The Goldman Munipal Conflict Non-Story Refuses to Die

Remember the silly ProPublica report about alleged Goldman Sachs conflicts of interest in California? ProPublica subsequently took its act on the road, and used exactly the same Goldman report to produce an almost-identical article about New Jersey, in the Newark Star-Ledger. Except that one was even weaker, because in this case the state officials weren’t playing ball:

Tom Vincz, a spokesman for the New Jersey Treasury Department, declined to comment. Douglas Love, a member of New Jersey’s State Investment Council, which sets investment policy for the state’s pension funds, said he was not troubled.

"Research is research; it’s supposed to be independent," said Love, chief investment officer for an insurance fund. "That is proof they’re independent."

In fact, the only person troubled by the allegations in the second article was exactly the same person who was troubled by the allegations in the first article: Geoffrey Heal, a professor at Columbia. It’s all quite a song and dance to make out of one person’s opinion that there might be a conflict of interest at an investment bank — especially considering that investment banks, as the intermediaries between buyers and sellers of the same securities, always and by definition have conflicts of interest.

The worst bit about the second article, however, was the headline: "Goldman Sachs Sells New Jersey Bonds, Then Warns of Default". Nothing in the article suggests that Goldman actually did warn of default; instead, it simply opined that CDS spreads on the bonds in question were likely to rise. ProPublica, here, is suggesting that Goldman thinks New Jersey might default; I don’t think Goldman ever thought that.

ProPublica is right, however, that warning of a possible default is something which could do serious harm to municipal finances. If Goldman uncritically published something like this, I can imagine that New Jersey’s officials would be very angry:

New Jersey, like many other states, is facing a budget crisis, leading some to worry that it may default on part of its bond debt.

"Of the approximate $32 billion in outstanding debt in New Jersey, approximately $28 billion was never approved by the voters," John L. Kraft, a bond attorney in New Jersey, told us.

The state has no legal obligation to repay that portion, according to Kraft, because the contracts specified that the repayments would only be made if the legislature voted to approve them every year.

"Faced with budget deficits of many billions of dollars, and also being required to adopt a balanced budget each year, in these economic times, it’s possible that the state would choose to spend its money on essential purposes such as aid to the elderly and welfare, education, rather than making a debt service payment that they’re not required by law to make," Kraft said.

Of course, that didn’t come from a Goldman report, that came from another article by ProPublica’s Sharona Coutts. Is she being deliberately inflammatory here? I don’t know, and in fact I’d let her fall off the radar, until Bloomberg’s Joe Mysak, for reasons known only to himself, decided to resuscitate the story today. It’s still a non-story, and it still teeters improbably on a single Goldman recommendation dating back to September, but Bloomberg’s imprimatur gives it more legitimacy than it had before.

The biggest irony of all is that Goldman was completely and utterly right. As you can see, when Goldman issued the report, credit spreads on municipal debt (the MCDX index) were significantly tighter than spreads on investment-grade corporate debt (the CDXIG index). But that’s no longer the case: the MCDX is now at 330bp, while the CDXIG is at 269bp.

Goldman’s strategists, it turns out, were inspired: if you shorted municipal debt in September and hedged by going long credit more generally, you would have made a lot of money by now. Does it really make any sense to say that the few people who are actually able to call this market correctly should shut up and say nothing, just because municipal issuers sometimes use Goldman to underwrite their bonds? Of course not. But for some reason, ProPublica — and, now, Bloomberg — doesn’t seem to understand that.