A deal too good to refuse

Quite a story from Bloomberg on California's disastrous $4.5 billion long-term debt offering in October that left the state with 8 percent less money than expected and an extra $123 million in interest costs. All this happened because, as the story begins, "the offer from Goldman Sachs Group Inc., JPMorgan Chase & Co. and Citigroup Inc. was too good to refuse." Basically, the state agreed to forgo competitive bidding on the bond offering in return for more money and a lower bill to taxpayers. So what happened?

The underwriters left [California Treasurer Bill] Lockyer "standing on the platform alone," said Christopher Taylor, former executive director of the Municipal Securities Rulemaking Board in Alexandria, Virginia, a self-regulatory organization. Taxpayers "probably didn't get their money's worth because California only got someone taking orders," he said. "They didn't get somebody out there that had any really strong incentive to sell." Banks don't want "any unsold bonds hanging around," so they prefer to help states set rates and see if the bonds sell, as happens in negotiated deals, Taylor said. If demand falls short, the dealers say, "Listen, we can't sell this" without higher yields, he said. "It's a wonderful world that the dealer community has created -- just fees, no risk."

Lockyer says that having an auction instead of the no-bid process would have led to even higher interest costs. Goldman, JP Morgan and Citi wound up making $12.4 million on the deal.