Aug. 14 (Bloomberg) -- In Chicago, the city competing to host the 2016 Summer Olympics, not even Mayor Richard M. Daley can do anything about a wastewater financing that forced taxpayers to pay almost $8 million more than they had to.

The Metropolitan Water Reclamation District of Greater Chicago, in a debt offering typical of President Barack Obama’s Build America Bonds, raised $600 million this week, relying on advice from Mesirow Financial Inc., a 72-year-old investment bank based in the city. Within 12 hours, the firm assured itself and investors a profit of at least 2 percent as the bonds appreciated as much as $25.82 for each $1,000 face amount, according to the Municipal Securities Rulemaking Board.

“They got a bad deal, if the people they sold to were able to flip the bonds immediately for a higher price,” said Forrest Claypool, a commissioner in Cook County, Illinois, where Chicago is located. “That means they left money on the table.”

The wastewater debt bonanza is among dozens by U.S. state and local governments whose elected and appointed officials aren’t meeting their obligation to obtain the lowest borrowing costs for the taxpayers they represent.

A 2-percent rise in a bond’s price the day of the sale “wouldn’t happen to an issuer who was on their toes,” said Brian Maher, a senior adviser at Saber Partners, a New York- based consultant to businesses and governments.

The best corporate-finance officers “negotiate tough on the pricing and hold underwriters accountable,” said Maher, who formerly oversaw debt offerings for Exxon Mobil Corp. “That doesn’t seem to happen as often as it should in the municipal market.”

Saber’s chief executive officer, Joseph Fichera, provides independent analysis for Bloomberg News.

No Competition

Like many American municipalities and agencies, the water district eschewed any competition to market the bonds when it selected Mesirow to lead a group of firms that were paid $4.5 million to handle the offering. The sale came less than a week before Daley plans a one-day closure of public libraries and health clinics on Aug. 17 to reduce costs.

Chicago’s metropolitan system runs sewers and wastewater purification services for more than 5 million people in the city and 128 suburbs. The agency should be able to borrow at the lowest cost given that its bonds are ranked AAA, the highest.

While top-rated municipal debt has a default risk one- fiftieth that of top-rated corporate issues, according to Moody’s Investors Service in New York, the agency’s securities were sold with a higher yield than what’s available to similarly ranked publicly traded companies.

The Chicago water securities, which mature in 2038, sold August 11 to yield 5.72 percent, or 1.25 percentage points more than benchmark U.S. Treasury bonds.

Johnson & Johnson

That day, debt of Johnson & Johnson, the New Brunswick, New Jersey-based medical-products company, also due in 2038, yielded 5.33 percent, or 0.84 percentage point more than Treasuries, according to data compiled by Bloomberg. Redmond, Washington- based Microsoft Corp.’s bonds due a year later were yielding 0.91 point more than government debt. Both are rated AAA.

After Mesirow and the other 12 firms participating in the sale allowed the debt to change hands freely, prices for transactions of $1 million or more rose as high 102.58, or $1,025.80 per $1,000 bond, to yield 5.54 percent in the first day of trading.

More than $28 million of the bonds were sold by customers or securities firms in the first two days of trading, at prices higher than the initial offering.

Daley, who has run Chicago since 1989 and was elected for a sixth term in 2007, won credit for taking over the city’s schools, reducing crime, planting 500,000 trees and building the $490 million Millennium Park near Lake Michigan.

Powerless Mayor

When it comes to getting a lower borrowing rate for voters in the water district, Daley is powerless. Lance Lewis, a spokesman for the 67-year-old mayor, said the city has no direct role in management of the agency.

“We don’t have anything to do with the Metropolitan Water District,” Lewis said. “They have their own budget office.”

The agency, which has more than 2,000 employees, is an independent political body governed by publicly elected commissioners. Neither Daley nor Governor Pat Quinn have a vote on the board.

After the district was established in 1889, it reversed the flow of the Chicago River to stop the discharge of sewage into Lake Michigan, pointing it toward the Des Plaines River, where waste could be diluted while flowing into the Illinois River and, eventually, the Mississippi.

Building America

Last year, 83 percent of the agency’s revenue came from taxes it levies, according to the annual report. The receipts rose 14 percent to $475 million, from $417 million in 2007.

The water district saved money for taxpayers with Build America Bonds, said Treasurer Harold Downs. The program, which started in April as part of President Barack Obama’s $787 billion stimulus plan, pays a subsidy for 35 percent of the interest costs on taxable debt sold by states, local governments and universities to finance capital projects creating jobs.

The sewer district will pay an annual rate of 3.72 percent after the subsidy, Downs said. The average interest rate for top-rated 30-year government utilities on Aug. 11 was 5.07 percent, according to Bloomberg data. The 1.25 percentage-point premium over Treasuries is the smallest since the program began.

