Chicago Pays for Selling Bonds Without Bids

Chicago Mayor Richard M. Daley hired JPMorgan Chase (JPM) investment banker Gene Saffold to be the city's chief financial officer 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 Saffold in March 2009. "We must be creative and bold."

Despite that mandate, Saffold is sticking with one costly tradition: the city's more than two-decade practice of selling long-term bonds through private negotiations with banks rather than through open bidding. Arranging competitive auctions for the $2 billion in bonds Chicago has sold since Saffold took the job would have saved taxpayers millions of dollars, according to internal city documents and a review of its sales by Bloomberg.

In a negotiated deal, the issuer hires a pool of banks to find buyers for its bonds, with interest rates set in discussions with those underwriters. In a competitive sale, underwriters electronically submit the interest rates they're willing to pay, and the lowest bidder wins. While about 85 percent of municipal bond sales around the country are negotiated, according to data compiled by Bloomberg, most cities and states do at least some via competitive bidding. "It helps to do a mix of both," says Daniel Kaplan, president of Kaplan Financial Consulting in Wilmette, Ill. "Chicago is the extreme of issuers that don't do any."

Chicago avoids bidding out its bond deals because local politicians don't want to alienate investment bankers who donate to charities and political campaigns, says J.B. Kurish, a former investment banker in Chicago who is now an associate dean at Emory University's Goizueta Business School in Atlanta. "Firms get chosen to be negotiated underwriters as payback."

Saffold, 55, a native of Chicago's South Side, rejects that charge. He says that industry and city rules prohibit making contributions in exchange for underwriting work. He argues that negotiated sales allow the city to react to changing market conditions and boost participation of minority-owned underwriters, and that they don't cost more. "We've gotten effective pricing," he says, "especially if you look at us compared to other state and local governments."

That's not always the case. On Apr. 12, the city sold $128.8 million of insured, tax-free O'Hare International Airport bonds. It paid about a third of a percentage point more than the Florida Transportation Dept. did on a lower-rated issue sold through bidding at around the same time, 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. Saffold says that attributing the price difference to the method of sale is "misleading."

Saffold's predecessor, Dana Levenson, says he regrets that he was unable to persuade city officials to switch to competitive bidding. "It's something that would have benefited the city of Chicago," says Levenson, who is now head of North American infrastructure banking at Royal Bank of Scotland Group's Chicago office.

The city could use the money. It faces the worst financial crisis of Daley's 21-year tenure. The mayor 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 and eliminating funding for civic traditions such as Venetian Night, a lakefront festival Daley's father started more than 50 years ago.

The bottom line: Chicago could pay lower interest rates on its bonds if it sold them via competitive bidding.

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