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

This article is from the May/June 2012 issue
of Dollars & Sense magazine.

http://www.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.

Perhaps worst of all has been the double standard set by
the federal government. In 2008 when the world's biggest
banks stumbled toward insolvency, the U.S. Treasury
stepped in to inject capital through the Troubled Asset
Relief Program (TARP). TARP allowed the banks to offload
or restructure their most toxic holdings, including many
derivatives like interest rate swaps.

Four years later no such relief has been mobilized for
cities, counties, and public agencies suffering from the
toxic interest rate swaps they have been forced to hold.
In its size and severity, the rate swap crisis rivals
other discrete financial injustices related to the global
economic meltdown of 2008. Unlike these other crises that
have received enormous attention from the media and
reform-minded officials, the foreclosure crisis for
example, the rate swap crisis has remained hidden from
public scrutiny, left to fester.

Some signs of resistance are appearing, however. Slowly,
but surely, nascent coalitions of civic activists are
exposing these swap deals and demanding that banks refund
the cities. In doing so they are challenging more than
just unfair financial deals. By contesting injustices
caused by financial derivatives embedded in the budgets of
local governments, activists are in fact criticizing a
core instrument of globalizing capital.

for the entire article, and a number of sidebars, go to
http://www.dollarsandsense.org/archives/2012/0512bondgraham.html

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