How Would You Define "Conflict of Interest"?

... That's what I thought. Me, too.

Today's New York Times carries an excellent, if depressing, piece by Gretchen Morgenson: "Exotic Deals Put Denver Schools Deeper in Debt".

It turns out that not-as-financially-savvy-as-they-thought-they-were individuals weren't the only ones targeted for bizarre financial instruments in the runup to the Wall Street implosion.

According to Morgenson's article, early in 2008, the Denver Board of Education, seeking to fill a $400 million hole in its pension fund, turned to JP Morgan Chase for help.

The bankers said that the school system could raise $750 million in an exotic transaction that would eliminate the pension gap and save tens of millions of dollars annually in debt costs -- money that could be plowed back into Denver's classrooms, starved in recent years for funds.

Yeah, I know. It smells, now. But then (the deal closed just weeks after the failure of Bear Stearns), well, let's just say that there were still a lot of house-flippers out there, and the Denver school board, as Morgenson puts it, "essentially made the same choice some homeowners make: opting for a variable-rate mortgage that offered lower monthly payments, with the risk that they could rise, instead of a conventional, fixed-rate mortgage that offered larger, but unchanging, monthly payments."

To date, the school system has apparently paid at least $25 million more in interest and other fees than it had originally expected. While they would like to renegotiate, to undo the deal completely, Denver would have to pay a huge "termination" fee.

The deal is getting extra attention in part because Michael Bennet, the superintendent of schools who, with the system's operating officer, pushed hard for the deal, is now a United States senator from Colorado.

But I found this paragraph the most telling, and the most depressing:

A spokesman at JPMorgan, which led the Denver deal, declined to comment. Royal Bank of Canada, which acted as the school system's independent adviser even though it participated in the debt transaction, declined to comment. Denver school officials said that they had agreed to sign a conflict waiver with Royal Bank of Canada. [Emphasis added]

Even though it participated in the debt transaction?!?! How could one ignore that level of conflict of interest?

I am not going to throw all the blame for this at Royal Bank of Canada, however. It would be easy to say, Oh those horrible greedy bankers, and leave it at that.

Sadly, there seems to be a fair amount of responsibility to spread around.

For example, unlike many school superintendents, now-Senator Bennet had extensive private-sector financial experience. Morgenson reports that "Mr. Bennet handled investments and structured financial deals for the Anschutz Investment Company, a private concern owned by the billionaire Philip Anschutz that has a stakes in telecommunications and oil." The district's chief operating officer (and currently superintendent), Thomas Boasberg, also had private-sector experience, having been a mergers and acquisitions deal maker for a telecommunications company.

Morgenson further reports that, according to then-members of the board of education, "the bankers' presentations for the 2008 debt deal outline its risks only in broad terms... [and] had not discussed problems in the variable-rate debt market that arose the previous year -- a development that would have alerted them to troubles they might have had securing a manageable rate on the debt they were refinancing."

Of course, if we're looking at responsibility, it's worth asking those same board members, How is it that it was OK with you that "for years, the school system had not met its required annual pension payments to ensure a fully funded plan"?