I've been reading Matt Taibbi. I can't wrap my brain around municipal bonds and bid rigging. Help?

[truth2power]

Here's what I know (I think)...

A municipality/schl. dist. wants to construct a new school building. They 'go to Wall street' (does that mean they go to their neighborhood bank?) and procure 'bonds' which are pieces of paper/IOU's. Does the bank charge the municipality for issuing these IOU's?

An individual investor buys one IOU, let's say for $1000, just to make it simple. The individual gives the schl dist $1000 and takes posession of the IOU. After a certain period of time, the bond 'matures' and the person can turn it back to the municipality and get their $1000 back.

In the meantime, the individual gets interest on their loan at the rate of ....% per yr. I assume the schl dist gets the money to pay back the investors by taxing the residents of the district.

Where does the bid rigging come in? What's rigged is the interest rate, but I don't get how the municipality gets scammed. You would think the investor would want the HIGHEST rate, but from Taibbi's articles it seems the banksters try to get the LOWEST rate.

I am hopelessly confused.

Thanks to anyone who can explain this.

[murray hill farm]

1. I will be watching for replies too!

Clearly, I am more than hopelessly confused....since you just explained well a lot that I did not know. Thanks!

[phantom power]

2. Here is my reading of that...

During a project, money not yet spent is kept in a bank, and earns interest. What is supposed to happen is, banks compete for keeping this money, and promise some rate of return. This bidding is supposed to take place without one bank knowing what others are bidding.

What actually happens: the banks tell each other (via the bidding broker, who is bribed), and they all agree (a) which bank will "win" the bid, and (b) for what interest rate. They give the township *less* rate of return than they could, and pocket the difference.

so, the banks invest the money, get (say) 5.1%, and give the township 5%, skimming the 0.1%. Which amounts to a whole shitload of money over time, and over all the loans to all municipalities in America.

[Po_d Mainiac]

5. yup n/t

[tularetom]

3. The municipalities don't GET the interest, they PAY the interest

So I'm not sure either how Taibbi's hypothesis makes any sense.

He makes it sound like banks are holding back interest payments that they should make to the municipalities. And that is just 180 degrees backasswards from how municipal bonds work.

On edit: If anybody is getting screwed here it's the bond buyers (investors/lenders) not the municipalities.

[phantom power]

6. the key is: municipalities both pay and receive interest...

They take out a loan, in the form of a bond, to fund some project X. The municipality pays interest on that.

However...

while Project X is progressing, they have this loan money that is only partially spent. And that money is kept in an interest bearing account. The municipality earns interest on this. And this account is the subject of Taibbi's article, and where the fraud is happening, in terms of illegally colluding on interest rate bidding.

[girl gone mad]

9. This isn't a hypothesis from Taibbi, tularetom.

You can read about United States v. Dominick P. Carollo, Steven E. Goldberg, and Peter S. Grimm, or any of the dozens of civil trials being brought against Wall Street firms for bid-rigging.

Here is the superseding indictment against Carollo, Goldberg and Grimm:

http://www.justice.gov/atr/cases/f280500/280591.pdf

Read the background if you want to understand these charges rather than just assuming the reporter conjured up some imaginary scheme one day when he was bored.

[truth2power]

10. Who gets and who pays? I think I'm hopelessly confused....

I've decided i have no hope of understanding this. No wonder it's so hard to prosecute these people.

[Po_d Mainiac]

4. Your town takes out a bond for a road, bridge, whatever

That money goes into a "special fund account" that diminishes in size as bills come due.

But while the money is sitting there, the town is paying interest on the original note, but offsetting it by collecting interest on the unspent funds on deposit. (kinda like a CD that you don't have to leave alone till maturity)

The big fix (bid rigging) is on the interest that gets paid on the unspent funds sitting in escrow.

[truth2power]

12. That escrow money is sitting in some bank somewhere....

You get the interest that bank is willing to pay. This makes even less sense than it did when I started this thread.

[Po_d Mainiac]

16. But, the bank ain't paying what it wood be 'willing' to pay. The payout is less

Due to the bid rigging, the interest earned on those funds is less than fair market.

Thus the total cost of the issuance to the town/state/sewer district/whatever (and therefore the public) is higher, and the difference ends up in the pockets of the consultant (who is 'supposed' to be 'representing' the best interests of the issuer) and the bankster/borrower

[A HERETIC I AM]

7. I'll do my best to help you.

Allow me to dissect your post.

A municipality/schl. dist. wants to construct a new school building. They 'go to Wall street' (does that mean they go to their neighborhood bank?)

Only if their neighborhood bank is an Investment Bank and/or is in the business of underwriting bonds

and procure 'bonds' which are pieces of paper/IOU's.

