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Morgan Keegan’s Bond Derivative Deals Backfire For Many Municipalities

When the small town of Lewisburg, Tennessee, needed help paying the interest on a bond for new sewers, officials thought investment firm Morgan Keegan had the answers. Little did they know that the advice and the poorly conceived municipal bond derivative deal Morgan Keegan came up with eventually would mean millions of dollars in unanticipated costs, leaving Lewisburg and other municipalities like it financially devastated. 

Lewisburg is just one of a number of cities in Tennessee that has found itself burned by municipal bond derivatives and the advice of Memphis-based Morgan Keegan. Today, instead of lower interest rates on its sewer bond, Lewisburg is looking at annual interest payments that have quadrupled to $1 million, according to an April 7 article in the New York Times.

Officials in Lewisburg say when they first entered into the transaction with Morgan Keegan, they never realized the possible ramifications of municipal bond derivatives and the fact that interest rates could skyrocket depending on economic conditions. When the inevitable happened and the economy went south, Lewisburg quickly got a dose of its new reality.

According to the New York Times story, at the time Lewisburg sought the advice of Morgan Keegan, regulations in the municipal bond marketplace were so lax that in Tennessee the investment bank dominated virtually every component of the derivative business. Since 2001, the firm has sold $2 billion worth of municipal bond derivatives to 38 cities and counties.

The predicament facing cities like Lewisburg has led federal regulators to now consider restricting the use of municipal bond derivatives altogether. That news is of little comfort, however, to Lewisburg or Claiborne County, Tennessee, which has been trying to get out of its municipal derivative contract with Morgan Keegan for months. The cost to do so: $3 million, a sum that the already financially strapped county cannot afford.

As for Morgan Keegan, acting in the dual role of investment adviser and underwriter for transactions involving municipal bond derivatives has served it extremely well in Tennessee, with the investment bank raking in millions and millions of dollars in fees.

Municipal bond experts say there is an obvious bias when an investment firm like Morgan Keegan gives advice to municipalities regarding derivatives and then turns around to underwrite the deal itself. Several states, in fact, prohibit a single firm from acting in the role of both adviser and underwriter.

“It’s like the lion being hired to protect the gazelle,” said Robert E. Brooks, a municipal bonds expert and a professor of financial management at the University of Alabama, in the New York Times article. “Who was looking after these little towns?” 

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