The Swap Crisis

    Interest rate swap deals have allowed the big
    banks to hold local governments and agencies
    hostage for tens of millions of dollars.

By Darwin BondGraham 
Dollars & Sense 
May/June 2012

http://dollarsandsense.org/archives/2012/0512bondgraham.html

In 2002 a little-known but powerful state agency in
California and Wall Street titans Morgan Stanley, Citigroup,
and Ambac consummated one of the biggest deals to date
involving a type of financial derivative called an "interest
rate swap." A year later the executive director of the Bay
Area's Metropolitan Transportation Commission, Steve
Heminger, proudly described these historic deals to a
visiting contingent of Atlanta policymakers as a model to be
emulated. Swaps were opening up a brave new world in public
finance by extending the MTC's purchasing power by $200
million, making a previously impossible bridge construction
schedule achievable in a shorter timeframe. The deal would
also protect the MTC from future volatile swings in variable
interest rates. To top it off, the banks would make a neat
little profit too. Everybody was winning.

Then in 2008 it all came crashing down. The financial
system's near collapse, the federal government's
unprecedented bailouts, and global economic stagnation mean
that the derivative products once touted as prudent hedges
against uncertainty have instead become toxic assets,
draining billions from the public sector.

The MTC was forced to pay $104 million to cancel its interest
rate swap with Ambac when the company went bankrupt in 2010.
Whereas once the Commission?s swaps portfolio was saving it
money, now it must pay millions yearly to a wolf pack of
banks including Wells Fargo, JPMorgan Chase, Morgan Stanley,
Citibank, Goldman Sachs, and the Bank of New York. The MTC?s
own analysts now estimate that the Commission's swaps have a
net negative value of $235 million. This money all ultimately
comes from tolls paid by drivers crossing the San Francisco
Bay Area's bridges, toll money that not too long ago was
supposed to purchase bridge upgrades. Now it's just a free
lunch for the banks.

The MTC is only one example. Local governments and agencies
across the United States have been caught in a perfect storm
that has turned their "brilliant" hedging instruments into
golden handcuffs. The result is something of a second bailout
for the Wall Street banks on the other sides of these deals.

To read more, go to:
http://dollarsandsense.org/archives/2012/0512bondgraham.html

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