Technically no, they aren't just pieces of paper/IOU's and they don't "Procure" them. The Municipality becomes the issuer and the banks are the underwriters. Bonds are at the same time an obligation and an asset, the first to the issuer and the other to the holder. Also, the days of the paper bond your grand dad may have kept in his safe deposit box are pretty much over. They're almost all electronic now.

Does the bank charge the municipality for issuing these IOU's?

Yes they do, but the way they do it is not by billing them for the service, rather they take a cut of the original issue. In other words, say the Town of Podunk want to issue $20 million. The investment bank will write them a check for say nineteen mill*** and the last mill is profit. The city is still responsible for paying back the entire twenty however. The preceeding is purely for illustration purposes. The bidding can come down to tens of "Basis Points" or 100ths of a percentage point.*** This BTW, is what Investment Banks do. The much hated Goldman Sachs is responsible for writing checks that have paid for hundreds if not thousands of sewer systems, water mains, Schools, Hospitals, Roads, Bridges etc. If it wasn't for these types of institutions, the building of a simple overpass could take twenty years instead of one or two because the local government would have to pay for it as it could afford to - when it collected the money. That is why the banks charge what they charge. Because THEY are taking the risk that the bonds might not get paid off or that they might not be able to sell them and are left holding the bag for the entire amount. It IS risky business, no matter how you look at it. Yes, that's a small defense of Goldman Sachs! So sue me!

An individual investor buys one IOU, let's say for $1000, just to make it simple.

Not only did you make it simple, you hit it spot on. The "Par" value of virtually every bond sold in this country is One Thousand Dollars. Bonds sold on the open market can and do trade either above (called a "Premium Bond&quot or below (called a "Discount Bond&quot this Par Value. There is however, a system called "Private Placement" wherein a very wealthy individual can be the sole funding source of a particular issue, say a $10 million Sewer project. That one individual gets all the interest and all the principal back at maturity, less the origination fees charged by the Private Placement Service provider, typically a major investment bank. If you win a $200 million Powerball, you can go to State Street Investment Bank in Boston or Goldman Sachs or a similar firm and they will have a division that can do this for you.

The individual gives the schl dist $1000 and takes possession of the IOU.

Actually, no. The School district already has the money by now. An individual buying one of these bonds is buying it on the secondary market, purchasing it from either one of the investment banks that participated in the issuance, one of their dealers or an individual who has offered them up for sale.

After a certain period of time, the bond 'matures' and the person can turn it back to the municipality and get their $1000 back.

Correct. This happens automatically these days however. The cash would show up in your investment account within 3 days after maturity.

In the meantime, the individual gets interest on their loan at the rate of ....% per yr.

Correct. These payments are also deposited directly to the same investment account the bonds are held in. Just as an FYI, if the bond pays a - say 5% "Coupon", then it pays $50.00 per year made in two payments of $25.00 each, 6 months apart. Also, this coupon payment is always based on that $1000 Par I mentioned above and it's regardless of what you paid for it. That brings in the difference between Yield and Coupon rate. If you were able to buy the bond for $850, you still get 5% of $1000 every year until the bond matures but your yield is much higher than 5% because even though you paid only $850, you get back $1000 at maturity.

I assume the schl dist gets the money to pay back the investors by taxing the residents of the district.

Correct, unless they have another funding source for the bond repayment. For the most part, Municipalities get their money from taxation of their citizens and businesses.

Where does the bid rigging come in?

On both sides of the agreement. Bid Rigging can occur on the underwriting side and as mentioned before, on the interest paid on unspent balances deposited with a bank.

What's rigged is the interest rate, but I don't get how the municipality gets scammed.

According to Taibbi, he is saying they are getting scammed because of the faulty credit ratings given them by the ratings agencies which forces them to pay a higher coupon rate as well as by the banks themselves paying less than they should in interest on deposited funds.

You would think the investor would want the HIGHEST rate, but from Taibbi's articles it seems the banksters try to get the LOWEST rate.

Both these are true but from what I understand, this is backward. The rate of interest a bond will pay - The "Coupon" rate is set during the initial bidding process based on many factors including general bond market trends and the perceived credit worthiness of the Municipality. The underwriters want the coupon to be as high as possible in order to make the issue attractive to potential buyers and the issuer wants the rate to be as low as possible so they don't have to pay as much in total.

Hope that helps a little.

[bemildred]

8. Not bad.

Pretty much the way I understand it too.

[truth2power]

11. I really appreciate your efforts, but I've read this over numerous times

and it makes no sense to me. None of the explanations do, actually. I'll just chalk it up to my limitations.

I still don't know how municipalities get cheated. Who gives interest and who gets interest?

What difference does it make if the banks all get together and decide on one rate of interest? Kind of like stores all deciding to sell Wheaties for one price. So what?

I give up.

