Broken Promises

October 4th, 2007
By William Selway, Martin Z. Braun and David Dietz
Bloomberg Markets Magazine

Pastor Willie Williams frowns as he approaches a 10-foot-high concrete wall that's topped by spirals of barbed wire. On a steamy August morning in Pensacola, Florida, he's entering the Oakwood Terrace apartments for low-income residents. Williams, 62, shakes his head as he passes an unmanned security station.

"It looks like a concentration camp," he says.

The 300-apartment complex was on a list of developments that were eligible to benefit from $220 million in bonds issued by a public agency in 1999 to promote affordable housing in Florida. None of the money went to Oakwood Terrace. Not a penny of the $220 million bond issue -- which was underwritten by JPMorgan Chase & Co., the third-largest bank in the U.S., and insured by a unit of American International Group Inc., the world's largest insurance company -- was ever spent on low- income residences.

During the past decade, local governments across the U.S. have issued more than 70 of these phantom bonds -- at least $7 billion of them. That's enough money to pay the salaries of 150,000 teachers in the U.S. for one year, based on an average pay of $46,597. Proceeds from the tax-exempt bond sales are supposed to be used to improve homes for the poor or upgrade health care for the elderly or supply computers to inner-city schools.

Taxpayers never get most of those benefits; the winners are the banks, insurance companies and financial advisers that get paid millions of dollars for crafting these transactions and then profit by using bond proceeds for their own investment gains.

Black Box Deals

The arrangements -- often called black box deals, because they're complicated and mysterious -- sometimes contain secret agreements that promise to pay the financial middlemen higher fees if none of the money from the bond offerings is used to help the public. The agencies that issue the bonds buy them back from investors. The money goes untapped, and the advisers keep their fees.

"You have people who are deliberately trying to find a way around the law, and that's not good for anyone," says Charles Anderson, field operations manager for tax-exempt bonds at the Internal Revenue Service, which is investigating such bond deals. "Clearly these schemes are designed so no money would be used and the maximum money possible could be made by the banks. It's not an accident."

Most of the black box deals consist of so-called blind pools, meaning the money is put in an account that's supposed to be used to finance a basket of projects. Local authorities give their advisers the power to decide how the money in the pool is dispersed -- or whether it's to be dispersed at all.

The Fees

In the Florida deal, a little-known government body called the Capital Trust Agency turned the work over to its advisers: Anchor National Life Insurance Co., a subsidiary of AIG; CDR Financial Products Inc., a Beverly Hills, California-based financial advisory firm; and underwriter JPMorgan. These companies and other middlemen extracted $12 million in fees from the bond issue; the rest of the money went unused.

The AIG unit and CDR had an agreement the agency says it didn't know about that allowed CDR to increase its fees as long as the money wasn't spent for its intended purpose, according to a Nov. 18, 1999, letter from CDR President David Rubin to AIG's Anchor National Vice President J. Franklin Grey.

The less money that was used to acquire and renovate apartments, the more money CDR stood to make, and the less risk AIG's affiliate faced as an insurer since all of the money stayed in a safe account.

Many Names

"Black box deals, pooled deals, blind pools -- people call them lots of things," says Sherman Golden, an Atlanta-based bond lawyer, who says he experienced one of these deals firsthand when he was a municipal official. He says he's seen too many schemes that benefited banks and other promoters at the expense of taxpayers. "The motivation is always the same: the fees," he says.

JPMorgan spokeswoman Brooke Harlow declined to comment. AIG spokesman John Pluhowski says AIG no longer participates in such transactions. CDR President Rubin says his firm has helped people acquire affordable housing.

Black box bond deals do more than deprive local taxpayers of promised spending on homes, schools and hospitals: They also rob the U.S. Treasury of about $100 million a year in revenue, Anderson, 55, says.

The IRS has found that at least 70 of these deals, including the one in Florida, violated U.S. tax laws. The agency has demanded more than $200 million in back taxes and penalties from banks, insurance companies and issuers since 2000. In the Florida case, AIG reached an undisclosed settlement with the IRS, and Capital Trust paid $920,000, agency records show.

