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University Of California Deals With Wall Street Banks Could Wipe Out Prop 30 Gains, Report Says

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UNIVERSITY OF CALIFORNIA INTEREST RATE SWAP
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Earlier this month, California voters passed Proposition 30, a ballot measure containing a number of tax increases that will help avoid drastic cuts to the state's higher education system.

But according to a recent UC Berkeley report, all of those gains could be wiped out by a series of deals made by University of California administrators. Many of those officials, the report notes, have close ties to Wall Street firms making millions in profits from the state's cash-strapped institutions.

The report, titled "Swapping Our Future: How Students And Taxpayers Are Funding Risky UC Borrowing And Wall Street Profits," charges that the University of California system has lost almost $57 million dollars on deals so far -- and the losses are continuing at a rate of some $750,000 each month. Potential loses, it claims, may reach up to another $200 million.

During the last decade, UC schools issued a number of bonds to finance medical centers in San Diego, San Francisco and Los Angeles. It's common practice for institutions issuing long-term bonds to enter into deals called interest rate swaps as a way to manage risk. Typically, bonds have interest rates that can rise and fall over time; however, the variability of these rates introduces a measure of uncertainty.

Institutions like the University of California would much rather know exactly how much it's going to cost to service their debt rather than face the possibility of a spike in interest rates, so they enter into agreements with banks that swap variable rates for fixed ones.

At first, interest rate swaps seemed a prudent way to mitigate risk. But these deals were struck immediately before the onset of the financial crisis, which caused interest rates to drop to historic lows. UC administrators took out a quarter of a billion dollars worth of interest rate swaps in 2007 alone, just about the worst possible time to make a bet that rates would rise.

UC Chief Financial Officer Peter Taylor defended the decision to make interest rate swaps in a recent San Francisco Chronicle editorial.

"UC has used swaps only when the advantage is significant," Taylor wrote. "When this comparison is done correctly, it shows that UC has saved more than $40 million through the life of the bonds through swaps."

But report co-author Charlie Eaton argued that defending the decision to make the swaps in the first place is beside the point. "Whether it made sense at the time isn't the question," he told The Huffington Post. "The question is: why haven't they done anything since then?"

Eaton argues that UC management should take the opportunity to renegotiate the swaps to get a lower rate, noting that other institutions such as the San Francisco Asian Art Museum and the city of Richmond, Calif., have saved millions of dollars by taking a similar course of action.

UC spokesperson Dianne Klein explained that the university system hasn't looked to renegotiate because the agreements cover such a long time period that they will still likely to come out in its favor. "The bonds don't mature until 2047, so we think they're still a good deal for us," she said. "It doesn't make sense financially to remove ourselves from the deal."

Klein also noted that renegotiating would likely put a hit on the UC system's credit rating, which is currently higher than the state of California's rating.

The report also criticized of the close relationship between Wall Street and top UC officials. It singled out Taylor, the CFO, for serving on the board of the UCLA Foundation while also overseeing Lehman Brothers' business with public institutions. The now-defunct investment bank struck a deal on an interest rate swap regarding UCLA's medical center that could end up costing the university up to $170 million.

"In 1990, there were no investment bankers on the Board of Regents," said Eaton. "Now you can't turn around without bumping into one."

Klein insisted that Taylor had no personal involvement in negotiating the Lehman-UCLA deal's inner workings.

To avoid similar situations in the future, Eaton and his collaborators are urging the UC system to create a committee that would conduct a thorough review of the institutions' investments.

"We don't need more tuition and fee increases," UC Student Association President Raquel Morales said in a statement. "We need good fiscal management to make financial decisions that are beneficial to all of the communities in the university, including students. The troubling data in this report suggests that we're not getting it."

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