The first public warnings over "swaptions" are being heard.

Most people have never heard of swaptions, which are complex financial agreements involving an option on a bet on interest rate trends. Despite the complexity of these deals, several school districts in Butler County and many more across the state approved these deals as if they were routine financial matters. They are not.

An in-depth article in the March edition of Bloomberg Markets magazine profiled swaption deals to school districts across Pennsylvania. The article noted that, often, those deals seemed too good to be true and looked like free money to financially struggling districts. But, over the longer term, some of them had disastrous consequences.

The Erie City School District, for instance, entered into a swaption deal inSeptember 2003 that produced an up-front payment of $785,000 for the cash-strapped district. Bloomberg reports that the district's financial adviser got $60,000, the bond insurer got $57,000 and lawyers and others were paid $106,000. But Bloomberg calculated the swaption contract was worth $2 million, and the investment bank decided how much it would keep for its own fee — about $1 million — and how much the district would be paid.

When they entered the risky financial deal, Erie school officials were not told how much the investment adviser or the investment bank would make. That deal, like the others examined in the article, was not competitively bid.

Three years later, when interest rates were not going the way Erie officials had bet, they paid $2.9 million to the investment bank to get out of the deal.

Erie's experience probably is among the worst, but there were others described in the Bloomberg article, which noted that hundreds of deals had been pitched to mostly rural school districts since state lawmakers made such investments legal in the past four years.

Further, the article said 15 districts entered into deals worth $28 million since 2003. Bloomberg's analysis revealed that districts were paid $15 million — the investment bankers, advisers and others took the remaining $13 million in fees.

ABloomberg columnist, Joe Mysak, writing about the revelations in the article, titled his commentary "Swap market is not place for school districts to play." He questioned the wisdom of the state legislature and governor in allowing schools to enter such complex and risky transactions, asking, "How could this legislative body vote to turn the wolves loose on so many sheep?"

Reacting to the Bloomberg revelations, Gov. Ed Rendell, who signed the swaption legislation into law, now says, "The school districts are getting fleeced."

What's needed is an investigation that traces the investment banks' lobbying efforts — who paid what to whom — in Harrisburg to get the law passed.

At a Mars School Board meeting last week, an investment banker and a lawyer who are both district residents warned the board about swaption deals in particular and, more generally, about entering into financial deals without getting competitive bids.

Resident Simon Goehring told the board that swaption deals could be financial disasters for the district, and that the hidden fees are another serious concern. Simon, who works for Mellon Financial Markets, noted the common denominator in most swaption deals gone bad was the lack of competitive bidding.

It's the dangers and costs associated with the lack of competitive bidding that Butler County Controller Jack McMillin has been focused on for years in pressing county officials to open up issuance of bonds and other financing deals.

While the county has not done the kind of swaption deals highlighted in the Bloomberg article, it has entered into deals that might be considered predecessors to swaptions.

Several school districts in Butler County and scores of districts across the state have been sold on swaptions by investment bankers and the districts' financial advisers.

Swaption deals, considered highly risky forms of financial instruments called derivatives, are appropriate for highly sophisticated financial institutions. But the Bloomberg article suggests they are not appropriate for the average school district. Most school board members, like most of the public, simply cannot understand the risks involved.

And even if school officials really understand the risks of swaptions and decide to proceed anyway, they should ensure the process is open and competitively bid. They also should be sure their investment adviser is truly independent, and does not have a relationship with an investment bank that would bias recommendations.

Warren Buffet, the legendary investor, calls derivatives "time bombs" and "financial weapons of mass destruction." Yet school boards across Pennsylvania have been advised that they are a good deal.

Writing about the unwary districts, the Bloomberg columnist said, "They're being cheated. And they are exposing the taxpayers to risks that far outweigh whatever rewards they get up front. You read the magazine article and you want to weep."

After the appearance of the Bloomberg article and the statements made to the Mars board, it is no longer possible for district or municipal officials to say they were not warned about swaptions and non-competitive bidding.