How millions of Dollars of ratepayer’s money has been put at risk with Collateral Debt Obligation Instruments

Posted: June 21, 2011 by admin in Uncategorized

Background

Prior to 2003 several changes were made to the Local Government Regulations concerning the types of investments that local councils were permitted to accept into their investment portfolios.   In general it was only normal bank accounts, term deposits and Government bonds that were designated as approved.    It is said that because of the pressure for better returns on monies placed with the banks and Government coming from outside the Local Council environment that the menu of “Approved Instruments”  was widened to accommodate higher earning products that naturally one would believe would have higher risks and thus more care would be necessary when considering including them into  portfolios of “approved investments”?

It was the challenge to get higher returns on funds invested and rate-pegging(the stipulation that rates could only be increased by a percentage amount set by the State Government which was somewhere around the inflation for the current year) that forced local councils to widen their horizons and consider Collateralized Debt Obligations (CDOs)  in an attempt to maximize the return of funds invested.

I suspect the rationale behind this was to ensure that Local Shire Councils would require less grants, rate increases and other type of external funding.

Why is this so?

People ask me “why do you keep harassing Council regarding the expected losses as nothing can be done about it?” My answer to that is, “we need to know what happened so that we ensure in the future that no investments will be made into similar debacles we now know as the sub-prime mortgage crisis.”

We are in our current predicament because there was not enough shared information or understanding by almost all the parties involved in purchasing the CDOs.  You could almost say that the only people in the Know were those creating, manufacturing and some organizations marketing these instruments!

http://www.smh.com.au/business/lehman-hid-true-nature-of-products-20110531-1feqi.html

However, there is something positive that can be achieved from this mess.  If we gather and make widely available information and knowledge about how these toxic assets were purchased, we all will then have better understanding and be a little wiser when similar schemes are proposed.  Hopefully this will avoid the present situation, which sees all affected parties taking costly legal actions in an attempt to retrieve some of the financial losses made via CDOs

So……………..

How could the present situation have been avoided?

There are three simple ways we could have avoided this mess:

  • firstly by not following the HERD ;
  • secondly,  getting competent advice from other than those organizations marketing the CDOs; and
  • finally,  ensuring that ‘due diligence’ is done so as to gain a good understanding of the products sold as ‘investments’  were investment vehicles that were suitable for the Shire Investment Portfolio.

Let’s go through each of these points:

  • Not following the herd

The herd is a term used in financial markets which describes those of us at the bottom of the knowledge food-chain.  At the top are the investors led by the pProfessionals who receive the first bite at the news & other types of facts relevant to the financial markets. Then there are the Bankers, the high income clients and the rest of us are at the bottom – the herd. The Eurobodalla Shire Council would fall into possibly the second group and the Individual Ratepayers the last group.

The name of the game is to move the money from the ‘weak-hands’ (or the herd) to the ‘strong-hands’ (the predators at the top, following the ecological analogy) to put it in a more cynical perspective.

  • Competent Advice

The Council has a number of sources of what should be independent competent advice. These include:

Council’s internal intellectual assets

As the Eurobodalla Shire Council employs about seven (7) directors to manage the various functions of our Shire, one would have to assume that there is sufficient expertise available to ensure that all the demands put on the Council for public-works and services can be carried out  by  the  specific departments of Council.  Functions that would include the basic job specifications of planning, investigation and other functions allotted to them.   This includes access to the Local Government Association of NSW fund of expertise mentioned previously.

Local Government and Shires Association

The Local Government Association of NSW should have been aware via the combined expertise and experience of all its members about the methods and workings of those marketing investment products to Local Councils.   I believe that the Eurobodalla Shire Council contributes somewhere in the vicinity of $40,000 to this body. Furthermore, with a search of the World Wide Web a mass of information and warnings were available from 1998 onwards about Collateral Debt Obligations.  Her is an example of what is available:

http://www.tavakolistructuredfinance.com/bloomberg5.html

www.streetfortreasurer.com/articles/01-072007-Toxic-Debt.pdf

  • Due Diligence

What in fact seems to have eventuated was that outside advice was accepted from Grange Securities and others who were the final end of the line of Financial Purveyors of Collateral Debt Obligations; the very same organization apparently that sold, advised and supplied CDOs manufactured by Investment Houses and  Investment Departments of Banks;  hardly in any persons language – INDEPENDENT!   Was there possibly a ‘conflict of interest’?  Grange Securities acted as Agents of these firms and was eventually sold to Lehman Bros for millions of dollars.

http://www.moneymanagement.com.au/news/lehman-brothers-buys-grange-securities

What Grange and Lehman received as fees or commissions is not publicly available because of the present Court proceedings in Sydney.   The original presentations by both Grange Securities and Lehman Brothers have been requested from the Eurobodalla Shire Council but this information was refused on the grounds of the current matters being contested in the Supreme Court.

When they do become available I will post the presentations up so that we can all see what the Council was being told (and sold) by Grange Securities.

Coming up:

In my next Newsletter I will attempt to show that these CDOs were not in fact Investments at all but a kind of OPTION or INSURANCE POLICY.   Whether or not the advice received by Councils spelled this out in detail cannot be ascertained until after the Court cases which could be well into the 2020 perhaps!     We are now spending good money on legal fees attempting to retrieve some of the losses incurred through the purchase of financial instruments that it is alleged were sound and would deliver.    The question is – did we expect to get cents in the dollar back or a reasonable return?

Joe Potts

June, 2011

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