By DON VAN NATTA Jr.
LEWISBURG, Tenn. — Five years ago, this small factory town was struggling to pay the interest on a bond for new sewers. Bob Phillips, Lewisburg’s part-time mayor and full-time pharmacist, was urged by the town’s financial adviser, an investment bank named Morgan Keegan & Company, to engage in a complex financial transaction to lower interest rates.
When a Lewisburg official attended a state-sponsored seminar intended to lay out the transaction’s benefits and risks, he was taught by investment bankers from Morgan Keegan.
And when Lewisburg decided to go ahead with the transaction, who was there to make the deal? Morgan Keegan.
In January, local officials were shocked to discover that annual interest payments on the bond had quadrupled to $1 million. Morgan Keegan, they said, did not serve them well in any of its roles.
“We’re little,” Mr. Phillips said, “and we depend on people wiser than us in financial ways to keep us informed, tell us what things mean, and I really didn’t think we got that.”
Lewisburg is one of hundreds of small cities and counties across America reeling from their reliance in recent years on risky municipal bond derivatives that went bad. Municipalities that bought the derivatives were like homeowners with fixed-rate mortgages who refinanced by taking out lower-interest, variable-rate mortgages. But some local officials say they were not told, or did not understand, that interest rates could go much higher if economic conditions worsened — which, of course, they did.
The municipal bond marketplace was so lightly regulated that in Tennessee Morgan Keegan was able to dominate almost every phase of the business. The firm, which is based in Memphis, sold $2 billion worth of municipal bond derivatives to 38 cities and counties since 2001, according to data compiled by the state comptroller’s office.
After The New York Times made inquiries, the Tennessee comptroller, Justin P. Wilson, ordered a statewide freeze on bond derivatives and a review of the seminar taught by Morgan Keegan and others.
Representatives of Morgan Keegan pointed out that they saved cities and counties money for years
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