Whoops! A $2 Billion Blunder: Washington Public Power Supply System

Fallout from a record default spreads from Washington State to Wall Street

D-day finally arrived last week for the Washington Public Power Supply System. D for default. D for debacle. With its coffers almost empty, WPPSS or Whoops, as everyone now calls the agency, formally declared that it could not repay $2.25 billion in bonds used to finance partial construction of two now abandoned nuclear power plants in Washington State. It is by far the largest municipal bond default in U.S. history, and the damage is incalculable. The fiasco has robbed thousands of investors of their savings, shaken confidence in the municipal bond market, angered and humiliated the people of the Northwest, tarnished the reputations of some of Wall Street’s leading institutions and provoked at least 70 lawsuits that will be clogging the courts for years to come.

Over the past decade, Whoops borrowed $8.3 billion to start construction on a total of five nuclear plants, only one of which is likely to be completed. The bonds in default were issued for two plants that Whoops calls Projects 4 and 5. Some $6 billion worth of other Whoops bonds for Projects 1, 2 and 3 are in no immediate danger of default, but investors are increasingly afraid that these securities will also eventually be in jeopardy. Projects 1,2 and 4 are located at the Hanford Nuclear Reservation in eastern Washington, while 3 and 5 are at Satsop, in the western part of the state.

The default had been expected for weeks, so the municipal bond market reacted quietly, with most prices holding fairly steady. But concern about Whoops’ woes had been depressing the market for months. Public utilities building power plants have had to promise exceptionally high tax-exempt interest rates of more than 9% to sell new bonds. Several utilities, like North Carolina Municipal Power Agency No. 1, postponed their offerings to avoid testing the market. Some industry insiders fear that the continuing Whoops mess could ultimately sour investors on the entire spectrum of municipal bonds. Says James Lebenthal, whose appearances in television commercials have made him America’s most recognizable municipal bond dealer: “I feel threatened, and so does the whole industry. I feel the shame of Whoops.”

Victims of the default, who thought the bonds were a safe haven for their money, were feeling outrage and despair. Many elderly bondholders were depending on the securities for retirement income, but the bonds that had been bought as recently as March 1981 for $5,000 sold last week for as little as $700. Robert Kahn, 69, a former court reporter living in Hollywood, Fla., and his wife Selma, 67, had $10,000 invested in Whoops Nos. 4 and 5 bonds. Says he: “I felt secure. That was the whole point of buying the bonds. I didn’t want to make extra money. I just didn’t want to lose what I had. I’m not a rich man.” For Theo Fullmer, 70, and his wife Bettie, 63, of Rexburg, Idaho, the Whoops default was their second disaster. In 1976 the Teton River Dam collapse in Idaho destroyed a motel they had owned for nearly 13 years. After the U.S. Government paid them about $100,000 for their loss, they invested $80,000 of it in Nos. 4 and 5 bonds. Says Bettie, who now works as a cook at the local high school: “You wouldn’t believe how frugally we have lived and how frugally we will have to live. I haven’t been sleeping. Not a wink.”

Insurance companies, which own about 15% of the Nos. 4 and 5 bonds, are probably the biggest losers. According to A.M. Best Co., an insurance-industry research firm, Aetna Life & Casualty held $50 million worth of the securities at the end of last year, while Fireman’s Fund, a unit of American Express, had $48.9 million at risk, and Kemper had $24 million. None of these companies, however, has fallen into financial trouble. Says an Aetna official: “Our losses will not be insignificant. But our other assets are very secure, and our foundation is very, very solid.” Aetna’s Nos. 4 and 5 bonds represent little more than one-tenth of 1% of its $44 billion portfolio.

Bondholders eager to reduce their losses are banding together to sue virtually everyone with any connection with the default. Besides Whoops, the defendants include a group of 88 utilities in the Northwest. They had originally agreed to pay for the plants, but later some of them backed out of their contracts. Other suits name such prominent brokerage houses as Merrill Lynch, Prudential-Bache Securities, Smith Barney and Salomon Bros., which enthusiastically sold the Whoops bonds. They are accused of withholding crucial information about the agency’s deteriorating finances. Even Moody’s Investors Service and Standard & Poors were hauled into court because they gave the bonds high ratings. “They are all responsible,” says Melvyn Weiss, one of the lawyers representing bondholders.

At the center of the maelstrom is Whoops, a once obscure but now infamous joint venture of 23 publicly owned utilities. With headquarters in the small city of Richland in southeastern Washington, the agency was set up in 1957 to build dams and power plants. By the early ’70s Whoops officials, who put their faith in energy experts, thought that the Northwest was facing serious potential power shortages. Demand for electricity had been burgeoning 7% annually and was expected to continue growing at that pace. Hoping to provide an abundant source of cheap energy, the power system began building its first three nuclear plants between 1972 and 1975. In 1976, the Bonneville Power Administration, a U.S. Government agency that sells electricity from federal dams to Northwestern utilities, warned that power demand was still likely to outstrip supply in the ’80s. With that encouragement Whoops went ahead with Nos. 4 and 5.

Whoops was ill prepared to build one nuclear plant, much less five. Many of the 23 members of the agency’s board were farmers and small businessmen who were neophytes in the nuclear business. Whoops used three different designs for the five projects, which suffered from repeated delays and huge cost overruns. Like all nuclear plants, the Whoops projects faced costly Government regulation in the wake of rising public concern about the safety of reactors and the growing strength of the antinuke movement. By 1982 the total projected price of the five plants had exploded from $4.1 billion to $23.8 billion.

