Nov. 13 (Bloomberg) -- Pennsylvania should ban the use of interest-rate swaps by municipalities and raise the bar for issuing debt to avoid the type of fiscal calamity that besets Harrisburg, the city’s former receiver told state lawmakers.
Taking both steps “would flush out any serious problem situations and avoid the sort of irrational piling on of inappropriate debt” as occurred in Harrisburg, David Unkovic, who quit as the capital city’s receiver in March, said today. He also recommended a criminal probe of Harrisburg’s bond deals.
Borrowers from California to Massachusetts and Italy have paid at least $4 billion to banks to end such agreements after the deals failed to protect them from changes in interest rates. Philadelphia, the fifth-largest U.S. city, may lose more than $570 million on swaps, Unkovic said, citing a January report. A state ban on municipal swaps would be a first in the U.S., Peter Shapiro, managing director of Swap Financial Group LLC, said by telephone before the Senate Local Government Committee hearing.
“Every aspect of daily life in Harrisburg -- water service, sewer service, police protection, fire protection, trash collection, economic development, parks and recreation -- has been negatively affected” by financing deals tied to a municipal incinerator in the city, Unkovic, 58, said in prepared testimony for the panel. He cited his experience as receiver.
Borrowing and interest-rate swaps connected with a trash-burning power plant, which doesn’t produce enough revenue to pay off more than $300 million in debt, “poisoned” Harrisburg’s relationship with other state and local governments, with the credit markets and even with suburban residents, Unkovic said.
Unkovic stepped down as Harrisburg’s first state-appointed receiver March 30, two days after calling for state and federal probes of the incinerator deals. William B. Lynch, his successor, is implementing a recovery plan drawn up by Unkovic, including the sale of assets such as the trash-fired generator.
“There is a small group of probably 25 to 50 people and institutions who collectively caused this devastation, because of what was done in the incinerator financings,” Unkovic said, without naming any individuals or companies. “As a group, they did this terrible thing.”
A forensic audit of the incinerator deals showed that laws ensuring that the debt taken on to finance the plant would be repaid from its revenue “were stretched or twisted or distorted or ignored or violated,” Unkovic said. He recommended tightening disclosure rules covering municipal borrowing and increasing state oversight.
A lawyer specializing in municipal finance for more than 30 years, Unkovic also urged lawmakers to name a special prosecutor to examine the incinerator transactions. He recommended creating new criminal penalties for public officials and legal and financial professionals who knowingly falsify information tied to such deals.
If municipalities aren’t banned from using interest-rate swaps, “there will be more multimillion dollar fiascos” similar to Harrisburg, Unkovic said. He joined Pennsylvania Auditor General Jack Wagner, who in 2009 recommended banning local governments from using the deals, in which two parties trade payment obligations to hedge against changes in rates.
No state explicitly bans cities and towns from entering into swaps, said Shapiro, who also testified at the hearing. He said there are states, such as New Jersey, that limit contracting powers of municipalities, which effectively bar them from the deals.
To help Harrisburg’s negotiations with creditors, Unkovic said the Legislature shouldn’t extend a measure preventing the city from entering bankruptcy protection. The ban, which has been extended once, will automatically expire Nov. 30.
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