Financial collapse and a Wisconsin school board

by Mathew on November 2, 2008 · 8 comments

I’ve read a lot of articles about the financial meltdown in the United States and elsewhere, about the credit collapse and the rise of systemic risk, etc. — but few of them have contained a paragraph that is as telling as the one below, which is from a New York Times front-page feature on the crisis and its origins, and how the damage has spread:

On a snowy day two years ago, the school board in Whitefish Bay, Wis., gathered to discuss a looming problem: how to plug a gaping hole in the teachers’ retirement plan.

It turned to David W. Noack, a trusted local investment banker, who proposed that the district borrow from overseas and use the money for a complex investment that offered big profits.

“Every three months you’re going to get a payment,” he promised, according to a tape of the meeting. But would it be risky? “There would need to be 15 Enrons” for the district to lose money, he said.

The board and four other nearby districts ultimately invested $200 million in the deal, most of it borrowed from an Irish bank.

How on earth did we get to a point where a school board in small-town Wisconsin comes to the conclusion that in order to bolster its retirement plan, it should borrow tens of millions of dollars from an Irish (but really German) bank and then invest it in a complex, hedge-fund style investment? In what kind of world does that sound like a sensible thing to do?

  • steve

    Always go for the local angle. The Wisconsin school district is now suing the Royal Bank of Canada over this screwup.

    http://www.wfbschools.com/newsfile19425_1.pdf

  • cw

    In a world where apparently it works most of the time (according to the article), or at least until the music stops:

    “Everyone knew New York guys were making tons of money on these kinds of deals,” said Mr. Hujik, of the school board. “It wasn’t implausible that we could make money, too.”

    “Variable-rate debt has helped M.T.A. save millions of dollars, and we’ve been conservative in issuing it,” he said. “But there are risks, which we work hard to mitigate. Usually it works. But what’s happening today is a total lack of marketplace rationality.”

  • http://www.mathewingram.com/work mathewi

    Thanks for pointing that out, Steve. The story makes it clear that RBC was involved (although of course they claim that the board should have known what they were doing — which is arguably true). I probably should have mentioned the Canadian connection, but my point wasn't to assign blame to any specific party — I think the whole thing is reprehensible, and pretty much everyone is to blame.

  • http://www.mathewingram.com/work mathewi

    Thanks, CW — I didn't mention the variable interest-rate part of the story because those kinds of bets aren't really that uncommon, or necessarily unwise (depending on the circumstances). A rural school board getting involved in guaranteeing collateralized debt obligations is a different story altogether.

  • http://smoothspan.wordpress.com/ BobWarfield

    Seems to me Orange County got into deep trouble making derivatives investments not so long ago.

    People never learn.

  • http://www.mathewingram.com/work mathewi

    Thanks for pointing that out, Steve. The story makes it clear that RBC was involved (although of course they claim that the board should have known what they were doing — which is arguably true). I probably should have mentioned the Canadian connection, but my point wasn't to assign blame to any specific party — I think the whole thing is reprehensible, and pretty much everyone is to blame.

  • http://www.mathewingram.com/work mathewi

    Thanks, CW — I didn't mention the variable interest-rate part of the story because those kinds of bets aren't really that uncommon, or necessarily unwise (depending on the circumstances). A school board getting involved in guaranteeing collateralized debt obligations is a different story altogether.

  • http://smoothspan.wordpress.com/ BobWarfield

    Seems to me Orange County got into deep trouble making derivatives investments not so long ago.

    People never learn.

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