Sunday, December 18, 2011

Risky Business

The Journal Sentinel is promoting, again, venture capital.

"The State of Wisconsin Investment Board (SWIB) said it will commit as much as $80 million to Danville, Calif.-based Northgate Capital. This is the first time the $85 billion public pension fund has had the opportunity to invest with the top venture capital pools, which are willing to take public funds' money because the weak economy has made it more difficult for the funds to lure private investors."

"We believe the current venture environment offers an unprecedented opportunity to access top-tier funds and invest into a climate with favorable valuations," Chris Prestigiacomo, SWIB portfolio manager, said. "Both should translate into higher future returns that meet SWIB's fiduciary duty to the Wisconsin Retirement System beneficiaries."

The Whitefish Bay school district's trust fund (along with 4 other districts) wanted to 'get a piece of the action' and leverage funds with some Wall Street high-rollers, with the hopes of cashing in. 

"So an old-fashioned financial romance began: Supply (Wall Street’s hottest financial products) met Demand (school districts seeking to build up their OPEB trust funds). It looked like a perfect match."

"Their trust fund for retirees’ benefits could accumulate almost $9 million in seven years by borrowing and investing $80 million. These CDOs would pay them over 1 percent more than what it would cost to borrow the money. The more the schools borrowed, the more they would make. It was practically free money. What was not to like?"

It didn't quite work out that way. The Wall Streeters made their money; Whitefish Bay, not so much.

"Whitefish Bay and the other school districts got something substantial too: nearly all of the risk. The school districts are about to lose all of their initial $37.3 million. They will also lose another $165 million of the money they’d borrowed from Depfa. As soon as the default rate is reached, $200 million will go to pay insurance claims to the Royal Bank of Canada. And the schools still will owe the full $165-million Depfa loan, and they will still owe on the bonds they had issued to raise much of their $37.3 million in collateral. The risk of reaching total default currently is so high that Kenosha’s entire piece of the CDO investment ($35.6 million) was valued at only $925,000, as of January 29, 2009—a decline in value of $36,575,000. Now the school districts are paying hefty fees not just to bankers but also to lawyers, as they sue to unwind the deal and recover damages."

We've been warned.

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