'Sense of Fairness'

The damage caused by black box bonds goes beyond the cheating of taxpayers, says Harvey Goldschmid, the Dwight Professor of Law at Columbia University in New York and a commissioner of the U.S. Securities and Exchange Commission from 2002 to 2005. Such abuses give the entire municipal bond market a black eye.

"Fundamentally, what they're doing is harming the integrity of the market and the sense of fairness in the market," says the 66-year-old Goldschmid.

Bond lawyers and advisers who've collected fees from pooled deals blame the IRS for stopping programs that could have helped the public.

Ron Tym, a former attorney in Kansas City, Missouri-based law firm Stinson Morrison Hecker LLP, who was the lawyer behind three black box deals in the Midwest, says housing would have been purchased had the IRS not started an audit. Robert Kolek, a lawyer representing an Illinois authority, says an IRS probe made interest rates soar and stifled a program to provide computers to schools and libraries.

IRS 'Shakedown'

"Maybe the cowboy in this whole game right now is the IRS," CDR's Rubin says. "Maybe there's a shakedown taking place by the service. Maybe the IRS is just using blackmail."

Many of the black box deals in Florida and across the U.S. are sold by invisible public authorities. The Capital Trust Agency, which issued the $220 million in housing debt in Florida, consists of three people working out of a ranch house that's situated behind the police station in the city of Gulf Breeze.

The city, with a population of 6,455, sits on a land spit that juts into Pensacola Bay, 531 miles (855 kilometers) northwest of Miami. Agency officials and the group hold public meetings in City Hall.

There are 35,000 authorities in the U.S., and many have the power to raise billions, according to a 1992 book by the late Donald Axelrod, who ran the Public Enterprise Project at the Rockefeller Institute of Government in Albany, New York. These agencies, the book says, make up a "shadow government" with control over $1 trillion in roads, sewers and buildings. They do so through such means as levying tolls or issuing debt.

No Voter Approval

Legislatures and local governments create the authorities to get around restrictions such as the need to get voter approval for projects, the book says. In many cases, their finances aren't included in city and state budgets.

Banks woo shadow agencies by offering them an alluring pitch: We'll underwrite your bonds for you, and it won't cost you a cent. We'll guarantee your authority an upfront fee for the privilege of doing business with you. Fees to the authorities come from the bond proceeds, and the agencies use the money to fund their budgets, while giving some of it to local communities to build parks, hire police officers or buy fire trucks, local records show.

Too Good

The banks' proposals to authorities often sound too good to turn down, says Mark Schwartz, a Bryn Mawr, Pennsylvania-based lawyer who specializes in corporate fraud and sold municipal bonds as head of the mid-Atlantic region for Prudential Financial Inc. from 1986 to 1989. "It's typically the poorest people who get involved in these scams," Schwartz, 52, says. "That's where the least-sophisticated municipal officials are."

The Community Development Authority, a public agency in Manitowoc, Wisconsin, a city of 33,917 on the shore of Lake Michigan, issued $150 million in bonds in 2002 to improve low- income housing. Bergen Capital Inc. of Hasbrouck Heights, New Jersey, underwrote the bond, and Tym was bond counsel. None of the money was spent; the agency bought back the entire issue, and its advisers collected $1.3 million in fees.

"It's outrageous," says Anne Fiorello, a caseworker at the Emergency Shelter of the Fox Valley in Appleton, Wisconsin, which could have benefited from the Manitowoc bond.

Life's Work

More than 900 people come to the shelter each year looking for housing, she says. Fiorello, 40, says she counts herself lucky if she can help a third of them. She says financial firms are exploiting the public need for private gain.

"I think it's criminal that they would use the whole low- income housing backdrop to put money in their pockets," she says. "I get incensed when I think about it. It's my life's work to get people into housing units, and it's really hard."

There's nothing illegal about collecting fees for bonds that are issued and then bought back as long as there is legitimate intent to use the money for the stated purpose, the IRS's Anderson says. Where local governments and their advisers run afoul of the law is when they invest the proceeds of tax- exempt bonds and take profits that exceed what the IRS allows.

