Here’s a great piece of watchdog journalism from Bloomberg, reporting that the Metropolitan Transit Authority sold a bond issue far too cheaply, enabling Wall Streeters to pick up immediate gains—ones that were essentially financed by federal taxpayers.
Bloomberg reports the lowball pricing resulted in an immediate $3 million profit for traders on the $750 million bond sale. The profit was so immediate, in fact, that the traders never had to actually pay for the bonds before they sold them higher. Even worse, the bonds, issued just last month have continued to increase in price. Had the MTA priced them higher and gotten just half of that gain, it would have saved $48 million at once and $103 million over thirty years.
Heckuva job, guys.
They had help, of course, from Wall Street. Goldman Sachs was there, as was JPMorgan Chase. Goldie got half a million bucks for its swell advice on how to price the issue.
Bloomberg reports JP Morgan sold $2.5 billion of its own debt a few weeks later at a rate 75 basis points (0.75 percent) cheaper than it sold MTA bonds. And JP Morgan doesn’t have the power to tax people (well, not in the traditional sense of “tax”) to pay its debt service.
That seems like an apples-to-oranges comparison to me, though. JPMorgan’s issue was five-year bonds, while the MTA’s are thirty-year ones. Longer-term bonds have to pay more interest because their longer payoff period brings more risk to investors (see this chart of the various Treasury bonds, for example).
Still it is worth comparing them in this sense:
The spread between the bond yield and the benchmark Treasury issue was 3.5 percentage points at the agency’s initial sale. When trading started, that gap narrowed to about 3.2 percentage points, then contracted to 3.1 points by April 27 and 2.29 points on May 13.
One day after Dellaverson’s statement, the underwriter of the MTA offering, JPMorgan Chase & Co., sold $2.5 billion of its own debt at 2.75 percentage points above Treasuries. Those bonds didn’t surge in price when trading began, and the spread was little changed.
Dellaverson is Gary Dellaverson, the MTA’s chief financial officer. Bloomberg calls him out here:
Dellaverson’s statement said Goldman Sachs Group Inc., the agency’s financial adviser, had access to market information that helped it sell with more favorable terms than the earlier transactions that week by California and the New Jersey Turnpike Authority.
Before the MTA transaction, the price of California Build America Bonds underwritten by Goldman Sachs traded at 3.33 percentage points over Treasuries, or less than the 3.5-point spread set at the transit authority’s sale, according to Bloomberg data.
Anybody who’s been watching the news knows that California is in deep doo-doo financially—much worse off than New York. And its issue was nearly seven times as large as the MTA’s and just a day earlier. So it doesn’t make much sense that it would get cheaper rates than New York.
And the issue was massively oversubscribed. Markets work like this: If you’ve got too many buyers, your prices are too low. Simple, right? Read this:
When the agency set a 7.336 percent yield for its new debt due 2039, there were more investor orders than available securities. About $4 billion of orders were submitted for the $750 million in Build America Bonds and another $500 million in tax-exempt securities, Patrick McCoy, MTA finance director, told the agency’s finance committee April 27.
A month later, those 7.336 percent bonds yield 6.36 percent, which Bloomberg wryly spells out:
The quick rise in the New York bonds’ price showed that some investors who couldn’t buy at the initial sale were willing to accept a lower yield than was set in negotiations between the authority and bankers.
There’s no hint of overt wrongdoing here, but these kinds of massive mispricings certainly make corruption far easier. Expect Andrew Cuomo to be on the case soon.
For its spadework on this story, Bloomberg gets a parade of “no comments” from the interested parties:
Brian Marchiony, a JPMorgan Chase spokesman, declined to comment on the MTA’s pricing or its own bond sale. The agency paid underwriters led by the New York-based bank $6.68 million to handle the sale.
And:
The MTA paid Goldman Sachs $487,500 for advice on getting the highest price and lowest yield, according to Aaron Donovan, spokesman for the agency. Michael DuVally, a spokesman for the New York-based bank, declined to comment.
And:
Dellaverson declined to be interviewed or respond to questions about the yield falling even more than the 0.25 percentage-point premium.
That 0.25 percent premium is as close as we get for an official excuse for the inflated bond yields (yields rise inversely to prices). Here’s Dellaverson’s statement from a couple of weeks ago:
Sellers of taxable debt such as Build America Bonds commonly pay a “new issue premium,” Gary Dellaverson, the agency’s chief financial officer, said in a statement May 12. Providing investors an extra 0.25 percentage point of yield on the MTA bonds “was neither unexpected nor a sign of inefficient pricing.”
But the twist here is that New York taxpayers aren’t taking a hit over what they normally would have paid. That’s because one-third of the interest paid on these Build America Bonds is subsidized by the federal government.
By subsidizing interest on Build America Bonds, the Treasury reduced issuers’ incentive to bargain for the lowest yield, said Peter Demirali, an investment manager at Vineland, New Jersey-based Cumberland Advisors.
“They’re looking at it and saying, ‘We don’t care. You guys make money, and we come out of it saving a lot of money by getting the 35 percent credit,’” said Demirali, who purchased Build America Bonds from California and the New Jersey Turnpike Authority.
Indeed it did:
The 4.92 percent overall cost of the issue after the federal subsidy was a savings over the 5.88 percent assumed in the authority’s budget for tax-exempt debt.
That means Uncle Sam paid for this boondoggle, or most of it, anyway. Demirali’s quote isn’t quite right. After all, had the MTA gotten, say, a half-point lower interest rate for its bonds, it would have saved the system another 0.33 percentage points. That’s a lot of money in bond land.
Bloomberg rounds all this up in a good kicker:
At yesterday’s yield of 6.38 percent and a price above 112 cents on the dollar, the bonds have attracted buyers for blocks of $1 million or more, a month after the initial sale at 7.34 percent and a price of 100. If half those gains had gone to the authority, it would have collected another $48 million at the sale, or $103 million over the securities’ life. The bonds are quoted today at 113 cents on the dollar to yield 6.36 percent, according to Bloomberg data.
“Those savings should go to the borrowers, not the investors, and certainly not the underwriters,” said Stanley I. Langbein, a professor at the University of Miami School of Law in Coral Gables, Florida. “We’re talking about a lot of taxpayer money being wasted.”
Excellent stuff by Bloomberg and reporter Michael Quint.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.