Meanwhile, the forecasts of power shortages proved to be wildly wrong. Conservation measures spurred by the 1973 and 1979 surges in oil prices reduced demand for electricity. So did a series of economic recessions that hit the Northwest particularly hard. The hypothetical need for the five plants vanished. First Whoops canceled Nos. 4 and 5 in January 1982, and later it mothballed Nos. 1 and 3. Only Project 2, scheduled to start generating electricity early next year, has a chance of being completed in the near future.

No hard evidence has yet surfaced that Whoops’ board members and managers over the years are guilty of deliberate fraud or corruption. But they are collectively to blame for bad judgment and bureaucratic bungling on an unprecedented, almost unimaginable, scale. Concludes Washington Governor John Spellman: “Good-faith people made poor decisions.” Those decisions were accepted by the merchants of Wall Street, who gladly peddled more and more Whoops paper.

Investors snapped up the bonds partly because they seemed to have the solid support of Government agencies. Securities financing the first three plants were backed by the Bonneville Power Administration, which has responsibility for making payments on the debt. To meet that obligation and other costs, BPA has boosted the rates it charges Northwestern utilities by 148% since 1979. The federal agency says it will raise rates further, if necessary, to pay off the bonds, even if only one of the plants is ever finished. Problems could still conceivably arise, however, for owners of Project 1,2 and 3 bonds. It is possible that lawyers for holders of the ill-fated Nos. 4 and 5 bonds will convince the courts that all the Whoops securities should be treated in the same way, so that losses can be spread among the investors.

The Project 4 and 5 bonds did not have the same kind of underpinning as the other securities. A change in federal rules passed by Congress in 1973 made it impossible for BPA to back the 4 and 5 bonds. Instead, they were supported solely by so-called take-or-pay contracts with 88 utilities in Washington, Oregon, Idaho, Montana, Wyoming and Nevada that signed up to buy electricity from Whoops. These agreements, dubbed “hell or high water” deals, committed the utilities to pay for Projects 4 and 5, even if they never produced a kilowatt.

When the two plants were abandoned in early 1982, the people of the Northwest were enraged at the prospect of paying off the bonds through higher electric bills, with no hope of getting anything in return. Citizens’ groups with such names as Irate Rate Payers and the Light Brigade sprang up and held town meetings to protest. Complained Mark Reis, executive director of a Seattle energy-conservation coalition: “They promised us power without cost, and they delivered cost without power.” Some of the utilities tried to renege on their take-or-pay contracts with Whoops, and that raised the specter of default. New York City’s Chemical Bank, trustee for the bondholders, took Whoops and the utilities to court. After 13 months of legal skirmishing, the Washington State Supreme Court decided against the bank and the bondholders. In a ruling that surprised legal experts, the court said that the public utilities did not have to abide by their contracts because they had no legal right to sign such agreements in the first place. Chemical Bank asked the court to reconsider the decision, but two weeks ago it refused, setting the stage for last week’s default.

Stunned Whoops bondholders grumbled about “hometown referees” who were making investors all over the U.S. pay for mistakes made by officials in the Northwest. Recalling the famous New York Daily News front page describing President Gerald Ford’s refusal to bail out a financially floundering New York City, one Manhattan bond trader growled, “If you could write a headline about the whole sorry affair, it would read, WASHINGTON STATE TO INVESTORS: DROP DEAD!” Critics point out that the Northwest has very low electric rates as a result of its cheap hydroelectric power. If the entire cost of all Whoops bonds were pushed into Northwestern electric bills, the rates would still be below the national average. Chemical Bank may ask the U.S. Supreme Court to overturn the Washington ruling and make the Northwestern utilities live up to their contracts.

As it is, the Northwesterners are not getting off unscathed. Their electric rates have already risen to pay for Projects 1,2 and 3. Moreover, their utilities will have to pay exceptionally high interest rates to raise capital in the bond market. At the moment, many investors are shunning bonds from the Northwest. “The whole thing is a nightmare,” says Paul O’Connor, press secretary to Governor Spellman. “If traders on Wall Street have the choice between something that says Washington on it or something that says Indiana on it, they are going to go for Indiana. We’ve got a cloud hanging over us.” Even the state government is suffering from guilt by association. Says Lyle Jacobsen, assistant state treasurer: “It’s scary. We’re launching a campaign to tell people that Whoops and the sovereign state of Washington are two separate things. The state will pay its bills.”

Some Northwesterners and Whoops bondholders think that Uncle Sam should bail out the power system. One argument for such action is that BPA, a federal agency, encouraged Whoops to build the five nuclear plants. Energy Secretary Donald Hodel, who headed BPA from 1972 to 1977, accepts some of the blame. “We looked at the energy forecasts,” he recalls, “and said, ‘Jiminy crickets, the Northwest is going to run out of power.’ ” Nonetheless, he says, “the Administration strongly opposes any bailout, and I don’t sense any sentiment for one in Congress.” Opponents argue that using federal money to rescue Whoops would boost the already alarming budget deficit and set a precedent that could lead to similar expensive bailouts in the future.

Chances appear slim that investors stuck with Whoops 4 and 5 bonds will ever recoup their losses. Says Bettie Fullmer: “The only people who are going to make money are the lawyers.” Many victims have already sold the securities at a tiny fraction of their face value to speculators, some of whom are betting that the Government will eventually bail out Whoops, giving them a big profit.

Investors will not be the only losers. As long as the fallout from the default hangs over the bond market, scores of electric utilities, and possibly other public agencies, across the U.S. will be facing higher interest rates to raise capital and will have to pass the added costs along to consumers and taxpayers. Either directly or indirectly, millions of Americans will be paying for the whopping blunders of Whoops.

—By Charles P. Alexander.

Reported by Deborah Peterson/Seattle and Adam Zagorin/New York