisiana has appealed the case.

To contact the reporter on this story: Debbie Baratz at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com