New Mexico Probe Just the Tip Of the Iceberg On Municipal Bond Scams?

Ever since New Mexico governor Bill Richardson withdrew his nomination for Commerce Secretary citing an investigation into the company that obtained a contract to advise the state on bond deals, news reports have been making reference to a broader nationwide probe of alleged price-fixing and corruption in the municipal bond industry, which the New Mexico investigation grew out of.

Here at Muckraker, we’ve started looking into that larger ongoing story, and today the New York Times delivers a helpful takeout on the subject — though many of the details still remain murky.

As the paper explains, federal and state investigators have over the last few years gathered evidence of what looks like a collusion scheme by financial firms that work with state and local governments on municipal bond deals worth around $400 billion each year.

Explains the paper:

E-mail messages, taped phone conversations and other court documents suggest that companies did not engage in open competition for this lucrative business, but secretly divided it among themselves, imposing layers of excess cost on local governments, violating the federal rules for tax-exempt bonds and making questionable payments and campaign contributions to local officials who could steer them business. In some cases, they created exotic financial structures that blew up.

And crucially, the paper makes clear that this isn’t just an isolated case, but rather goes to the very heart of the municipal bond system.

People with knowledge of the evidence say investigators are not just looking at a few bad apples, but also at the way an entire market has operated for years.

A former IRS investigator estimated to the Times that as much as $4 billion has vanished into the system as a result of the schemes.

A source tells the paper about evidence that sheds light on one way in which the scam works. People from firms that have contracted with local governments to help them pick their bankers were taped telling the bankers: “We want you to bid on this deal, but you’re not going to get it — you’re going to get the next one. We want you to submit a sloppy bid.” Then, in some cases, banks would be paid in cities where they did not work, to reward them for throwing the other contract to a competitor.

Part of the problem appears to be the lack of regulation, especially of companies that have emerged in recent years to advise governments on complex derivatives deals like swaps and options.

The Times explains:

The packages are presented as money-savers to the municipalities, which may want to protect themselves against interest rate changes. But over the last year, as turmoil spread through the credit markets, some of the derivatives have blown up, leaving local governments stuck with unexpected costs.

CDR, the firm that’s being investigated in New Mexico, leading to Richardson’s withdrawal, is one such company that handles derivatives.

That firm and two that do similar work — Investment Management Advisory Group, (known as “Image”), and Sound Capital Management — had their offices raided by the FBI in 2006 as part of the investigation.

The former Treasurer of the city of Phladelphia is currently in jail for accepting illegal payments in exchange for giving city bond business and other contracts to selected companies. CDR and Image appeared frequently in the indictments, and CDR was found to have paid for the Treasurer’s trip to the Super Bowl, but neither firm was formally charged.

Financial services companies including JP Morgan Chase, AIG, and Merrill Lynch have been subpoenaed as part of the investigation.

The exact mechanism or mechanisms by which these scams works remains a bit obscure, and may vary from case to case. But the broad picture is clear: financial firms, including some Wall Street powerhouses (at least until recently) are suspected of colluding to rip off state and local governments — that is, taxpayers — for billions.

We’ll be staying on top of this…

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