The penalties can be severe. The IRS may order local governments to forfeit all of these so-called arbitrage gains and hand them over to the U.S. Treasury. The IRS can also revoke the tax-exempt status of municipal bonds if local governments don't spend at least 95 percent of the proceeds within three years -- one reason many of the black box bonds are bought back by the authorities that issued them.

Taxpayers Stung

The IRS is seeking a penalty of $73 million in one unidentified black box deal, Anderson says.

Taxpayers are stung three times by these bond schemes, Anderson says. The public doesn't get the housing or health care the bond was intended for. The U.S. Treasury is being cheated. So many pooled bonds have been issued that the market has become saturated, driving up interest rates for all municipal debt.

"The public suffers," Anderson says. "Every citizen gets hurt. At some point, there has to be due diligence. The public has to wonder what their politicians are doing."

Banks and bond advisers have found new ways to circumvent IRS regulations, says attorney C. Willis Ritter, who wrote the first tax arbitrage rules in 1972 as a Treasury Department official in President Richard Nixon's administration. "The potential is huge for gamesmanship," says Ritter, 66, who represented Capital Trust in Florida.

Dual Role

Anderson says the IRS investigation is finding that financial firms are increasingly hiding arbitrage profits in bond insurance fees. He says banks sometimes play the dual role of insuring and investing the proceeds of a bond.

"The schemes are getting more and more sophisticated," he says.

Bond deals that never help the public harm all U.S. taxpayers, says former banker Schwartz.

"The people who put these things together say nobody gets hurt," he says. "What they don't say is that the deal makers are the only ones who get helped. The people who get hurt are basically us. It's like backing a truck up to the federal treasury and taking out gold bullion. It's that simple."

Black box deals have something else in common with each other. They're sold without competitive bidding -- part of a growing national trend in municipal finance. Eight out of 10 times, the banks that underwrite bonds for schools, roads and hospitals clinch those assignments in private discussions with local authorities.

No Competition

That's a complete reversal in 30 years. In 1974, banks competed at public auction for bond sales 75 percent of the time, according to data compiled by Bloomberg and Thomson Financial.

There was no competition for the $220 million housing bond issue in Florida. Former JPMorgan Chase banker Charles LeCroy pitched the idea to the city of Gulf Breeze, according to Capital Trust records. The city created the agency after hearing of the JPMorgan deal.

LeCroy -- who would later be sentenced to three months in federal prison in a municipal corruption scandal in Philadelphia -- came to the Gulf Coast city from his Orlando, Florida, headquarters with solid credentials. He produced $70 million in fees for JPMorgan in 2003 from selling municipal bonds, according to documents released at his sentencing in 2005. Public officials described LeCroy, 52, in those documents as a tenacious banker with a keen knowledge of municipal finance.

Need for Housing

The housing bond deal LeCroy pitched was crafted by financial adviser CDR, according to documents prepared by Capital Trust's attorneys. CDR has negotiated more than $158 billion in transactions since it was founded in 1986, according to its Web site, which says CDR "creates and markets leading edge financial products."

LeCroy described to Gulf Breeze officials a program that would allow nonprofit groups to buy and improve low-income housing. "Given the need for affordable housing, the program just made a lot of sense," Capital Trust Executive Director Ed Gray says.

In 1999 and 2000, Gulf Breeze became a money machine for CDR, JPMorgan Chase and Anchor National, which became AIG SunAmerica Life Assurance Co. Three deals -- two for housing and another to improve assisted-living centers -- produced about $29 million in fees for the bank and other participants, according to an analysis of expenses over the life of the bonds.

Gulf Breeze

All told, JPMorgan Chase got $4.3 million in underwriting fees, and AIG made an estimated $15 million by guaranteeing to pay bondholders in case of a default, a promise that allowed Capital Trust to win a AAA rating, the highest possible, from Standard & Poor's for the housing bonds and an equivalent rating from Moody's Investors Service for the assisted-living bonds.

In those two years, the tiny city of Gulf Breeze and Capital Trust sold $650 million in bonds -- $350 million for housing and $300 million for assisted-living facilities. Just $130.7 million, or 20 percent, of that $650 million was ever used.