[ret5hd]

15. Well, if you have no problem with businesses colluding to fix prices i guess things look o.k.

I guess we could also get rid of any anti-monopoly laws and let all the banks merge into one.

I guess i will try my hand at this:
Question: I still don't know how municipalities get cheated. Who gives interest and who gets interest?

A probably oversimpliffied answer:

1) The municipality gets interest (which has been set artificially low by the colluding banks) from money (which was raised by selling bonds) held in escrow.

2) The municipality pays interest (which was set artificially high by the colluding banks) to the bondholders.

[truth2power]

18. This is beginning to make some sense, but something is tripping me up and

I don't even know what it is.

I am so sorry. I probably shouldn't even have started a thread in this forum. I think I need one of those animated things where little cartoon characters walk from one building to another carrying large amounts of cash. I just can't visualize this.

I'll keep working on it.

[Shagman]

21. let me try

Let's see if I can simplify this a little more. (yes, it's probably oversimplified, so sue me)

Suppose you live on a dirt road with nine other families. The state DOT won't pave it. You get together with everyone on the road to talk about getting it paved. The cost will be $10,000, or $1000 per household. Nobody has that much cash, so you all work out a scheme. You, being the most trustworthy, go to your bank, put up some collateral, get a loan, and have the road paved. Everyone else gives you an IOU for $1000. Now you, and only you, are responsible for paying off the loan. Meanwhile you have to collect money from the other families every month to make that payment, and you're liable if any of them doesn't pay, or moves away, or gets fired, etc. You have an agreement to cover such things, for instance, if you sell your house, the buyer has to keep making those payments.

That's the classical way of doing things. You are the government. Your neighbors are the taxpayers. The bank, of course, is the bank. The IOUs are the bonds.

Now here's what happened with the investment banks (as I understand it).

Same situation as above, only one of your neighbors has the $10,000 on hand. Let's call him Mr. Banker. He proposes a deal. He will pay to pave the road immediately (for a small extra fee). Each of the other nine households will owe him $1000, payable in installments, with interest.

So far so good. You get the road paved. Then Mr. Banker tells you that he has sold your IOU to a friend for $990, and you'll be making your payments to the friend. Assuming you make your payments, the friend gets a profit of $10. Mr. Banker lost $10 on the IOU, but a) he already has $990 out of his $1000 back without waiting for the payments, and b) he'll make the other $10 back and more.

You soon find out that Mr. Banker has sold the other IOUs to other friends. He's also offered to collect the payments (for a small fee) from you and distribute the money to his friends.

Now, what if Mr. Banker told his friends the interest rate was smaller than what you're actually paying, while he keeps the extra money? and what if he didn't tell you that his friends are getting that $10 profit, or even that his friends are getting your money? and what if you found out all his friends would have charged you the same high interest rate? You'd want to kick Mr. Banker's ass, wouldn't you?

I think the example is good, but I'm not following the sleaze trail exactly right.

[Egalitarian Thug]

13. I haven't read the article, do you have a link? Generally bond scams are pretty

complicated because of the numbers and degree of cooperation required. The basics are laid out by A HERETIC I AM, but I suspect he didn't emphasize the details enough to make it clear.

Since Gramm–Leach–Bliley, we have an environment where a single entity, G$ for example, can be any or all of the players, by influencing the rating and having control over each part of the deal, they can take a much larger than normal profit from deals that regularly amount to 10's of billions of dollars. Even with a straight bond rating, if you are the underwriter, receive and manage the deposits, sell and/or buy the issues, there is money to be made along the way. With these sums changing hands, it doesn't take a huge bite to get a big pile of money and by playing multiple, cooperative roles, they take several bites. As always with these parasites, in the end the taxpayers end up paying far more for the money than they should have.

[Roland99]

14. Try these >>>>

http://www.rollingstone.com/politics/news/the-scam-wall-street-learned-from-the-mafia-20120620

http://www.rollingstone.com/politics/blogs/taibblog/notes-on-wall-streets-bid-rigging-scandal-20120622

[Po_d Mainiac]

17. Ain't nothing complicated about this scam. n/t

[Egalitarian Thug]

19. Obviously it is. truth2power has read the article and tried to learn about the mechanism

and is still somewhat confused. When the majority of people don't understand even the basics of our national economic system, that is, by definition complicated.

Add to this the deliberately misleading jargon that serves to mask what virtually everyone that does learn how this financial system works, sees as blatant theft, and I think you'll find that it is indeed quite complicated. The system itself is a morass of obfuscation and facade, and more mysterious still is how and why we allow it to continue.

[Po_d Mainiac]

20. fail n/t

[Egalitarian Thug]

22. Do you ever have anything to add to a conversation? n/t

[Po_d Mainiac]

25. Ayuh n/t

[banned from Kos]

23. ALways -- I repeat ALWAYS assume Matt Taibbi is wrong

because he always is wrong.