Local governments and organizations across the country are paying billions to Wall Street banks after being scammed into deals banks said would save them money.
Wall Street banks and insurance companies have scammed local governments, hospitals, universities and other non-profits into deals they said would save money on paying back interest rates on bonds they issues to raise money.
The deals, called interest rate swaps were supposed to protect those using bonds to raise money against a rise in interest rates.
Instead, with a little help from their partner in crime, The Federal Reserve, the banks are raking in billions of dollars in taxpayer money and bankrupting communities across the country.
As we all know, the Federal Reserve has lower interest rates to an all time low and plans on keeping them there for an extended period of time to help the economy recover from its failure due to Wall Street’s greed and speculation.
What most don’t know is that by keeping the interest rates low the Federal Reserve is forcing those who entered into interest rate swaps arrangements to pay Wall Street banks billions of dollars.
The result is the bankruptcy and insolvency of many local and county governments across the nation.
Web of Debt – The Shocking Truth About Our Money System
Web of debt explains below, Wall Street had collected over $4 billion in payouts from municipalities on the interest rate scheme by the end of 2010.
Since then the payouts have only continued and the Federal Reserve has pledged to keep interest rates at an all-time low until 2014.
Even then, if the economy has recovered, interest rates will only be inched slightly upward after which the Federal Reserve will wait a period of time and monitor the result of raising the rate.
This process of marginally incrementing the rates will continue over a period of years before the interest rates get back to normal levels.
In the mean time, we will see more municipalities raise taxes while cutting spending and public services in an attempt to payoff the bankers.
Hurting the local government’s even more is the rating agencies have cut the credit ratings of state and local governments across the nation.
Of course, this forces the government’s to payout even more money to raise the funds required.
Here’s the first half of an article from Web of Debt explaining in more detail: (If you like the article, click on the image to the right to order the author’s book).
Wall Street Confidence Trick: The Interest Rate Swaps that Are Bankrupting Local Governments
Far from reducing risk, derivatives increase risk, often with catastrophic results.
— Derivatives expert Satyajit Das, Extreme Money (2011)
The “toxic culture of greed” on Wall Street was highlighted again last week, when Greg Smith went public with his resignation from Goldman Sachs in a scathing oped published in the New York Times. In other recent eyebrow-raisers, LIBOR rates—the benchmark interest rates involved in interest rate swaps—were shown to be manipulated by the banks that would have to pay up; and the objectivity of the ISDA (International Swaps and Derivatives Association) was called into question, when a 50% haircut for creditors was not declared a “default” requiring counterparties to pay on credit default swaps on Greek sovereign debt.
Interest rate swaps are less often in the news than credit default swaps, but they are far more important in terms of revenue, composing fully 82% of the derivatives trade. In February, JP Morgan Chase revealed that it had cleared $1.4 billion in revenue on trading interest rate swaps in 2011, making them one of the bank’s biggest sources of profit. According to the Bank for International Settlements:
[I]nterest rate swaps are the largest component of the global OTC derivative market. The notional amount outstanding as of June 2009 in OTC interest rate swaps was $342 trillion, up from $310 trillion in Dec 2007. The gross market value was $13.9 trillion in June 2009, up from $6.2 trillion in Dec 2007.
For more than a decade, banks and insurance companies convinced local governments, hospitals, universities and other non-profits that interest rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools. The swaps were entered into to insure against a rise in interest rates; but instead, interest rates fell to historically low levels. This was not a flood, earthquake, or other insurable risk due to environmental unknowns or “acts of God.” It was a deliberate, manipulated move by the Fed, acting to save the banks from their own folly in precipitating the credit crisis of 2008. The banks got in trouble, and the Federal Reserve and federal government rushed in to bail them out, rewarding them for their misdeeds at the expense of the taxpayers.
How the swaps were supposed to work was explained by Michael McDonald in a November 2010 Bloomberg article titled “Wall Street Collects $4 Billion From Taxpayers as Swaps Backfire”:
In an interest-rate swap, two parties exchange payments on an agreed-upon amount of principal. Most of the swaps Wall Street sold in the municipal market required borrowers to issue long-term securities with interest rates that changed every week or month. The borrowers would then exchange payments, leaving them paying a fixed-rate to a bank or insurance company and receiving a variable rate in return. Sometimes borrowers got lump sums for entering agreements.
