Bloomberg Markets Uncovers a Staggering Scandal

The magazine reports on $7 billion in phantom bonds issued by local governments across the country over the past decade, making an arcane issue come alive.

The headline is “Broken Promises,” the special report “Duping Main Street.” Words clad in mulberry explain: “Wall Street created $7 billion in bonds for housing and schools. The tax-exempt deals were a ruse; banks and advisers collected millions in fees and investment gains. The public got nothing.”


A large photo of seven children and their mother standing in front of a Pensacola housing project, the matriarch staring forcefully into the camera, illustrates the plight of one Florida family.


The publication? Bloomberg Markets magazine.


The initial effect of this introductory two-page spread is startling, coming as it does from “The magazine for and about people who move markets.” But judging by its current issue, and its relentless 18-page “Broken Promises” package, Bloomberg Markets takes a more expansive view of business news, one that values that seemingly quaint notion of the public good.


In this case, Bloomberg’s William Selway, Martin Z. Braun and David Dietz outline a scandal of staggering proportions, then make their case through exhaustive research and reporting that backs up the splashy start.


Their story begins with Pastor Willie Williams in Pensacola, Fla., as he remarks that the Oakwood Terrace complex of 300 apartments for low-income residents “looks like a concentration camp.” It didn’t have to be that way, as the complex was one development “eligible to benefit from $220 million in bonds issued by a public agency in 1999 to promote affordable housing in Florida.” But, says Bloomberg, “None of the money went to Oakwood Terrace. Not a penny of the $220 million bond issue — which was underwritten by JPMorgan Chase & Co., the third-largest bank in the U.S., and insured by a unit of American International Group Inc., the world’s largest insurance company — was ever spent on low-income residences.”


“During the past decade, local governments across the U.S. have issued more than 70 of these phantom bonds — at least $7 billion of them,” Bloomberg continues, explaining that the money generated by the sale of these tax-exempt bonds should be used for, say, housing renovations or computers for inner-city schools. But “Taxpayers never get most of those benefits; the winners are the banks, insurance companies and financial advisers that get paid millions of dollars for crafting these transactions and then profit by using bond proceeds for their own investment gains.”


This sort of behind-the-scenes scam is possible because these complicated “black box deals,” Bloomberg says, “sometimes contain secret agreements that promise to pay the financial middlemen higher fees if none of the money from the bond offerings is used to help the public. The agencies that issue the bonds buy them back from investors. The money goes untapped, and the advisers keep their fees.”


Municipal bonds might not naturally come to mind when considering financial corruption, but Bloomberg’s writers manage to make this obscure, arcane issue come alive for Street obsessive types and general readers alike. (Our only quibble is that the story is too long, but we’ll take this kind of business reporting any day. Not surprisingly, searches in LexisNexis of major papers, magazines and news wires and in Factiva of the Wall Street Journal and Reuters turned up no relevant articles on black box bond deals over the past six months.)


Bloomberg does so by zeroing in on a number of case studies, from Fulton County, Georgia to Manitowoc, Wisconsin, but for our purposes one example will suffice: the $220 million bond deal involving the Capital Trust Agency in Florida, a narrative at the heart of the story.


An “invisible” public authority, the Capital Trust Agency “consists of three people working out of a ranch house that’s situated behind the police station in the city of Gulf Breeze,” pop. 6,455. In fact, it was only created after Charles LeCroy, a former JPMorgan Chase banker, pitched the idea for the housing bond in question to the city. As “part of a growing national trend in municipal finance,” JPMorgan won its underwriting gig without competitive bidding.


“The housing bond deal LeCroy pitched was crafted by financial adviser CDR, according to documents prepared by Capital Trust’s attorneys,” Bloomberg writes, and the program purportedly “would allow nonprofit groups to buy and improve low-income housing,” sensibly fulfilling such a need in Florida. In December 1999 Capital Trust sold the bond, allowing JPMorgan Chase to take $1.3 million in fees, while Anchor National Life Insurance Co. (a unit of AIG) got $220,000, and CDR $200,000. Capital Trust itself “garnered an upfront payment of $140,000” — a typical part of an underwriter’s seduction of a municipal agency, described by Bloomberg as “We’ll guarantee your authority an upfront fee for the privilege of doing business with you.”


A Boston-based nonprofit, Community Builders Inc., was tagged to do the housing work. But then nothing happened — frustrating the nonprofit’s executive director and confounding Capital Trust’s executive director, Ed Gray, who in May 2002 “wrote to Anchor National asking that the bonds be called because he was concerned the money wasn’t being used, agency records show.” But, Gray says, Anchor National “insisted that the money stay in the investment account.”


They had good reason to: Anchor and CDR had a secret agreement “that gave both companies an incentive to deny all of Community Builders’ spending proposals,” according to a November 1999 letter from CDR’s president to an Anchor VP. Writes Bloomberg: “The less money that was used to acquire and renovate apartments, the more money CDR stood to make, and the less risk AIG’s affiliate faced as an insurer since all of the money stayed in a safe account.” This “covert pact” dictated that CDR “was paid 0.25 percent per year of the bond proceeds that weren’t used,” Bloomberg adds, estimating that “If none of the money was used for housing, CDR would get about $550,000 a year in fees.”


That agreement violated the U.S. tax code, jeopardizing the tax-exempt status of Capital Trust’s bonds; the SEC investigated; and AIG and Capital Trust finally settled with the IRS. “The bottom line on the $220 million housing bond” for the Florida agency, Bloomberg writes, was this: “$12 million in fees to banks, insurers and advisers; $920,000 to the U.S. Treasury; and zero spent on housing.”


There are three principal deleterious effects of this sort of scheme, the IRS’ Charles Anderson tells the magazine: “The public doesn’t get the housing or health care the bond was intended for,” the U.S. Treasury is cheated to the tune of “about $100 million a year in revenue,” and the market has been saturated with these “pooled bonds,” “driving up interest rates for all municipal debt.” (Black box deals are also called “pooled deals” or “blind pools.”)


All of which damages average Americans far removed from the world of high finance, such as a shelter worker in Wisconsin or a father of a Chicago fifth-grader, who tell Bloomberg how angry and deceived they feel.


Bloomberg’s story — which is accompanied by numerous graphic boxes with a populist feel and lengthy sidebars, not to mention part two of “Duping Main Street,” entitled “The Insurance Charade” — ends where it started with Willie Williams in Pensacola, as the pastor “looks over his shoulder at the Danger sign on the barbed-wired wall ringing” Oakwood Terrace.


“You hope that something would change, that something would actually come true,” Williams says. “But it doesn’t, and it leaves you with nothing but anger. Now we’re right back in a cesspool.”


If only more business journalists could be similarly angry.

Edward B. Colby was a writer at CJR Daily.