“I’m really happy with the net result,” Downs said.

Some buyers of the issue at the initial price of 100 sold securities within hours of the sale. On the first day of trading, banks bought more than $21 million of the bonds from customers or other securities firms at prices as high as 102.58, MSRB data show.

No Benefit

Individuals bought some of the district’s bonds, at a price of 103 to yield 5.51 percent, according to the data. Since the authority sold all the debt at the higher 5.72 percent yield, it didn’t obtain the benefit of investors willing to accept the lower return.

Investors have been rewarded with instant price increases on Build America Bonds. Iowa, also rated AAA, raised $221 million with the securities in mid-July. Bankers sold them, mostly to institutions at a price of $994.16 per $1,000 bond and a yield of 6.79 percent.

As the debt was then resold to individuals at a price of $1,021.66, the yield fell to 6.45 percent.

In the Chicago sale, there were about $1.5 billion in orders from investors for the $600 million of bonds, said Dominic Mondi, Mesirow’s head of sales and trading. The price rose in part because Treasuries advanced Aug. 11, he said.

Government Tracking

The sewer debt didn’t fully track government securities prices. On Aug. 11, when the Chicago issue rose more than $25 for trades of more than $1 million, the benchmark government bond gained $15, according to data compiled by Bloomberg.

A day later, when the district’s bonds were still more than $15 above their initial price, Treasuries fell $1.25 from Aug. 10.

“For a deal this size, a tightening of 15 basis points is typical, especially when it’s distributed as well as it is,” said Scott Harris, a trader at Mesirow. “It’s supply and demand. The price action on all this comes in as the bonds dry up.”

A basis point is 0.01 percentage point.

Balky Customers

Some potential investors wouldn’t have bought the Chicago debt if its premium over Treasuries had been narrower, Downs said in an e-mail, without specifying amounts. Reducing the yield on the securities only .05 percentage point, to 5.67 percent, would have saved taxpayers almost $8 million over the life of the debt.

Regulators are growing concerned about sudden increases in bond prices in the secondary market. The Chicago water district’s securities were sold the same day as the Alexandria, Virginia-based MSRB proposed changes to curtail flipping of new issues -- when debt is sold to selected buyers during an underwriting and quickly trades at a higher cost.

“The proposed changes help make the case for competitive rather than negotiated bond sales,” said Robert Doty, president of American Government Financial Services, a Sacramento, California-based adviser to issuers.

Issuers take the best price offered by bankers in competitive sales. During negotiated offerings, they rely on the advice of the underwriter and, sometimes, financial advisers, who say these transactions allow more time to find investors and get the lowest cost.

Local governments and not-for-profits have negotiated most sales since 1977. Last year, such issues made up 86 percent of the $391.3 billion of new municipal bonds, according to Thomson Reuters data.

District’s Advisers

The sewer district’s financial advisers on the sale, Scott Balice Strategies and A.C. Advisory Inc., both of Chicago, were paid $332,000.

Lois Scott, president of Scott Balice, and A.C. Advisory’s president, Adela Cepeda, didn’t respond to phone calls.

Price gains for new bonds immediately after underwriters allow trading is a symptom of “the unhealthy relationship between dealers and institutional investors,” said Christopher “Kit” Taylor, a former executive director of the MSRB.

Setting valuations low enough that investor orders will exceed the available supply allows underwriters to select buyers who “dribble it out through the same dealer at higher prices,” Taylor said. Bankers then have the opportunity to sell the bonds again at still higher levels, he said.

Quick price jumps are less common in the corporate market. After Credit Suisse Group AG sold $2 billion of Aa1 rated 10- year notes Aug. 10 at 99.916, they rose to no more than 100.147 when trading began that day.

Unsold Debt

One day later, the highest price for the Zurich-based bank’s bonds traded in blocks of more than $1 million was 100.49, Bloomberg data show.

Increases in municipal-security prices have become more common this year because bankers set them relatively low to limit the risk that they might be stuck holding unsold bonds, said Dave Johnson, a senior managing director at Ziegler Cos., a Chicago-based investment firm.

To obtain the lowest possible yield, issuers should try to sell at least some of their bonds to individual investors, who typically accept lower returns than institutional buyers, said Johnson, formerly a banker at Citigroup Inc.

Downs, the Chicago water district treasurer, said the bonds weren’t aimed at individual investors because few would want securities that mature in 29 years.

“No special effort was made to attract retail buyers,” he said.

To contact the reporter on this story: Michael Quint in Albany, New York, at mquint@bloomberg.net; Michael McDonald in Boston at mmcdonald10@bloomberg.net.

Last Updated: August 14, 2009 00:00 EDT