Understanding the Municipal Bond Market Scam - a California Trend

By Banksy

Once upon a time, local government bonds were considered a safe haven, where it was guaranteed you would get your money back with some earned interest. But recent local government bankruptcies challenge that notion. Since 1994 - starting with Orange County - governments have been filing bankruptcies in the billions of dollars. Investors should not put blind faith in local agency bonds, especially in corruption-stricken cities. It is highly likely bondholders will lose their investments when such local corrupt agencies file bankruptcy. As an example to stress in alarming trend in California and perhaps elsewhere, this article will show how the City of Baldwin Park misrepresents its financial accounting to deceive investors.

Before understanding the California municipal bond crisis, we need to look at the Godfather of corporate scandal: Enron. Enron was an energy company that engaged in "cooking the books" by stating every quarter it was earning incredible profits, when it was actually hemorrhaging money. In a nutshell, Enron did this by hiding their losses in other alter-ego corporations. Hence, Enron's books always showed it was making a profit. (It was also gauging California's deregulated energy market.)

Although this is obvious, the basic rule of investing is that investors want to put their money in winners and not losers, because winners will bring you back more money over time. Enron looked like a winner. It kept reporting profits, but it was really a sinking ship.

At the end of the day, Enron executives, like Ken Lay and Jeffrey Skilling fleeced not only investors, but also employees from their pensions. The main takeaway point is that Enron had to lie about its finances, so investors would keep putting money in. Only then, could the Enron executives steal stockholder funds.

Let's come back to Baldwin Park, which is doing the same thing. Yet, cities can't sell stock. Instead, they sell bonds - which means investors are guaranteed to get their money back, plus interest in loaning government agencies money. (What they don't tell you, is you don't get your promised money back if the local agency files for bankruptcy.)

So, like Enron, Baldwin Park has made the City's finances look good, when it's really a sinking ship. The city's finance director, Rose Tam, did this in at least two ways, possibly three. First, it alleges that it has $22 million more in assets in something called the Baldwin Park Successor Agency. But in 2013, Tam reported that the Successor Agency owes $64 million.

It can't be true that the Successor Agency is in the plus and negative at the same time. Can something be boiling hot and freezing cold at the same time? No. It appears that this is an outright lie.

Second, also like Enron, the City took the employees' pension. The City has $51 million more in pension debt than its reporting. In other words, the City's financial statement doesn't reflect this owed money.

Like Enron, it took pension money from the employees, and never put it with its investment agency, CalPERS. In total, Baldwin Park owes at least $119 million, very little which appears to be in assets. (I reported earlier it was $117 million, but I found another loan recently for $2 million).  That's almost 400% or 4 times the amount of debt compared to the income stream the city brings in per year.

To give an analogy, Mark makes $60,000 a year, but Mark has $240,000 in credit card debt, which is growing still. Almost $100,000 of that is at a really high interest rate. He needs to borrow more to pay off the ballooning old loans. He asks you to borrow some money and promises to pay you back with interest. Do you believe him? Would you loan him the money?

Third, the City alleges it has $12-$14 million in cash. But when I looked at the books, there was more like $6-$8 million. The city refuses to provide proof in the form of bank statements that it has this much money.

Since I wrote my last article, there have been other red flags that echo the Enron scandal. Enron hired the firm Arthur Anderson to audit its books. Guess who else used Arthur Anderson? Worldcom. And Worldcom, at that time point, was the largest bankruptcy in human history, at $3.8 billion. (Bernie Madoff later broke that record.) Arthur Anderson was complicit in both corporations' accounting fraud.

Like Enron, the City's independent accounting firm, Vasquez & Company LLC is in hot water. As of March 2013, Los Angeles County has sued Vasquez for $9 million for not doing its basic job in auditing. Apparently, a scam artist, under a nonprofit, fleeced the county and other agencies out of millions.

Has the Vasquez company been doing its job when it verifies Baldwin Park's audit? I don't think so; if it did, it would have asked questions about this Successor Agency like I'm doing.

Also, a red flag is that a family member of Baldwin Park's former Mayor is associated with the underwriter (the entity that will loan the city the money) of its forthcoming bond for $55 million. Two sources allege that Carmen Vargas, Vice-President of Ramirez & Co., the underwriter, is the sister of Fidel Vargas, former Mayor of Baldwin Park. These facts highlight the lack of independent oversight by interrelating agencies.

I've been asking numerous questions about Baldwin Park's finances currently. Allegedly, the city attorney (and others) have ordered for the finance director not answer any of my questions by email. Then, the city said it would answer all my requests by public records act requests. Now the city says it won't send me any letters by public records act, because I haven't purchased a business license this year, but I haven't even been residing in Baldwin Park for over a year. And one doesn't need a business license to make a public records act request.

Like Enron, questions into the city's financing are met by fierce hostility. The ex-CEO of Enron called an analyst an "a**hole" after he asked for Enron's balance sheet.

But unlike Enron, Baldwin Park is not a corporation; it's a government agency. Under law, the City must provide answers and not give taxpayers the runarounds, because a city exists to supposedly serve the people. If questions are asked, especially basic ones about the city's finances, answer must be provided. But like Enron, under violation of law, the City refuses to provide an accurate balance statement of how much it really owes. If everything was really clean, the city would have no problem easily and quickly answering basic questions.

Currently, it appears that California's municipal bond market may be one alarming scandalous trend. The Securities and Exchange Commission (SEC) is investigating Montebello Unified School District (MUSD) for potential fraud with the issuance of their bond. (Incidentally, the financial officer at MUSD is Mark Scavarny, former Superintendent of Baldwin Park School District.) Like Baldwin Park, the underwriter for MUSD's bond is Ramirez & Co. Also, the SEC popped the City of Beaumont for also cooking the books. Later, news surfaces that $43 million was embezzled through over 40 bank accounts. Including Baldwin Park, here are at least three cases that show a trend in potential bond fraud.

Given that the Parks and Recreation Director, Manuel Carrillo has been caught laundering money through his sham nonprofit, I wouldn't be surprised if he's been doing this for previous bonds and wants to do this with the ones coming up. (It almost makes me wonder if this whole bond racket is a money laundering scheme, like the one Bernie Madoff was involved in.)

How do we proceed from here?

Investors and bondholders need more answers. Like Enron, how much did Baldwin Park loan its officers and employees? It won't say.

Also, like Enron, where did the previous $66 million that was borrowed go? Accounting needs to be provided.

And finally like Enron, you know an entity is at the end of its ropes, when its borrowing new money to pay off old debt, which is known in the trade as a Ponzi scheme. So, let's get this straight - Baldwin Park wants to borrow $55 million to pay off existing pension debt.

It almost sounds like taking a cash advance on your credit card to pay off part of the mortgage. You heard it here first: If it's a municipal bond from California that's babbling "Buy me" - stay away. "[I]t's Californication."