In December 1999, the agency sold the $220 million housing bond. The issue was to mature in 2032 at a floating rate starting at 4.81 percent that reset weekly. Out of the proceeds, JPMorgan Chase collected $1.3 million in fees, Anchor National got $220,000 and CDR took $200,000. The agency itself garnered an upfront payment of $140,000. It then invested the remainder of the $220 million in a guaranteed investment contract with AIG SunAmerica.

'Many a Phone Call'

The bond issue's offering statement said that a Boston- based nonprofit organization called Community Builders Inc. would use the money to finance or refinance the "costs of acquiring, erecting, extending, improving, equipping or repairing" multifamily rental housing for low-income residents.

Gray, 54, says he constantly called Community Builders to ask why no work was being done with the $220 million. "I made many a phone call to them, saying, 'Why aren't we being successful? Why aren't you originating? Why aren't you doing what we intended?"' he says. "Their response was either a political problem wherever they might have found something, or they were critical of underwriting guidelines' being too stringent."

The standards for loan approval were written by Anchor National. Patrick Clancy, executive director of Community Builders, declined to comment specifically on why his organization was unable to acquire properties. He attributed the failed program to his group's inexperience in Florida. "It was a very frustrating experience," Clancy says.

Secret Agreement

In May 2002, Gray wrote to Anchor National asking that the bonds be called because he was concerned the money wasn't being used, agency records show. The AIG unit insisted that the money stay in the investment account, Gray says. Anchor Vice President J. Franklin Grey didn't return phone calls seeking comment.

Gray says he was stunned to learn from the IRS three years ago that Anchor National had a secret agreement with CDR that gave both companies an incentive to deny all of Community Builders' spending proposals. Under the covert pact, CDR was paid 0.25 percent per year of the bond proceeds that weren't used, according to the Nov. 18, 1999, letter from Rubin to Grey.

If none of the money was used for housing, CDR would get about $550,000 a year in fees, according to an analysis of expenses over the life of the bonds. Agreements in the three Gulf Breeze deals between CDR and Anchor National violated the U.S. tax code and thus jeopardized the tax-exempt status of Capital Trust's debt, the IRS said in three letters to the agency in June 2003.

'Smoking Gun'

"There was a side agreement that only those two parties knew about," Gray says. "That little side deal was a smoking gun." He says a lawyer whose name he can't remember told him the agreement meant the IRS could force participants in the deal to forfeit investment gains to the federal government.

The SEC began an investigation of the bond issues in November 2003, according to a letter from the federal regulator to Capital Trust.

CDR President Rubin says no one asked about CDR's agreement with Anchor; he says he would have disclosed it if asked. He says his firm had no role in approving or rejecting loans to borrowers. "CDR's role was solely to inform the borrower as to whether the project would meet the underwriting criteria provided by SunAmerica," Rubin says.

Writing Hank Greenberg

In May 2004, Gray wrote a letter of complaint to Maurice "Hank" Greenberg, then chief executive officer of AIG.

"Now, many months from the first IRS notice and hundreds of thousands of dollars in legal fees expensed, I am requested to appear before the SEC in Miami," Gray wrote. "I must speculate an adverse ruling by the SEC will produce financial fallout far in excess of the current liability of AIG if it were to settle these cases sooner than later."

Two months after Gray wrote to Greenberg, AIG and Capital Trust reached a settlement with the IRS. It paid the IRS. The bottom line on the $220 million housing bond: $12 million in fees to banks, insurers and advisers; $920,000 to the U.S. Treasury; and zero spent on housing.

The agency fared much better with a second housing deal, a $130 million variable-rate bond issued in January 2000 and maturing in 2032. The interest rate, which reset weekly, began at 3.45 percent. The issue was also underwritten by JPMorgan Chase and insured by AIG's Anchor National. CDR again acted as the adviser.

This time, though, the designated developer, Fort Lauderdale, Florida-based Reliance Housing Foundation, spent $110 million --85 percent of the bond proceeds -- to acquire six Florida apartment complexes. Records filed with the IRS and Reliance's financial statements show that CDR loaned Reliance at least $2.2 million to help acquire three properties.

