The fall out from the fraud induced Great Recession continues and in
the meantime, no one tries to re-establish the common sense regulatory scheme
that carried us through to 1999. without
question, the only effective solution and salvation available to local credit
markets are local credit institutions in the form of state Banks at the least.
There needs to be a new rule.
All credit is local just as all news is local for exactly the same
reason. That is where the market and
need coexist. So let us be jerks about
it all. Mandate all loans must be owned
as to fifty percent in the jurisdiction in which it is deployed. There are plenty of government guarantees to
support weaker jurisdictions so this should not be a hardship anywhere. What it does do is impose an aspect of local
control over what gets done.
If local lenders see no upside to polluting the local lake because they
all own cottages there, it becomes pretty hard to sell the chemical factory as
it should be!
It may appear inconvenient but it immediately creates an active class
of booster lenders quick to solve lending problems. It also establishes phenomenal confidence in
a local economy. Lenders will work
actively to turn around the economy they live in as walking away ceases to be
an option.
Wall Street Confidence Trick: The Interest Rate Swaps that Are
Bankrupting Local Governments
By Ellen Brown (about the author)
opednews.com
March 23, 2012 at 12:13:07
Count Blankfein by business insider
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:
Interest 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.
. . . With 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.
Courts have dismissed
complaints from aggrieved borrowers alleging securities fraud, ruling that
interest-rate swaps are privately negotiated contracts, not securities; and
"a deal is a deal." So says
contract law, strictly construed; but municipal governments and the
taxpayers supporting them clearly have a claim in equity. The banks have made outrageous profits by
capitalizing on their own misdeeds. They
have already been paid several times over: first with taxpayer bailout money;
then with nearly free loans from the Fed; then with fees, penalties and
exaggerated losses imposed on municipalities and other counterparties under the
interest rate swaps themselves.
Bond-Graham writes:
The windfall of revenue accruing to JP Morgan, Goldman Sachs, and their
peers from interest rate swap derivatives is due to nothing other than
political decisions that have been made at the federal level to allow these
deals to run their course, even while benchmark interest rates, influenced by
the Federal Reserve's rate setting, and determined by many of these same banks
(the London Interbank Offered Rate, LIBOR) linger close to zero. These
political decisions have determined that virtually all interest rate swaps
between local and state governments and the largest banks have turned into
perverse contracts whereby cities, counties, school districts, water agencies,
airports, transit authorities, and hospitals pay millions yearly to the few
elite banks that run the global financial system, for nothing meaningful in
return.
Why are these swaps so popular,
if they can be such a bad deal for borrowers?
Bond-Graham maintains that capitalism as it functions today is
completely dependent upon derivatives.
We live in a global sea of variable interest rates, exchange rates, and
default rates. There is no stable ground
on which to anchor the economic ship, so financial products for "hedging
against risk" have been sold to governments and corporations as essentials
of business and trade. But this
"financial engineering" is sold, not by disinterested third parties,
but by the very sharks who stand to profit from their counterparties'
loss. Fairness is thrown out in favor of
gaming the system. Deals tend to be
rigged and contracts to be misleading.
How could local governments reduce
their borrowing costs and insure against interest rate volatility without
putting themselves at the mercy of this Wall Street culture of greed? One possibility is for them to own some
banks. State and municipal governments
could put their revenues in their own publicly-owned banks; leverage this money
into credit as all banks are entitled to do; and use that credit either to fund
their own projects or to buy municipal bonds at the market rate, hedging the
interest rates on their own bonds.
The creation of credit has too
long been delegated to a cadre of private middlemen who have flagrantly abused
the privilege. We can avoid the
derivatives trap by cutting out the middlemen and creating our own credit, following
the precedent of the Bank of North Dakota and many other public banks
abroad.
Prepared for the Public Banking in America Conference, April 27-28,
Philadelphia.
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