Friday, April 11, 2008

CDO Investing: The Real Question

The Waukesha School District, burdened by massive future-pension obligations for its retiring teachers (and other employees) decided to make an investment and use the proceeds to fund the obligation.

The investment utilizes the District's ability to borrow money cheap; they turned the borrowed funds around and bought CDOs (Collateralized Debt Obligations) at a higher interest rate.

This is called "arbitrage," and it's a common device with municipal entities. Their borrowings are tax-advantaged and CDOs are not.

Well, bye-and-bye, the CDOs were 'marked to market,' and with the deteriorating state of the mortgages (in part) backing those CDOs, the School District was given a margin-call; they may have to borrow another buncha money to shore up their position.

This caused a stir. And an excellent question was raised by a Waukesha taxpayer, Steve Edlund.

"It is unethical for my school district to create and operate a margin account with my house (property tax obligation) as collateral for a borrow[ing], without my permission (referendum) to invest in uninsured securities in hopes of supplementing payment obligations created by the district of their own mismanagement and demands of the public employee unions," he wrote.

Hmmmm. Did the District put Edlund's house up as collateral? Interesting (cough, cough) question, no?

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