'Saddened and Bewildered'

Gray says he believes Reliance was willing to put more money into the projects and had more experience in Florida than Community Builders. CDR President Rubin says Reliance had a better understanding of the Florida real estate market than Community Builders.

At Pensacola's Oakwood Terrace, Pastor Williams says the housing bonds that were sold and never used duped people living on low wages, pensions and welfare. "I'm saddened and bewildered," says Williams, who heads Pensacola's Top of the Bottom Ministries, as he hands out donated bread in front of a cluster of tan-colored, two-story apartment buildings that together house 1,000 residents.

Located on the edge of a warehouse district and ringed by a wall with barbed wire that's meant to fend off drug dealers, Oakwood Terrace was on a list of thousands of developments across Florida that bond promoters identified for improvements.

Get Angry

"You get angry about the money that was available," Williams says. "Who would dangle it and then not give it to you?"

Shewaun Boyd, a convenience store cashier, lives with her seven children in a three-bedroom apartment at Oakwood Terrace. A sheet provides the only covering for a living room window that faces a weedy courtyard. Boyd, 32, says banks and other finance firms won, while needy residents lost.

"Somebody should be held responsible," she says. "This is just a case of banks' making their pockets fatter."

Gulf Breeze itself issued the assisted-living deal, with -- JPMorgan Chase, AIG's Anchor National and CDR. In April 1999, the city sold $300 million in bonds to develop centers that would improve care for Alzheimer's patients. The bonds paid an initial coupon interest rate of 3.6 percent that adjusted variably based on the J.J. Kenny Index of municipal bonds.

Dreaded Disease

Gulf Breeze put Heritage Healthcare of America, a Los Angeles-based operator of assisted-living facilities, in charge of spending the money. The city bought back the bonds between 2001 and 2003 as less than 10 percent of the $300 million was spent.

Thomas Conklin, a Sarasota, Florida-based lawyer who is board chairman of the nonprofit Johnnie B. Byrd Sr. Alzheimer's Center & Research Institute in Tampa, says it's shocking that most of the bond money was never used to help Florida's 450,000 Alzheimer's disease sufferers.

"To say you're going to benefit a dreaded disease like Alzheimer's and then nothing comes through, that's a sham," he says. "They need real help now. It's an incredible story of exploitation."

Gray says he was disappointed the money wasn't used and believes difficulty in obtaining liability insurance helped stymie the program. "There was a lot of need in Florida," he says.

14 Percent Loaned

JPMorgan Chase, using credit guarantees from AIG affiliates, underwrote similar black box housing deals in Georgia, Oklahoma and Tennessee. The bank sold $425 million in housing bonds in the three states in 2001 and 2002. Just $60.5 million, or 14 percent, was used for housing; the rest of the bonds were bought back by local governments.

In December 2001, the Housing Authority of Fulton County in Georgia sold a $150 million bond. The cast of characters was familiar: JPMorgan Chase as underwriter, AIG's Anchor National as insurer, CDR as adviser. None of the money from the sale was used for its stated purpose -- to buy housing for low-wage earners.

Workers in northern Fulton County, a woody stretch of suburban towns just north of Atlanta, commute about three hours a day by bus to get to entry-level jobs at newly minted strip malls that pay $3 more an hour than similar jobs south of the county where they live.

'No Subsidized Housing'

Leonard McClain commutes 40 miles from Decatur, Georgia, to his job as a cook at one of Waffle House Inc.'s restaurants in Fulton County. "It doesn't pay enough down there, and it's too expensive for me to live out here," McClain, 32, says.

Ayanna Banks, a saleswoman for a pest control company, says she wants to live in northern Fulton County because of the school district. When her former husband stopped sending child support payments to her in 2003, she fell behind on her $545 monthly rent, she says. She was evicted from her one-bedroom apartment with her three children that year in Sandy Springs, Fulton County.

