On a spring night in 2005, Stanley J. Majewski Jr. dazzled the Bethlehem Area School Board with a budget presentation that highlighted how a rise in home sales was triggering "a vibrant local economy" not seen since the fall of Bethlehem Steel a decade earlier.
"The PowerPoint presentation was excellent, the best the board has had, and very comprehensive," then-board member Margaret Williams said, according to minutes of the April 21, 2005, budget hearing.
To ease the financial pain, Majewski said he and the district's financial adviser had a plan for the board to save $400,000. It called for the board to amend two variable-rate derivative bond deals called "swaps," which the district had been using since 2003 to finance construction projects. The recommendation was familiar to the board. At the time of the presentation, it had already approved seven swap transactions, which members assumed were saving taxpayers money.
"It is always the goal to look at trying not just to get savings, but to keep in mind the fiduciary responsibility to the taxpayers to do something without risking the finances of the school district," Majewksi said then.
His presentation ended with the district's long-time financial adviser, Les Bear, president of Arthurs LeStrange Co., explaining the deal, saying "the swap world is about a $250 trillion" global industry that needs cash to survive, according to board minutes.
"That is what this transaction will do," said Bear, whose firm would be paid a fee whenever he finalized a swap deal. "It would feed the system."
The swaps would work to save taxpayers money even in a horrendous economy, Bear said. "It enhances the transaction almost in the worse-case scenario."
The board approved Bear's and Majewski's swap plan in May 2005, even though board members later said in interviews with The Morning Call that they didn't understand it.
Swaps, which come with hefty fees, are layered on top of variable-rate bonds. They are used to hedge against a potential increase in the underlying bonds' variable-rate interest. Swaps also are used to try to make money. The district and investment banks set up predetermined formulas to calculate interest rate swings in an unregulated market. The two sides then "swap" monthly interest rate payments. The side that generates the larger payment receives the difference between the two sums.
While hedging and betting with taxpayer money, the school board ignored the first law of finance.
"If someone offers you something that sounds too good to be true, it probably is," said Temple University finance professor Bruce Rader.
In their quest to save $400,000 in 2005, records show, school directors agreed to two swap deals that would cost taxpayers $1.3 million in swap fees to Bear's company, another financial firm called Access Financial Management, and two law firms. Contracts show the banks backing the swaps paid those fees when the deals closed. The banks then began recouping their fronted costs from the district over time by paying lower bond premiums and adjusting swap interest rates they charged to the district.
The 2005 deals also added more variable-rate debt to the district's portfolio, compounding its risk in a changing market. When the "worst case scenario" hit last year, that risk proved costly.
As of April 1, the district has lost $3.2 million on the restructured swap deals Bear and Majewski recommended four years ago, according to a Morning Call analysis of BASD records.
Signing off with few questions
The district entered into 17 swap transactions -- more than any school district in Pennsylvania -- according to records at the state Department of Community and Economic Development. All but two were sold by Bear, a former school business manager whose firms were paid more than $5 million by Bethlehem taxpayers to handle the swaps and bonds between 2003 and 2008.
Bear's company, Arthurs LeStrange, was purchased by Ferris Baker Watts of Baltimore in 2006. Bear continued as the district's financial consultant with that firm until last summer, when the new board ousted Bear against the advice of Majewski and Superintendent Joseph Lewis.
"[I have] concerns regarding the several moves that Mr. Bear has made in the past," said new School Director Irene Follweiler, according to the minutes of the July 21, 2008, board Finance Committee. "We need to do our homework and find out what is best for the district."
RISKY BUSINESS: Part 2 of a 4-part series