Submitted by Elaine Magliaro, Guest Blogger
I’ve heard many politicians talk about what they believe were the causes of the financial meltdown of 2008 and the money problems facing our federal, state, and local governments today. These causes include: collective bargaining, pensions, healthcare costs for public workers; subprime mortgages taken out by poor people who couldn’t actually afford to buy homes; the high costs of Social Security, Medicare, and Medicaid. Many of these same politicians rarely put the blame for the financial crises we are experiencing in this country today on the cost of waging two wars—or on the financial shenanigans of the big banks of Wall Street.
In February of 2010, Mike Elk wrote an article for the Huffington Post titled How Big Banks’ Greek-Style Schemes Are Bankrupting States Across the U.S. In it, he talked about a financial instrument called the “interest rate swap”—which is a kind of unregulated derivative.
Here’s an excerpt from Elk’s article:
Just when you thought Wall Street couldn’t get any more clever in their attempts at predatory lending, they have.
Big Banks have created an exotic financial instrument that is the equivalent of a payday loan for cash-strapped state and local governments, innocently labeled an “interest rate swap.”
In the United States, states and local governments cannot run deficits. This year states face a $357 billion budget shortfall and local governments are facing an additional $82 billion budget shortfall. States have begun cutting basic services like snow removal, reduced garbage pickup, and in Colorado Springs they went to the pawn shop – selling police helicopters on the Internet.
In a desperate effort to meet budget needs, states and local governments over the last decade have gone to the big banks to ask for exotic instruments known as interest rate swaps. These desperate state and local governments were taken advantage of in the same way that Greece was by Goldman Sachs. Likewise, these swaps are threatening the economic health of local cities and states.
Shouldn’t there be more discussion on news programs and in Congress about these “exotic financial instruments” that may be a big contributing factor to the poor financial health in which many of our states and municipalities find themselves?
In Looting Main Street, an article Matt Taibbi wrote for Rolling Stone in the spring of 2010, the author detailed how interest rate swaps were helping to bankrupt Jefferson County, Alabama. Jefferson County’s troubles began when it had to finance a new sewer project and went looking for money. Then the vultures of Wall Street came swooping into town.
Taibbi wrote:
In 1996, the average monthly sewer bill for a family of four in Birmingham was only $14.71 — but that was before the county decided to build an elaborate new sewer system with the help of out-of-state financial wizards with names like Bear Stearns, Lehman Brothers, Goldman Sachs and JP Morgan Chase. The result was a monstrous pile of borrowed money that the county used to build, in essence, the world’s grandest toilet — “the Taj Mahal of sewer-treatment plants” is how one county worker put it. What happened here in Jefferson County would turn out to be the perfect metaphor for the peculiar alchemy of modern oligarchical capitalism: A mob of corrupt local officials and morally absent financiers got together to build a giant device that converted human shit into billions of dollars of profit for Wall Street …
He continued:
And once the giant shit machine was built and the note on all that fancy construction started to come due, Wall Street came back to the local politicians and doubled down on the scam. They showed up in droves to help the poor, broke citizens of Jefferson County cut their toilet finance charges using a blizzard of incomprehensible swaps and refinance schemes — schemes that only served to postpone the repayment date a year or two while sinking the county deeper into debt. In the end, every time Jefferson County so much as breathed near one of the banks, it got charged millions in fees. There was so much money to be made bilking these dizzy Southerners that banks like JP Morgan spent millions paying middlemen who bribed — yes, that’s right, bribed, criminally bribed — the county commissioners and their buddies just to keep their business. Hell, the money was so good, JP Morgan at one point even paid Goldman Sachs $3 million just to back the fuck off, so they could have the rubes of Jefferson County to fleece all for themselves.
According to Taibbi, the original cost for the sewer project was estimated to be about $250 million. That amount was reported to have ballooned into a total indebtedness of $5 billion for Jefferson County over the years. Because of the sewer debacle, the county was not only “saddled with an astronomical debt on its sewer project, it also saw a downgrade in its overall credit rating, which left it paralyzed in its attempts to borrow money to pay for general expenditures.” This is why people’s sewers bills exploded by 400%! This is why the county had to lay off many of its employees—who also lost their health insurance. This is also why Jefferson County had to file for bankruptcy last fall.
