Thursday, March 26, 2015

How Wall Street used swaps to get rich at the expense of cities

Thanks to a helpful correspondent for flagging this.  Since the late 1970s cities have been trying to find ways to compensate for lost revenue sources.  The property tax revolt, suburbanization, loss of federal grants in aid, globalization of the economy, and other forces have left many cities in  precarious condition. CIDs are one of those compensation strategies.  And here is another one:  cities are getting hooked up with Wall Street investment banks that promise to create gains by engaging in interest rate swaps.  For example,  a city has outstanding fixed rate municipal bonds, and an investment bank--Goldman Sachs, J.P. Morgan Chase, or another one of these financial vampires--proposes to swap them for variable rate bonds that are linked to LIBOR or some other index, that pays the bond holders a lower interest rate.  Sounds good, right?  Except that local governments have been known to lose  a fortune doing it.  Chicago, led by former Wall Streeter and now Mayor Rahm Emanuel,  is in deep on these swaps.  Emanuel thinks he's smarter than everybody. But the swaps aren't turing out  to be such a good deal. Here's a detailed article taking the whole thing apart.

And for the worst case scenario, consider Jefferson County, Alabama.   After a series of swaps orchestrated by J. P. Morgan to pay for a new sewer system, they went bankrupt.   Until Detroit, it  was the largest local government bankruptcy in US history.

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