The State of California has sued investment bank Morgan Stanley, filing a complaint in San Francisco Superior Court, seeking redress for what officials said was massive harm to its public-sector workers.

“Public employees in California, including peace officers, firefighters, teachers, and other public servants, suffered major losses as a result of Morgan Stanley’s residential mortgage-backed securities, in which high-risk home loans were purchased from subprime lenders, bundled together and sold for billions of dollars to investors,” the complaint alleges, according to CBS San Francisco.

Lack of disclosure

The complaint depicts Morgan Stanley as doling out bad deals out of “fear that transparency would be ‘a relationship killer,’ hampering a lucrative business with the companies taking on the risky debt,” Bloomberg noted. “Harris accuses the bank of bundling high-risk loans from subprime lenders — some directly funded by Morgan Stanley — and selling them to investors without disclosing its own concerns about the poor quality of the debt.”

In a statement, the office of California Attorney General Kamala Harris singled out the state’s large twin public pension funds as suffering particularly large losses. “The California Public Employees Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS) — two of the nation’s largest institutional investors — lost hundred of millions of dollars on these Morgan Stanley investments,” the statement read. “CalPERS provides retirement security and health plans to more than 1.6 million California firefighters, peace officers, and other public employees. CalSTRS provides retirement, disability, and survivor benefits for over 850,000 of California’s pre-kindergarten through community college educators and their families.”

Swinging for the fences

Blaming “a culture of greed and deception,” Harris accused the bank of obscuring the investment risk posed by “toxic residential mortgage-backed securities and ‘structured investment vehicles’ it marketed from 2004 to 2007, sometimes encouraging credit rating agencies to award unjustifiably high ratings,” as Reuters reported. Seeking to maximize compensation, “California seeks to triple the damages sustained by the pension funds, plus penalties of $2,500 for each violation of the state’s business code,” according to Bloomberg, plus a court order barring similar misrepresentations in the future.

The lawsuit reflected a hope that Morgan Stanley might also be vulnerable to an approach successfully taken in the past toward ratings agencies accused of their own misdeeds. “CalPERS had previously recovered hundreds of millions of dollars in settlements with agencies such as McGraw Hill Financial Inc’s Standard & Poor’s and Moody’s Corp’s Moody’s Investors Service over alleged inflated ratings,” as the wire service noted. In previous lawsuits, officials had pegged the combined losses facing the funds at over $1 billion, according to the Sacramento Bee, with the lion’s share falling on CalPERS.

A vigorous defense

The fight came at a moment when Morgan Stanley and the state of California have been working hand in hand on another big-ticket issue of central concern to state officials: new water bonds. “California’s Infrastructure and Economic Development Bank will issue $414.2 million of clean water state revolving fund revenue bonds as green bonds through lead manager Morgan Stanley,” as Reuters observed.

Last week, President Obama dumped a bucket of cold water over his fellow Democrats in California on water policy. He’s emphasizing private investment, while they’re trying to ban it.

His Environmental Protection Agency announced on its website:

“WASHINGTON — The U.S. Environmental Protection Agency launched the Water Infrastructure and Resiliency Finance Center today to help communities across the country improve their wastewater, drinking water and stormwater systems, particularly through innovative financing and by building resilience to climate change.”

This new program emphasized private investment as part of “a government-wide effort to increase infrastructure investment and promote economic growth by creating opportunities for state and local governments and the private sector to collaborate, expand public-private partnerships, and increase the use of federal credit programs.”

However, the Proposition 1 water bond past last November by California voters specifically stipulated “the joint powers agencies described … shall not include in their membership any for‑profit corporation or any mutual water company whose shareholders and members include a for‑profit corporation or any other private entity” (Section 79759(b)).

Although Prop. 1 was supported by some Republicans, it was placed on the ballot by the Democratic Legislature and strongly pushed by Gov. Jerry Brown.

But how long will this statewide ban on public investments hold up when the president is emphasizing just such investments at the federal level, and private water companies already receive bond funding in California?

CA already has a public-private integrated water system 

Witness the new Poseidon ocean water Desalination Project in Carlsbad. It’s financed by $840 million in bonds authorized by the State of California Pollution Control Financing Authority.

But Poseidon is a private, investor-owned company that develops water and wastewater infrastructure. For example, Wells Fargo Bank’s Municipal Bond Fund Portfolio includes Poseidon’s Carlsbad project. Poseidon will own and operate the Carlsbad Desalination Plant.

Environmentalists incorrectly claim the Kern Water Bank (which is made up of underground water) was privatized in 1995 to serve a “handful of corporate interests.” Actually, the bank is operated by the Kern Water Bank Authority. And according to the KWBA’s website FAQ:

“The Kern Water Bank is operated by the Kern Water Bank Authority, which is a public agency known as a Joint Powers Authority (JPA). The JPA includes six member entities, including several water districts, a water agency, and a mutual water company. The JPA is governed by a board of directors which oversee operation of the Kern Water Bank.” 

Yes, the KWB serves corporate farmers. But so do the Metropolitan Water District of Southern California and the East Bay Municipal Utility District serve private corporate farms and thousands of urban corporate customers.

