How Bethlehem Area School District Got Screwed

When I think of Bethlehem Area School District, the first image that comes to my mind is that of drug dealing former Nitchamnn middle school principal John Acerra, who was arrested in his office ... naked ... watching porn ... with sex toys and pictures of me nearby. Others think of the whitewashed report of that close encounter of the strange kind, or the goofy fight between Freedumb and Liburtie parents over home field advantage in the face of the lowest standardized test scores in the Lehigh Valley. Morning Call columnist Bill White has recently fixed his glare on the high salaries paid to administrators. Swaptions are not the first thing on most people's minds.

Hell, most of us don't even know what the hell they are. As explained in Wikipedia, a swaption "is an option granting its owner the right but not the obligation to enter into an underlying swap. Although options can be traded on a variety of swaps, the term "swaption" typically refers to options on interest rate swaps."

Still confused?

You're not alone. According to Bloomberg, at least fifteen school districts since 2003 have been shnookered into interest rate swap deals worth $28 million. Schools have raked in $15 million, but banks and advisers have taken the rest as fees. This is thanks to a law passed unanimously in the land of midnight payraises. Of course, financial advisors lobbied heavily for that bill's passage. And shortly after that, Bethlehem got nailed with eight swaps on just two bond issues.

Here's what happened, according to Bloomberg:

At an April 2005 meeting, Les Bear, of advisory firm Arthurs Lestrange & Co. in Pittsburgh, told the school board by arranging two interest-rate swaps tied to $110 million in bond issues, the 15,350-student district could generate more than $11 million over 25 years.

School finance director Stan Majewski supported the plan. "Mr. Majewski commented that we all try to surround ourselves with people who know more than we do," minutes of the meeting say. "He believes Arthurs Lestrange is the best public financing department of any organization in this country."

None of the board members asked Bear or Majewski how much the district would pay for the swaps, the minutes show.

A month later, Lestrange, working with a Lancaster, Pennsylvania, firm called Access Financial Markets, negotiated two swaps with JPMorgan and Morgan Stanley without competitive bidding.

$3 Million Fees

So far, the district has taken in about $900,000 from the deals, Bloomberg data show. That compares with $3 million in transaction fees. Lestrange and Access made $630,000 each for arranging the swaps, according to school district records. New York-based Morgan Stanley made $840,000 and JPMorgan received fees totaling $900,000, Bloomberg data show. Lestrange and Access earned a fee 10 times more than the Easton Area School District, Bethlehem's neighbor, paid its adviser on a comparable interest-rate swap in 2004. In a memo to school board members, Majewski said the fees included annual interest rate monitoring that would cost the district hundreds of thousands of dollars.

Bear of Lestrange and Matthew Kirk of Access didn't respond to requests for comment. The rates the banks charged Bethlehem were twice the average for comparable swaps deals. In this kind of swap, in which both sides pay floating interest rates, a bank calculates its fees by subtracting an amount from the rate it will pay.

In the average deal of this type, banks lower the rate by 0.06 percent, says Jeff Pearsall, a managing director of Philadelphia-based Public Financial Management, the largest municipal adviser in the U.S.

JPMorgan subtracted 0.13 percent in the Bethlehem deal, and Morgan Stanley lowered its rate by 0.11 percent. Morgan Stanley spokeswoman Jennifer Sala declined to comment.

One of the financial advisors who pushed for this new law is Elmer Heinel, who has kicked in $141,245 since 2000 to state lawmakers. Locally, this includes $550 to Doug Reichley, $700 to Pat Browne, $2,500 to the Lehigh County Republican Committee, $900 to Craig Dally, $200 to Karen Beyer, $500 to Judge Simpson, $850 to Charlie Dent and $2,100 to the Lehigh Valley Republican Action Team. But that's peanuts compared to Dave Eckhart, whose firm (under investigation) publicly supported this bill. During the same period, he threw $469,400 at Pennsylvania elected officials and made sure the Dems got their sugar, too - $47,000 to Vince Fumo, $22,000 to Ed Rendell, $5,900 to state rep. Bill DeWeese and $10,000 to the state Democratic party.

Pay to play is alive and well.