She's since lived as a housesitter because she can't find an affordable place in the northern Atlanta suburbs. "I'm not the only one who's struggling," Banks, 34, says. "It's hard here. It's just so difficult. There really is no subsidized housing."

Projects Rejected

The $150 million Fulton County bond was supposed to change that. Housing Authority records identified at least 31 potential properties it could buy and use for low-income housing, and took steps toward acquiring 12 of them. Anchor National, CDR and JPMorgan Chase lawyers for the transaction took fees totaling more than $5 million, according to an analysis of authority records. No money from the housing funds was spent because none of the proposed property purchases was approved.

"I can tell you it wasn't because of lack of effort by Fulton County," says Andrew Patterson, the housing authority's general counsel. "Several projects were proposed, and they were rejected by CDR."

In 2004, the housing authority used the money to buy back the bonds from investors and end the project.

CDR worked on the Fulton County bonds with Anchor National Life Insurance, the same unit of AIG that had a secret deal in the Gulf Breeze bond transactions in Florida, according to Fulton County Housing Authority records obtained in Georgia open records law requests.

Anchor National was paid $150,000 when the debt was sold by JPMorgan and was given the authority to approve acquisitions made with the funds. The insurance company also made about $1.3 million a year for insuring the bond, the records show.

Getting the Fees

Atlanta bond attorney Golden, who had worked on a deal with CDR in the past, says CDR's managing director Stewart Wolmark approached him about serving as the attorney on the Fulton County transaction.

Golden says he was dubious of the deal. The transaction was similar, he says, to a financing deal done by the Fulton County Housing Authority when he served on the authority's board of directors in the 1980s. In the previous suggested transaction, credit insurance costs and closing fees made the funds from the tax-exempt bonds more expensive than a bank loan, he says.

"At the end of the day, it was a black box deal so the people involved could get fees," Golden says of the $150 million Fulton county housing transaction. "It was obvious that's what this deal was."

While the bond provided no money for housing, it earned JP Morgan Securities Inc., a subsidiary of JPMorgan Chase, $997,500 for underwriting the debt and an estimated $305,000 more during the life of the 2 1/2-year program. Five law firms made $359,375 for their role.

AIG's Dual Role

As in Florida, AIG had two roles in the deal: It was insurer of the bonds, and one of its units, SunAmerica Life Insurance, had beaten five other bidders, including Zurich-based UBS AG and JPMorgan Chase, for the right to reinvest bond proceeds until they were needed to pay for apartment purchases.

SunAmerica agreed to pay the authority 0.74 percentage point more than the bonds' rate, which changed weekly along with benchmarks. In return, Sun-America could invest the money as it chose. Housing Authority attorney Patterson says AIG's dual role appears to him to be a potential conflict of interest.

"It should have been a concern," he says. Grey didn't respond to telephone calls seeking comment about the potential conflict.

Deal Falls Through

Bob Boyd, a former executive for Maitland, Florida-based real estate firm NAI Realvest, sought to find properties for the Fulton County authority to buy. Boyd negotiated an agreement for the authority to pay $31.6 million for four complexes with a total of 816 apartments, Fulton County authority records show. CDR wrote a memorandum on July 8, 2002, saying it would allow a loan of $18.4 million from the bond proceeds for that purchase.

Since that amount wasn't enough to buy the properties, the deal fell through, and Boyd's group didn't buy any housing.

"We thought we had found properties that fit all the criteria, but we could never get them approved," Boyd, 60, says. "In a perfect world, they were perfect deals, almost. We were puzzled." Boyd says he made 17 trips to Atlanta from Orlando in about 18 months to scout properties before finally giving up.

By late 2003, authority officials were frustrated by the failures. "I have been involved in quite a number of acquisitions, and I have not seen one like this where it is as if the issue went into a black hole," wrote Lin Velarde, the asset manager for the housing authority, in an Oct. 23, 2003, e- mail to an official at an AIG affiliate.

No Disclosure

In 2004, after an IRS probe into whether the authority owed federal taxes, the authority reached an unspecified settlement, according to files obtained from Fulton County. The only details in the records show that the authority had an agreement with AIG barring the authority from disclosing anything about the insurance company's role in the bond program.

