As the global economic crisis unfolds, a group of school districts in Wisconsin has found itself at one end of a chain of exotic and risky financial products. At the other end is a troubled German bank — and smack in the middle is the school districts' $200 million investment.
When school officials plunked down the money, they believed the investments were as safe as a corporate bond, David Kestenbaum and Adam Davidson of NPR's global economics unit, Planet Money, tell host Steve Inskeep. But now they're waiting to see how — or if — their investment weathers the financial crunch.
The districts' finances — and their teachers' retirement plans — are entwined with the fate of German bank Hypo Real Estate, which in turn impacts municipalities from California to New York.
Shawn Yde, a finance official for the Whitefish Bay School District, said that when he realized the extent of the risk, "My heart just sunk. I mean, it's one of those times where you just absolutely got sick. How did we get here? We don't invest in these things."
In reality, they bought what financial professionals call "toxic waste," a complex financial instrument known as a synthetic collateralized debt obligation.
The schools put in $35 million — and borrowed $165 million more — for an enterprise that could be compared to selling insurance to homeowners along the coast, Kestenbaum says.
In most years, the arrangement would likely yield a profit. "But right now, we have a financial hurricane bearing down," Kestenbaum said.
In this case, the CDOs were used to insure corporate bonds — leaving those who invested in them vulnerable to steep losses if the corporations don't cover their debts.
School officials have filed a lawsuit, saying they were misled by the brokers who sold them the financial instruments.
The school districts borrowed money from Depfa, an Irish bank specializing in municipal financing around the United States, which was bought by Hypo Real Estate last year.
And Dublin-based Depfa came close to bringing down its German parent a few weeks ago, said Davidson. The news that Hypo — one of Germany's biggest banks — was imperiled nearly threw the country's economy into total chaos, forcing the German government to step in and save both banks with a $75 billion bailout.
But now Depfa's near-collapse is making it harder for local governments across the United States to get money for services and development — especially as more city agencies report that they were lured into CDOs and similar investments.
One of the institutions that is closely connected with Depfa's financing is the New York Metropolitan Transit Authority. With Depfa and world money lenders now in trouble, the MTA will now have to pay millions more to borrow money for projects, with costs likely to be passed on to mass transit riders.
"Municipalities all over the U.S. tied themselves up with this global web of advanced finance that just all went bad," Davidson said.
NPR is reporting this story in collaboration with The New York Times.