Wall Street’s Sale of Toxic CDOs Undermines Education and Other Government Services

 

The Securities and Exchange Commission is investigating the sale of $200 million in collateralized debt obligations (CDOs) to several Wisconsin school districts, according to a recent Wall Street Journal article by Meena Thiruvengadam and Kelly Nolan (“SEC Investigates Failed CDOs Sold to Wisconsin Schools”). The schools have also filed a lawsuit alleging that the CDOs were misrepresented and that important risk disclosures were omitted.

Many cities, states and municipalities across the country are finding that their fiscal crises are further aggravated by investments in these toxic securities whose risks were not fully disclosed. According to Janet Tavakoli, a finance industry consultant in Chicago, investment firms sold CDOs to municipalities around the country on a widespread basis because of their lack of sophistication. “Bankers sell them products stuffed with junk,” she was quoted as saying.

The Wisconsin school districts apparently invested $200,000 of which $165 million was borrowed money. The districts were reportedly advised by Stifel Nicolaus & Co. “Every three months you’re going to get a payment,” Stifel’s representative allegedly told the board. “There would need to be 15 Enrons,” for the investments to fail, he said, according to a November 2, 2008 report in the New York Times. The school districts’ objective in making the investment was to cover $432 million in unfunded post-employment benefits, according to the article.

The complicated CDOs that were sold to the school districts, in effect, would only have returned about the same as ultra-safe US Treasuries under a best-case scenario, but were significantly riskier. In effect, the school district borrowed money to insure obligations issued by other companies. When those companies began to default, the district started receiving demands for payments. The result is that it is likely to lose its entire investment.

With regard to their debt, the school districts are caught between a rock and a hard place. If they do not pay their debt, their credit ratings will be downgraded. If they do pay their debt, which they cannot afford, their credit ratings will likely be downgraded. Moody’s Investors Service noted that one district’s share of the debt makes up almost 70% of its annual budget. Being downgraded would mean higher borrowing costs.

“The school districts had no need to take on the amount of risk the CDOs represented in order to get the rate-of -return being offered,” according to J. Boyd Page, senior partner at Page Perry. “Financial advisors that either know they are peddling junk or don’t take the time to understand and disclose the risks to their clients are deserving of severe sanctions,” he added.

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 35 occasions, and have aided clients who have been the victims of financial adviser abuse and scams. Page Perry’s attorneys are actively involved in counseling institutional and individual investors regarding CDOs. For further information, please contact us.