Bloomberg News blows the whistle on Daley's pinstripe patronage scams... How no-bid bond deals costs Chicago, CPS, and others tens of millions annually

Bloomberg News, which recently revamped the venerable Business Week (and doubled the amount of hard information in the magazine) has come through in a big way for Chicago by exposing how City Hall wastes millions of dollars every year. Millions — or tens of millions. Sadly, most Chicagoans won't hear about it if Mayor Richard M. Daley and the sychophants who write about education for Chicago's daily newspapers have anything to say about it. No sooner had the Chicago Board of Education voted (at its April 28 meeting) to add $450 million in debt to "Debt Service" that is already making CPS look more and more like Greece than Bloomberg linked CPS and City Hall in a revealing story about how pinstripe patronage is a way of life in Chicago — and costs the taxpayers tens of millions every year.

Chicago Mayor Richard M. Daley takes a break (above) during a media event at E.F. Young Elementary School in Chicago in September 2008. Substance photo by George N. Schmidt.One thing Bloomberg missed in this growing story is that Chicago Public Schools lately has been issuing more bond debt that the City of Chicago.

"Chicago CFO Taking Orders From Daley Increases Taxpayers’ Costs", By Darrell Preston and John McCormick, ran on the Bloomberg news wires a week after the Chicago Board of Education's latest borrowing binge was approved without comment from the public or note in the city's corporate media.

The entire story follows:

May 4 (Bloomberg) -- Chicago Mayor Richard M. Daley hired JPMorgan Chase & Co. investment banker Gene Saffold and gave him a simple order: protect the taxpayer.

“During these tough times, when people are hurting, this is more important than ever,” Daley said in introducing the city’s new chief financial officer in March 2009. “We must be creative and bold in our thinking as we better manage government.”

Not much has changed. Saffold is sticking with the city’s more than two-decade tradition of shunning open bidding for Chicago’s long-term debt, selling $2 billion in bonds through private negotiations with banks. Arranging competitive auctions instead would save taxpayers millions of dollars, according to internal documents and a review of bond sales by the country’s third-largest municipality.

Efforts to introduce competition fail because the city and its aldermen want to reward those who support public officials and politically connected charities, said a former investment banker in Chicago.

“Firms get chosen to be negotiated underwriters as payback,” said J.B. Kurish, now an associate dean at Emory University’s business school in Atlanta.

The city, which requires public bids for any other purchase of more than $100,000, faces the worst financial crisis of Daley’s 21-year tenure. He closed a $520 million deficit in the current budget by tapping a reserve fund from a 75-year lease of parking meters, putting workers on unpaid furlough days and eliminating funding for civic traditions such as Venetian Night, a lakefront festival Daley’s father started as mayor more than 50 years ago.

Breaking the Habit

Eighty-five percent of the $378 billion of long-term municipal bond deals in the U.S. last year were negotiated privately, according to data compiled by Bloomberg. Breaking Chicago from that habit proved challenging for one of Saffold’s predecessors.

“I accomplished a lot of things in my time in Chicago, but getting the city to go competitive was not one of them,” said Dana Levenson, now head of North American infrastructure banking at Royal Bank of Scotland Group Plc’s Chicago office. “It’s something that would have benefited the city of Chicago greatly if it had gone competitive.”

Saffold, 55, defended the use of negotiated sales in a Dec. 4 interview in Bloomberg’s Chicago bureau.

“We’ve gotten effective pricing, especially if you look at us compared to other state and local governments,” he said. “You don’t get best pricing because you have done a competitive bid.”

Internal Memo

One of the city’s own advisers found otherwise. Six weeks after the interview, Kristina Eng of the New York office of A.C. Advisory Inc. sent a memo to Chicago’s finance department.

It showed how $500 million of a Jan. 11 bond sale yielded more than half a percentage point more than a comparable Pennsylvania issue sold competitively. On a taxable portion of the issue, Chicago paid 152 basis points more than a benchmark Treasury rate while Pennsylvania paid 80 basis points over Treasuries, according to the memo. A basis point is a hundredth of a percentage point.

The Pennsylvania issue may have won a better spread in part because its bonds matured six years earlier than Chicago’s and had a rating one level higher from two of three credit evaluators, Eng wrote. Fitch Ratings graded them both AA.

She declined to comment on the memo, which was obtained through an open records request. Saffold spoke on behalf of the administration, said Lance Lewis, a spokesman for Daley.

Comparison ‘Misleading’

The city chose a negotiated approach for the January issue because of its complexity, Saffold said last week in response to written questions. “To then attribute the pricing difference to the method of sale is both inappropriate and misleading,” he said.

Saffold, an investment banker with 25 years of experience, said he prefers having the city hire a pool of banks to find buyers for its bonds, with interest rates set by consulting with underwriters.

“I’m a proponent of negotiated sales,” Saffold said. “Cost isn’t the sole objective.”

Chicago’s negotiated sales haven’t weakened the city’s finances, he said. Such sales allow the city to react to changing market conditions and boost participation of minority- owned firms when the city selects underwriters, he said.