Banks and borrowers were supposed to be paying equal rates: the fat years would balance out the lean. But the Fed artificially manipulated the rates to the save the banks. After the credit crisis broke out, borrowers had to continue selling adjustable-rate securities at auction under the deals. Auction interest rates soared when bond insurers’ ratings were downgraded because of subprime mortgage losses; but the periodic payments that banks made to borrowers as part of the swaps plunged, because they were linked to benchmarks such as Federal Reserve lending rates, which were slashed to almost zero.
In a February 2010 article titled “How Big Banks’ Interest-Rate Schemes Bankrupt States,” Mike Elk compared the swaps to payday loans. They were bad deals, but municipal council members had no other way of getting the money. He quoted economist Susan Ozawa of the New School:
The markets were pricing in serious falls in the prime interest rate. . . . So it would have been clear that this was not going to be a good deal over the life of the contracts. So the states and municipalities were entering into these long maturity swaps out of necessity. They were desperate, if not naive, and couldn’t look to the Federal Government or Congress and had to turn themselves over to the banks.
Elk wrote:
As almost all reasoned economists had predicted in the wake of a deepening recession, the federal government aggressively drove down interest rates to save the big banks. This created opportunity for banks – whose variable payments on the derivative deals were tied to interest rates set largely by the Federal Reserve and Government – to profit excessively at the expense of state and local governments. While banks are still collecting fixed rates of from 4 percent to 6 percent, they are now regularly paying state and local governments as little as a tenth of one percent on the outstanding bonds – with no end to the low rates in sight.
. . . [W]ith the fed lowering interest rates, which was anticipated, now states and local governments are paying about 50 times what the banks are paying. Talk about a windfall profit the banks are making off of the suffering of local economies.
To make matters worse, these state and local governments have no way of getting out of these deals. Banks are demanding that state and local governments pay tens or hundreds of millions of dollars in fees to exit these deals. In some cases, banks are forcing termination of the deals against the will of state and local governments, using obscure contract provisions written in the fine print.
By the end of 2010, according to Michael McDonald, borrowers had paid over $4 billion just to get out of the swap deals. Among other disasters, he lists these:
California’s water resources department . . . spent $305 million unwinding interest-rate bets that backfired, handing over the money to banks led by New York-based Morgan Stanley. North Carolina paid $59.8 million in August, enough to cover the annual salaries of about 1,400 full-time state employees. Reading, Pennsylvania, which sought protection in the state’s fiscally distressed communities program, got caught on the wrong end of the deals, costing it $21 million, equal to more than a year’s worth of real-estate taxes.
In a March 15th article on Counterpunch titled “An Inside Glimpse Into the Nefarious Operations of Goldman Sachs: A Toxic System,” Darwin Bond-Graham adds these cases from California:
The most obvious example is the city of Oakland where a chronic budget crisis has led to the shuttering of schools and cuts to elder services, housing, and public safety. Oakland signed an interest rate swap with Goldman in 1997. . . .
Across the Bay, Goldman Sachs signed an interest rate swap agreement with the San Francisco International Airport in 2007 to hedge $143 million in debt. Today this agreement has a negative value to the Airport of about $22 million, even though its terms were much better than those Oakland agreed to.
Greg Smith wrote that at Goldman Sachs, the gullible bureaucrats on the other side of these deals were called “muppets.” But even sophisticated players could have found themselves on the wrong side of this sort of manipulated bet. Satyajit Das gives the example of Harvard University’s bad swap deals under the presidency of Larry Summers, who had fought against derivatives regulation as Treasury Secretary in 1999. There could hardly be more sophisticated players than Summers and Harvard University. But then who could have anticipated, when the Fed funds rate was at 5%, that the Fed would push it nearly to zero? When the game is rigged, even the most experienced gamblers can lose their shirts.
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