Attorney Wes Strickland is with Jackson Walker LLP in Austin, Tex. He has pointed to California Water Code Section 78712, which reads:

“79712. (a) Eligible applicants under this division are public agencies, nonprofit organizations, public utilities, federally recognized Indian tribes, state Indian tribes listed on the Native American Heritage Commission’s California Tribal Consultation List, and mutual water companies.” 

“Public utilities” means regulated, investor-owned utilities like Pacific Gas and Electric and Southern California Edison that both run dams and hydropower projects; and such private water retailers as the California Water Service Company and the Golden State Water Company. All these are stockholder-controlled companies.

As Strickland explained:

“If public utility projects were not eligible for bond funding, it would mean that the 20 percent of California citizens who are served by pubic utilities would be paying taxes to the State of California to pay for water infrastructure for the exclusive use of the other 80 percent who are served by public agencies. The unfairness of such an outcome seems obvious.”

Additionally, the retail water provider for the city of San Jose is San Jose Water Company, a private, investor-owned water company, which is part of the Texas Water Alliance. Fifty percent of San Jose’s water supply comes from the Santa Clara Valley Water District, which originates with the state and federal water projects.

Cadiz, Inc., in the Mojave Desert, is the first private company to reverse the traditional relationship between public water wholesalers and municipal and private water retailers. Cadiz is a privately owned, common stock company that provides wholesale water to Central Valley irrigation districts, Southern California municipal water departments and private water companies.

Projects

Some dilemmas: How long can opponents continue to attack “privatization,” when the funding of such private entities already exists in California?

Will large water projects elect to undertake public-private water projects with federal and local municipal bonds and avoid bond financing from Prop. 1?  This is a plausible scenario that could be self-defeating for the $2.7 billion set aside in the Prop. 1 for water storage projects.

As Strickland summed up the situation:

“It has started to seem like every criticism of a water project or initiative leads inevitably to a claim of ‘privatization, even when as here that concept has no real application. I suspect in [the] future we will see other arguments against the California water bond, and numerous other water projects that also use the ‘privatization’ bogeyman to instill fear and loathing in the public.  I also wonder how long it will take for the ‘privatization’ argument trend to move on, and what spurious argument will replace it?”  

Those who favor public control don’t like the private involvement. And libertarians have proposed getting rid of the public part and have proposed privatizing the entire system.

Yet the fact is the state already is saturated with public-private partnerships in water, something that somehow will remain as surely as the state some day will suffer another drought.

A longstanding truism when it comes to needed goods such as water systems, flood control or catastrophic earthquake insurance is that the public wants them but does not want to pay for them.

This was confirmed anew by a recent USC-L.A. Times poll, which found only 36 percent of those polled were in favor of raising taxes for statewide water system upgrades. A plurality of 46 percent indicated they would be willing to pay more to assure a more stable water supply.  However, 51 percent indicated that taxes should not be used to upgrade water storage and conveyance facilities.

As pollster Drew Lieberman of the Democratic polling firm of Greenberg, Quinlan and Rosner put it, “Support evaporates entirely when you put a price tag on it.”

The results of this poll may affect the $11.1 billion water bond on the Nov. 4 ballot that may or may not contain funding for any new water storage facilities. This bond will not fund the proposed new $15 billion twin tunnels to convey water under the Delta southward to farms and cities.

The water bond was pulled from the ballot in 2010 and 2012 for fear of voter rejection.

Voters like status quo’s stable cost

But there may be good reason beyond aversion to taxes as to why Californians don’t want to pay for added new taxes to build new water tunnels under the Delta and re-create a new Delta ecosystem for fish.

Consider the selling points for the bond. It would:

–Provide a fix for the Sacramento Delta for fish

–Upgrade flood levees

–Prevent a catastrophic loss of Delta water in an earthquake

–Provide more water storage for droughts

The idea that these projects are urgently needed at a cost of many billions of dollars is tough to sell to the public when they perceive the existing system to be working just fine, and when most urban areas have enough water to weather the drought. Many Californians probably feel they have already done their part — 87 percent of those polled indicated they have cut back their daily water usage. This leads most people to believe that conservation keeps the state water shortage manageable.

Voters favor more conservation

This viewpoint is borne out by the USC poll. All the highly favored policies were conservation-oriented: water recycling (92 percent), urban storm-water capture (91 percent), more underground water storage (83 percent), more personal cutbacks in water usage (81 percent) and desalination plants (75 percent).

Building new dams and reservoirs was only approved by 65 percent of those polled.

Water policy-makers have so successfully sold the public on water conservation that the public apparently does not believe in paying taxes for any new system-wide improvements because conservation is perceived as free.

From 2000 to 2006, Californians approved five water bonds totaling $18.7 billion. But that water bond funding mostly went for land acquisitions for wetlands or preserving existing mountain watersheds, landscaping for water retention, eliminating water-consuming invasive plant species, environmental studies, etc.  But not one drop of new system water storage was funded by those bonds.

Once again, voters will approve waterless water bonds that are conservation-oriented during economic boom times. But when it comes to funding hard water infrastructure projects in an economy still recovering from recession, the public believes that more conservation is the solution.

Those who opposed the proposed Peripheral Canal in 1982 in favor of conservation policies have been so successful that it is now difficult to get the public to favor any taxes for water projects — even in a crisis.