Levenson, the city’s CFO from 2004 to 2007 and chairman of its Commission to Strengthen Chicago’s Pension Funds, said he was thwarted when he recommended at least twice that the city use competitive sales.

Competitive Advantage

The Chicago-based Government Finance Officers Association recommends competitive sales for bonds rated A or better, including those backed by secure revenue sources with structures that don’t require extensive explanation to buyers. Negotiated sales are best suited for those rated below A or with unusual features, according to the association.

Some states require a portion of municipal bonds to be competitively bid. Illinois law sets a minimum of 25 percent for most of its bonds, said Kelly Kraft, a spokeswoman for the governor’s Office of Management and Budget.

Municipal bonds don’t fall under Chicago’s procurement policy that requires competition when it buys goods and services costing more than $100,000. The finance department chooses the underwriters with the approval of the city council, Saffold said.

Charitable Giving

Chicago avoids bidding out its bond deals because investment bankers in the city donate to charities and political campaigns, said a former city official with knowledge of the process. Many local politicians fear damaging that relationship by asking banks to compete for Chicago’s bond business, the former official said.

Saffold said industry and city rules prohibit making contributions in exchange for underwriting work. The city “does not participate in pay-to-play selection processes,” he said.

Daley, 68, announced Saffold’s hiring last year by saying he is “ideally suited to help us maintain our commitment to sound management and fiscal responsibility.”

Saffold, JPMorgan’s managing director for national accounts at the time, had headed the company’s public finance investment banking group.

Daley Connection

While at JPMorgan, he worked with the mayor’s brother, William M. Daley, the bank’s head of corporate responsibility. Saffold, who grew up on Chicago’s South Side, is a former member of the Chicago Board of Education.

The January bond deal examined by Eng, the financial adviser, isn’t the only recent example of competitively bid issues proving cheaper than Chicago’s.

The city paid about one-third of a percentage point more when it sold $128.8 million of insured O’Hare International Airport bonds April 12, compared with a lower-rated issue sold through bidding by the Florida Department of Transportation, according to data compiled by Bloomberg.

During the 20-year life of the bonds, that translates to about $8.2 million in additional interest payments. The bonds were part of a $1 billion no-bid issue in which the city paid $7.9 million, including a $5.3 million underwriting fee, to banks led by Bank of America Corp., according to bond documents.

Saffold said, as with the January bond issue, that attributing the price difference to the method of sale was “misleading.”

Revenue Hole

Savings from competitive deals would help Chicago plug revenue holes left by declines in real estate and income tax collections as well as the loss of convention business to warmer, less expensive cities such as Orlando, Florida, and Las Vegas.

In March, the city met with more than 90 bankers and other financial advisers to present a request for qualifications for firms wanting to help it address its budget challenges. Chicago was looking for “creative financing ideas and techniques that may help ensure the fiscal health of the city in 2011,” according to a news release.

The city’s purchase agreements for recent negotiated deals don’t require underwriters to adhere to performance standards for obtaining the lowest borrowing cost, according to the documents obtained under open-records requests.

Even cities such as Los Angeles that mostly sell without bids sometimes use competitive deals to make firms earn the negotiated underwritings, said Daniel Kaplan, president of Kaplan Financial Consulting Inc. in Wilmette, Illinois.

‘Extreme’ Example

“It helps to do a mix of both,” said Kaplan. “Chicago is the extreme of issuers that don’t do any.”

Saffold said he can show taxpayers that the city’s approach leads to the lowest borrowing cost.

“The information is out there,” he said. “Call the city of Chicago department of finance, and they can get whatever information that they’re looking for. Ask for Gene Saffold.” Bloomberg News reported in December that the Metropolitan Water Reclamation District of Greater Chicago, an agency independent of the city, paid $8 million in unnecessary interest when it issued $354.3 billion of bonds in August through a negotiated sale.

Cities and states that negotiate don’t borrow at the lowest cost for taxpayers in the $2.8 trillion U.S. municipal bond market, said Craig Brown, an assistant professor of finance at City University of New York who has surveyed research in his study of borrowing costs.

Research findings put the difference at 17 to 48 basis points, according to a 2008 article in the Municipal Finance Journal by Mark D. Robbins, associate professor, and William Simonsen, professor, at the University of Connecticut.

Matching Wits

“Finance officers are persuaded they can match wits with the underwriters they work with and negotiate a better sale than competitive bids can provide,” Robbins said in an interview. The city officials are “just trying to get a transaction done. Cost is less of a consideration.”

A negotiated deal restricts a city’s ability to force underwriters to offer the lowest interest rates or show taxpayers it got the best price, said Ralph Martire, executive director for the Center for Tax and Budget Accountability, a non-partisan group in Chicago.

“There is no way it could be in the public’s interest to do a no-bid deal on a bond,” Martire said. “There is no way you can win.”

Last Updated: May 4, 2010 00:01 EDT


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