As taxpayers in Florida and Georgia scorn the misuse of bonds meant to improve housing and health care, citizens in Illinois wonder what happened to $150 million in bonds the Illinois Finance Authority, a state agency that funds public projects, sold in 1999 to pay for computers in schools and libraries.

Illinois, the fifth-largest state in population, ranked 33rd in providing public school students with computers and connecting them to the Internet, according to a survey conducted by Education Week magazine.

Computers for Kids

"We've struggled," says Barbara Clark, the principal of Skinner Elementary School in Chicago. Skinner has fewer computers than the state average -- about one for every five students compared with the Illinois rate of one for every 3.8 pupils, according to state and school figures. Many of the machines are aging and slow, Clark says.

The 1999 variable-rate bonds, which initially sold at an annual interest rate of 3.3 percent, were supposed to make more computers available to kids. The Illinois Finance Authority, which is based in the state capital of Springfield, paid $1.4 million in fees to the underwriter, Kansas City, Missouri-based investment bank George K. Baum & Co., and an additional $1.8 million to advisers and promoters.

The schools got almost nothing. Of the $150 million from bond proceeds, a total of $833,000, or less than 1 percent, was used for technology. The Illinois authority ended the program in 2002 and bought back the bonds to avoid having the IRS declare them as taxable.

Randy Steinmeyer, whose 10-year-old son, Conrad, attends fifth grade at the Skinner school, says he feels cheated because the program promised much and didn't deliver.

"It's sad this equipment never made it to the classroom," says Steinmeyer, 46, an actor and freelance marketing executive. "They had these grandiose schemes, and then you see that the money never reaches where it's supposed to."

Financial Advisor's Role

Daniel Denys, president of Austin Meade Financial, the Illinois authority's financial adviser, says his firm developed the program with honest intentions. Denys was also a principal stockholder in Skokie, Illinois-based National Technology Network Inc., which helped promote the bonds and was in charge of handing out loans, according to bond documents.

He says Chicago public schools expressed interest in borrowing all of the money and then backed out. Rising interest rates also stifled borrowing, he says.

"It was a failure to realize a noble cause," he says. "We stand by the work we did."

The IRS began investigating the program in 2002 and says in records provided by the authority that the program exploited schools, while allowing financial firms to profit.

"In this case, the farce has been shown because there were only two loan originations totaling $833,000 out of a bond issue of $150 million," the IRS wrote.

Fees Too High

The IRS said the authority, as issuer of the bonds, owed almost $2.3 million in taxes and interest because George K. Baum's fees diverted too much money from the loan pool, violating IRS arbitrage rules.

When the bonds were sold in 1999, Baum had picked New York- based CDC Funding Corp. to invest the loan pool through improper competitive bidding procedures under federal tax laws, the IRS says in documents released by the authority. The IRS says CDC had the inside track for the contract because three other bids were late or incomplete.

After a year of negotiations starting in 2004, the authority reached a settlement with the IRS on May 11, 2005. The authority paid $804,716 in penalties and legal costs. Bobby Wilkerson, who was executive director of the authority at the time of the bond sale, didn't return telephone calls and messages left at his home seeking comment.

Midwestern Housing Bonds

When the IRS clamped down on black box municipal bond deals throughout the Midwest -- in Missouri, Oklahoma and Wisconsin -- there was a common thread in all of the transactions. Tym, the bond attorney, created all of the deals, and Gold Banc Corp., a client of Tym's law firm, underwrote a portion of each deal, which it then sold to itself.

Tym, 52, then an attorney in the Stinson firm, designed programs that led two cities and a state agency to sell a total of $450 million in bonds with the promise that the money would be spent to provide housing for low-wage workers, according to local records. "All the professional parties were brought to the table by Ron Tym," says Mike Martin, the lawyer for the Oklahoma Housing Development Authority.

No money went to housing, and eventually the issuers used the money to buy back the bonds. Banks, advisers, issuers and others collected at least $5 million in fees. The Wisconsin deal generated $265,000 in fees for Tym, $125,000 for Stinson and $140,000 for Tym Firm, a company the lawyer owned. Tym received a similar fee in Missouri, documents show. In Oklahoma, his fee wasn't disclosed.

