Banks earn millions in fees from states as they plug budget holes with new debt

TRENTON, N.J. – Bank of America Corp., owner of the most-active subprime lender, Countrywide Financial Corp., earned $2.9 million in interest and fees for a line of credit Arizona used through June to balance a budget undermined by the housing-market collapse.

Morgan Stanley, fined $102 million by Massachusetts last month for allegedly breaking home-lending laws, shared in $579,000 of fees from helping run a $120 million bond sale for the state last week that pushed debt payments from this fiscal year into future budgets. Wachovia Bank NA and Bank of America managed $400 million of Chicago transportation note sales in 2009 and 2010 to cover delayed state funds even though Wachovia’s parent Wells Fargo & Co. and Countrywide have been sued by Illinois for steering minority borrowers to subprime loans.

New Jersey, New Hampshire and other U.S. states also needed budget-balancing help that enriched the same Wall Street firms that touched off the longest economic slump since the 1930s by packaging loans to unqualified borrowers. States issued $92 billion of long-term debt since Jan. 1, 2009, generating about $488 million for banks based on the average underwriting fee of $5.30 per $1,000 of bonds, data compiled by Bloomberg show.

“You’re basically rewarding those who got you into the mess,” Arizona’s Treasurer Dean Martin said in an interview.

Martin’s state, with the nation’s second-highest home- foreclosure rate after Nevada, paid Wells Fargo, Morgan Stanley, Goldman Sachs Group Inc. and other firms involved in subprime-mortgage trading more than $5 million to help raise $1.4 billion to balance its budget by selling state offices, prisons and future state lottery revenue, bond-sale documents show.

How to ‘stick it’

“Everyone’s saying they want to stick it to Wall Street,” Martin, 35, said from Phoenix. “If you want to stick it to Wall Street, balance your budget.”

Banks helped states add $43 billion of debt last year, the most since 2004, Moody’s Investors Service said in May, as they coped with what the U.S. Census Bureau says was a $95 billion decline in tax collections from September 2008 to the end of 2009. Cost cuts are needed, too: budget deficits will reach $140 billion in fiscal 2011, which began July 1 for most states, the Center on Budget and Policy Priorities, a Washington-based researcher, said in June.

States have little choice but to use prominent Wall Street firms to market their debt because only the biggest banks have the resources to support such large deals, said John Sinsheimer, Illinois’s capital-markets director.

Services rendered

“To put together a group of small banks would be an unmanageable task,” Sinsheimer said by telephone from Chicago. Illinois paid Bank of America’s Merrill Lynch & Co. $754,000 when it sold $1.3 billion of short-term notes July 20 to make up for a decline in tax revenue. “We pay for services rendered, and we’re getting services rendered,” he said.

Underwriting debt isn’t the only way banks profit from states battered by a decline in tax revenue last year that was the steepest on record, according to the Nelson A. Rockefeller Institute of Government in Albany, N.Y. At least 12, including New Jersey, New Hampshire and Ohio, are hiring investment banks to devise ways to use borrowing to finance or put off millions of dollars of interest payments they can’t afford in their 2010 or 2011 budgets.

New Jersey paid Morgan Stanley $143,000 to sell $94 million of four-month notes July 12 to cover bond payments due July 15 and Aug. 1, according to testimony from the Office of Public Finance meeting at which the deal was approved. The notes will be refinanced in September in a $268 million deal that will defer for about a decade $202 million of payments due this year. The maneuvers will generate $1.2 million in fees, said a June 29 transaction summary Morgan Stanley prepared for lawmakers.

Shifting payments

New Jersey earlier this year paid Merrill Lynch and others more than $3.5 million in a refinancing of $703 million of bonds that shifted $679 million of debt payments due through 2014 into the future. New Hampshire paid $119,000 to UBS Financial Services Inc., a unit of Zurich-based UBS AG, for a $45 million deal that saved $48 million for this year’s state budget by pushing current interest payments into the next nine years, according to bond documents.

“Debt restructuring, in the form of issuing bonds to defer debt service, became a common solution” to budget gaps in 2009, Moody’s said in its report on state borrowing.

Budget-survival tactics that benefit banks extend beyond the state level.

In New Jersey, 56 school districts issued $183 million in short-term notes after the state withheld aid payments due June 8 and June 22, said Richard Vespucci, a spokesman for the state Department of Education.

University Borrowing

Illinois public universities were given authority by the state legislature to issue debt to make up for missed state payments, and Chicago’s Regional Transportation Authority, the second-largest U.S. public transport system, has borrowed $400 million since last year to cover delayed aid. New Hampshire this month used a $25 million advance from its state university, which will be repaid with borrowed funds, to help plug a budget gap.

Suggesting that New Hampshire’s deals will reward firms that caused the state’s budget problems is “simplistic,” New Hampshire Treasurer Catherine Provencher said by telephone from Concord. “The issues are much more complicated and interwoven to make a direct connection,” she said on July 12.

New Jersey Treasurer Andrew Eristoff said the Wall Street bankers’ that states work with are distinct from the banking segments that were involved in mortgage finance.

“It’s a huge company we’re talking about,” he said July 12 after the $94 million Morgan Stanley-led debt restructuring was approved.

Millions in settlements

Massachusetts Attorney General Martha Coakley fined investment banks including Morgan Stanley and Goldman Sachs for funding brokers lending to homeowners who couldn’t afford their mortgages, a violation of state law. Since 2008, she’s won more than $440 million of settlements, according to news releases from her office.

Morgan Stanley was among four co-senior managers of a $120 million Massachusetts debt-restructuring last week and Goldman was part of the 21-firm selling group, bond records show. Both firms admitted no wrongdoing in their settlements with Coakley.

Coakley would not discuss the state’s continued use of the firms, according to her spokeswoman, Amie Breton. Michael DuVally, a Goldman Sachs spokesman in New York, and Jennifer Sala of Morgan Stanley declined to comment.

Illinois suits

In Illinois, Attorney General Lisa Madigan has sued Wells Fargo and Countrywide, the two largest U.S. mortgage lenders before the housing market collapsed in 2007, for improperly steering minority homeowners into subprime loans. The banks’ actions led to a surge in foreclosures projected to reduce Illinois property values by $126 billion by 2012, Madigan’s complaint against Wells Fargo says.

“Plummeting property values mean a shrinking tax base for funds to support governmental services,” the July 31, 2009, complaint against San Francisco-based Wells Fargo says.

Wachovia Bank, which Wells Fargo acquired in January 2009, was senior manager of a $260 million short-term bond sale in June 2009 by the Chicago Regional Transportation Authority. The agency was seeking to cover state payments delayed as part of a budget-balancing strategy. Bank of America’s Merrill Lynch served as lead underwriter on a new $140 million deal on July 19 to help the same agency manage delays in state aid.

Bank comments

Through spokeswoman Robyn Ziegler, Madigan declined to comment. So did Ferris Morrison, a spokeswoman for Wachovia, in a July 19 telephone interview. Bill Halldin, a Bank of America spokesman in San Francisco, said his firm gives states good value.

“Our credit solutions are all priced competitively based on current market dynamics,” he said in a telephone interview July 21.

Arizona’s Martin, a Republican who ended his run for governor July 10, said as long as states don’t cut spending to match reduced tax revenue, Wall Street will be waiting to help them borrow.

“The state is doing exactly the same thing a lot of subprime homeowners did,” he said. “You’ve got a crisis that was caused by too much debt, and states are resorting to exactly the same thing.”