New Jersey pays Goldman millions for swaps on redeemed bonds

By Dunstan McNichol
Bloomberg News
Friday, October 23, 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=aufmSRtDn0gg

TRENTON, New Jersey -- New Jersey taxpayers are sending almost $1 million a month to a partnership run by Goldman Sachs Group Inc. for protection against rising interest costs on bonds that the state redeemed more than a year ago.

The most-densely populated U.S. state is making the payments under an agreement made during the administration of former Governor James E. McGreevey in 2003, when New Jersey's Transportation Trust Fund Authority sold $345 million in auction-rate bonds whose yields fluctuated with short-term interest costs. The agency finances road and rail projects.

"This vividly shows the risk of entering into interest-rate swap agreements," said Christopher Taylor, former executive director of the Municipal Securities Rulemaking Board in Alexandria, Virginia. "The world's got to see what stupidity even the sophisticated investors like the transportation fund can get into."

While New Jersey replaced the debt with fixed-rate securities in 2008 after the $330 billion auction-rate bond market froze, the swap, in which two parties typically exchange fixed payments for ones based on floating interest rates, isn't scheduled to expire until 2019.

The state paid $940,000 under the agreement last month and a total of $11.4 million since the auction-rate bonds were redeemed. The expenditures come as the fund reaches its borrowing limit and Governor Jon Corzine, Goldman's former chairman, who was a U.S. senator when the contract was signed, seeks $400 million in budget reductions as tax receipts fall.

Municipalities and universities across the U.S. have paid hundreds of millions to terminate swaps on variable-rate debt after interest costs, instead of climbing, fell to record lows in the worst credit crisis since the Great Depression. Harvard University last week disclosed it had given $497.6 million to investment banks to exit such agreements following similar terminations by New York's Metropolitan Transportation Authority and the Oakland, California-based Bay Area Toll Authority.

In New Jersey, the 3.6 percent fixed rate the trust fund is paying on the swap has pushed the cost to taxpayers of the original $345 million borrowing to 7.8 percent, the most the authority has paid since it was formed in 1985, according to records posted on its Web site.

The payments are draining money from a dwindling account that may not be able to support new projects because the $895 million in annual gasoline taxes and toll revenue dedicated to the fund will be needed to pay debt service on $10.3 billion in obligations. To help prop up spending, officials have suggested raising New Jersey's 14.5 cents-a-gallon gasoline levy, the fourth-lowest among U.S. states, according to research by the Tax Foundation, a Washington, D.C.-based research organization.

New Jersey's contract with Goldman Sachs Mitsui Marine Derivative Products L.P., a partnership of the bank and Japan's Mitsui Sumitomo Insurance Group Holdings Inc., allows the state to terminate the deal without penalty after 2011. Canceling before then would require a payment estimated at $37.6 million on Sept. 30, according to state records.

The state's payments on the swap in the past year have exceeded the $10 million budgeted to maintain the 76-year-old Pulaski Skyway, the 3-mile (4.8 kilometers) elevated road from Newark to Jersey City.

"I'm sure there's an explanation," Corzine, 62, said during a brief interview as he left a contractors' convention in New Brunswick, New Jersey, on Oct. 14. "They don't just send money out."

The governor declined further comment on the transaction according to his spokesman, Steve Sigmund.

"We believe Treasury should continue to aggressively manage the termination, conversion, and management of swaps that this administration inherited, while dealing with the realities of the most difficult credit conditions in history," Sigmund said in an e-mail.

Corzine, a Democrat, is the only U.S. governor seeking re-election this year and is tied in this month's Quinnipiac poll with Republican Christopher Christie, 47, a former federal prosecutor. Each had about 40 percent, with a 2.8-percentage-point margin of error.

New Jersey couldn't reach acceptable terms when it tried to issue variable-rate bonds last year to replace the failed auction-rate securities hedged by the Goldman swap, the Office of Public Finance said in a three-page response to questions about the transaction. It is unfair to judge the ultimate performance of the 16-year agreement until it concludes in 2019, the agency said in the statement.

"Cherry-picking one date in time for a net payment or net receipt of swap payment does not accurately or objectively reflect the true economics of the contract," the office said in the e-mailed statement.

Goldman Sachs is working with the state to make adjustments in light of "changes in market conditions that have made the transaction less attractive," spokesman Michael DuVally said in an e-mail. "The economics and risks involved in this transaction were fully understood when the authority decided to enter into this swap six years ago."

Acacia Financial Group Inc., the Marlton, N.J.-based adviser on the fixed-rate bonds that replaced the auction securities, referred questions to the Office of Public Finance.

"Decisions were made to proceed with the swap," said Vivian Altman, the trust fund's adviser on the original debt issue in 2003, said in a phone interview.

"I can't speak to what discussions they had internally," she said. "I would have no way of knowing. I just have no idea of what information they had been provided."

New Jersey, which Moody's Investors Service called "one of the largest users of swaps in the municipal market," has 28 such contracts outstanding on $4.4 billion worth of debt, according to a monthly valuation report.

The trust fund agreement was made three years before Corzine became governor. Auction-rate obligations involved in the transaction were supposed to allow borrowers to realize short-term interest rates on long-term debt by offering the bonds for periodic resale. The market froze after banks that historically volunteered to buy unwanted securities stopped doing so during the global credit crisis.

Kevin Willens, a managing director of Goldman and currently a director of the MSRB, which sets standards for banks and securities firms in the $2.8 trillion market, presented the swaps proposal on the bank's behalf, authority minutes show.

Charts "described the success rates of swaps," according to the minutes. Willens was not an MSRB director at the time.

New Jersey saved $9.9 million from 2003 to 2008 by issuing the auction-rate bonds instead of fixed-cost debt, the Office of Public Finance said in a report last year.

The trust fund paid $4.5 million in penalty interest payments when the auction-rate market collapsed and some borrowers' costs soared. After it failed to put together a sale of a different type of variable-rate bonds, New Jersey then reissued 11-year notes yielding 4.18 percent in August 2008, according to the Office of Public Finance.

Refinancing the bonds cost $2.1 million, reducing the authority's savings on the transaction to $3.3 million, state records show.

Since then, the fund has paid almost four times that amount on a contract that hedges nothing.

For New Jersey, the swap became "a tool for no purpose," former regulator Taylor said.

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