Bloomberg reported that Jefferson County’s Chapter 9 filing left creditors like JP Morgan “facing hundreds of millions of dollars in losses” and that it could “revive concern that defaults may rise in the $2.9 trillion municipal bond market.” The filing also leaves county residents uncertain as to how much they may be charged for sewage fees in order to repay the debt. Bloomberg also reported that JP Morgan agreed to a $722 million settlement with the SEC in 2009 “over payments its bankers allegedly made to people tied to county politicians in order to win business.” According to a Reuters report, at least twenty-two individuals have been convicted on charges of corruption, bribery, and fraud.
So…corrupt county officials and contractors have gone to jail. So…JP Morgan pays a multi-million-dollar fine to the SEC. So what? Does it fix things for all the people in Jefferson County who lost their jobs and health insurance because unethical politicians, contractors, and bankers were made to pay for their crimes? Does it help the poor people who can’t afford to pay their water and sewer bills? Does it help the poorest residents of Birmingham who say they can no longer afford to pay for running water?
One gentleman who lives in Birmingham says he has found it cheaper to purchase water from a gas station and to pay a sanitation company to remove waste from his “porta-potty” than to pay his water and sewer bill—which can amount to $300 some months. One Birmingham woman said that after she pays her water and sewer bill she doesn’t have much money left from her monthly $600 Social Security check to pay for food and electricity.
And so it goes. No help for the poor of Jefferson County. Yet, the wizards of Wall Street who are helping to bankrupt our communities are making a killing!
I’d say we need some REAL financial reform in this country NOW…before we become a third world country. Shouldn’t interest rates swaps and other “exotic financial instruments” be regulated? What do you think?
SOURCES
How Big Banks’ Greek-Style Schemes Are Bankrupting States Across the U.S. (Huffington Post)
Jefferson County Files for Chapter 9 Bankruptcy Protection (JEFFCOnline—The Offical Website of Jefferson County, Alabama)
Looting Main Street: How the nation’s biggest banks are ripping off American cities with the same predatory deals that brought down Greece (Rolling Stone)
Jefferson County, Alabama: Screwed By Wall Street, Still Paying (Rolling Stone)
“Looting Main Street”–Matt Taibbi on How the Nation’s Biggest Banks Are Ripping Off American Cities with Predatory Deals (Democracy Now)
Alabama county files biggest municipal bankruptcy (Yahoo/Reuters)
Alabama’s Jefferson County Declares Biggest Municipal Bankruptcy (Businessweek)
The Fleecing of Alabama: The Bills Come Due (Bloomberg)
Swarthmore Mom,
those are some serious numbers in your linked article.
http://www.dailykos.com/story/2012/01/10/1053386/-Wall-Street-posts-huge-numbers-against-Elizabeth-Warren?via=blog_1
Dave,
I believe we need some real financial reform in this country. I don’t think we should continue to bail out these banks that were/are the cause of their own problems.
No one disagrees that wall street exploited these people who didn’t do their due diligence. But since they were not allowed to go bankrupt, what have we done? Told them keep it up no matter what you can’t lose, that is moral hazard 101, and merely makes my point.
Governments Using Swaps Emulate Subprime Victims of Wall Street
Bloomberg Businessweek
11/14/11
http://news.businessweek.com/article.asp?documentKey=1376-LQ6VQJ0UQVI901-15TD5JJPS94EFD7F5EJDI5VDIO
Excerpt:
Ask a Nobel Prize-winning economist what’s the difference between the mayor of Baltimore losing taxpayer money with derivatives sold by Wall Street and millions of Americans defaulting on subprime loans and he’ll say there isn’t any: State and local governments are victims of opaque financing they don’t understand, the same way individuals go broke on borrowing at rates too good to be true.
Martin O’Malley, Baltimore’s mayor in 2002, led his constituents into a financial trap that was supposed to save money on water, sewer and other projects. Now O’Malley, 48, is Maryland’s Democratic governor and the state’s biggest city faces a $90 million loss to get out of so-called auction-rate securities, the municipal equivalent of a floating-rate home loan that exploded when subprime lending collapsed and helped push Jefferson County, Alabama, into bankruptcy last week.
Like first-time buyers who stretched to finance a house and are stuck with underwater mortgages, borrowers from Baltimore to Denver are locked into more than $50 billion of auction-rate bonds sold by banks, which earned an estimated $20 billion in fees on related derivatives that municipalities and local governments in U.K. are prohibited from using because of the risk for catastrophic loss. U.S. cities face hundreds of millions more in penalties if they refinance the bonds into fixed-rate securities with the lowest yields since the 1960s.