Large Fee Volume

As Tym pitched the housing bonds to local authorities, he underscored that authorities themselves would make money.

"This program generates a large volume of fees for the issuer of the bonds," Tym said in a sales pitch to officials in Lee's Summit, Missouri, according to a transcript of a Sept. 20, 2000, city meeting. "We have a long-standing relationship with the city of Lee's Summit, so we thought we would offer you the opportunity to issue the bonds to get those fees."

Officials involved with each of the transactions say Tym brought in the banks that would underwrite the bonds. Stinson, Tym's law firm, also signed the legal opinion vouching for the bonds' tax-exempt status even as Tym was the one who promoted them to the issuers, records show.

The Winner

Gold Banc, based in Leawood, Kansas, stood to be a winner in the bond sales -- with the kind of return that would have dazzled a hedge fund manager. Gold Banc bought $14.2 million of the $450 million in bond sales that Tym arranged. Under the terms of the purchase, gains on those bonds paid Gold Banc 30 percent annually on its investment, or about $4.3 million a year. Those payments came from investment gains of the entire bond pool, which was kept in an investment account.

The Gold Banc arrangement drew the attention of the IRS because of the exceptionally high return for the bank. "This particular deal is one of the most abusive arbitrage schemes seen by this office in recent years," wrote Anderson in a May 2005 letter to one of the issuers, the Manitowoc Community Development Authority.

Tym, who's now with Savannah, Georgia-based Hunter Maclean Exley & Dunn PC, says everything he did was proper; he blames the IRS for the failure of the housing programs.

IRS to Blame

He says the agency effectively closed down the programs when it began an audit in Oklahoma in 2003 and then audited the deals in Missouri and Wisconsin. He says the audits scared away investors in the housing programs.

"It was sort of like dominoes," Tym says. "When one fell, they all fell."

In October 2005, Gold Banc paid about $3.5 million to settle with the IRS, which said the bank didn't have the right to avoid income tax on the debt payments. Stinson agreed to pay $3.25 million to Gold Banc to settle the bank's claims against it. All told, Gold Banc, which has since been acquired by Milwaukee-based Marshall & Ilsley Corp., made a small return on its investment, former Gold Banc CEO Mick Aslin says.

"Gold Banc was led to believe that this was a good opportunity and there was a high likelihood that projects would be built," Aslin says. He says he didn't have details of the transaction and wasn't involved in buying the debt.

'A Nightmare'

The unraveling of the program in Manitowoc -- the birthplace of the ice cream sundae, according to the community's Web site -- has left bitter feelings. That's especially true for Jeff Deprez, executive director of the Great Lakes Training & Development Corp., a job center. Deprez says he got a memo from Tym in 2001 suggesting his agency expand into housing by selling bonds. Deprez recommended that Manitowoc sell the bonds. He says he now regrets that decision.

"For us and for the city of Manitowoc, this is a nightmare," he says.

David Less, director of the Community Development Authority and Mayor Kevin Crawford, who signed off on the deal, declined to comment. Deprez says his job center now has less money to spend because it has had to draw down on its reserves to pay its mounting legal bills to pay for its negotiations with the IRS.

Manitowoc, like towns and cities across the U.S., sold bonds that never helped the public. Florida Auditor General William Monroe examined the unused bonds in that state and published his findings in a May 2003 report.

"The effect of issuing these bonds has been to generate significant fees for financial advisers, underwriters, insurers, attorneys, consultants and other bond professionals with minimal demonstrated benefit to local citizenry," Monroe wrote. He suggested tightening oversight.

Nothing But Anger

Public officials in Florida, Georgia and three states in the Midwest say they were deceived by bankers or lawyers and now are left where they started, minus payments to the IRS.

In Pensacola, Pastor Williams looks over his shoulder at the Danger sign on the barbed-wired wall ringing the housing project. "You hope that something would change, that something would actually come true," he says. "But it doesn't, and it leaves you with nothing but anger. Now we're right back in a cesspool."