‘Exploited’ by Banks
“These financially unsophisticated local officials were being exploited by big banks,” said Columbia University Professor Joseph Stiglitz, who won the Nobel Prize in 2001 with George Akerlof of the University of California, Berkeley and Michael Spence, now at New York University, for their analysis of markets with asymmetric information.
“The outrage was not just that there were high transaction costs, but that the risk wasn’t understood by those who used them,” Stiglitz said.
JPMorgan Swaps Occupying Cassino Prove Curse Like World War II Destruction
By Elisa Martinuzzi and Vernon Silver
December 27, 2011
Bloomberg
http://mobile.bloomberg.com/news/2011-12-27/jpmorgan-s-swaps-occupying-cassino-prove-curse-like-world-war-ii
Excerpt:
World War II’s Battle for Cassino leveled the Italian town and its hilltop abbey. Now, the 33,000 residents are digging out from the rubble left by Wall Street.
Six decades after U.S.-led forces ousted the Nazis from Cassino, a new generation is grappling with the fallout from the debts of postwar rebuilding — borrowings that grew because of a derivative that backfired. Soaring costs forced Cassino, 80 miles southeast of Rome, to settle an interest-rate swap with JPMorgan Chase & Co. (JPM) in 2009, leaving the town unable to pay for daycare for 60 infants and services for the poor.
For Iris Volante, who chairs Cassino’s assembly finance committee, the bankers who share responsibility for peddling the derivatives should pay with their jobs. She, like Occupy Wall Street protesters around the world, is demanding an overhaul of the financial system to stop history from repeating itself.
Wall Street’s Tax on Main Street
By GRETCHEN MORGENSON
Published: August 6, 2011
New York Times
http://www.nytimes.com/2011/08/07/business/wall-streets-tax-on-main-street.html
Excerpt:
AMID all the talk of debt and default in Washington last week, tiny Central Falls, R.I., went bankrupt.
Like many states and cities in these hard economic times, Central Falls — population: 19,000 — was caught short by hefty pension obligations and weak tax revenue. It may not be the last municipality to file for bankruptcy. Jefferson County, Ala., is now on the brink of it, thanks to a sewer bond issue gone wildly bad.
But while pensions and the economy are behind many of municipalities’ troubles, Wall Street has played a role, too. Hidden expenses associated with how local governments finance themselves are compounding financial problems down at city hall.
Wall Street banks have peddled to municipalities all sorts of financial products, some of which have turned out to be costly mistakes. Testifying on July 29 at a public hearing on municipal securities sponsored by the Securities and Exchange Commission, Andrew Kalotay, an expert in financial derivatives who runs a debt management advisory firm in New York, asserted that poorly structured financial transactions involving bonds and derivatives known as interest rate swaps represented “Wall Street’s multibillion-dollar hidden tax on Main Street.”
Mr. Kalotay is talking about a type of complex financing that big banks have pushed on state and local authorities in recent years. The arrangements are typically made when borrowers want to exchange variable-rate debt for fixed-rate obligations.
These deals are lucrative for the banks, but many of the issuers don’t seem to understand them. Mr. Kalotay told the S.E.C. that excessive fees charged by banks had cost issuers, and therefore taxpayers, $20 billion over the last five years. Real money, in other words, that could have been used in other ways by states and towns short on cash.
There’s much for banks to love about these deals. Because there is no central market for interest rate swaps, prices of swaps are shrouded in secrecy. Banks can mark up costs significantly, often without their clients’ knowledge.
Banks offering such deals can act as both adviser and counterparty to borrowers, putting the banks in direct conflict with their customers. And under agreements governing many of these swaps, borrowers that want to unwind these deals must go back to the banks that created them, putting the issuers at a disadvantage.
The costs of unwinding swaps can be onerous. Banks justify their fees by saying they are exposed to credit risk. But Mr. Kalotay asked, “What is the justification for a high margin on unwinding, when credit risk is nonexistent?”
Another plus for the banks is that they book immediately the entire amount earned over the life of the swap; salespeople working on the deals receive bonuses — typically 10 percent — on these windfalls.
Bron,
Don’t go getting your knickers in a twist. I was expressing my own opinion on the subject. If you want your water and sewer and other essential services provided by a private company, I’d suggest you go hire one that will do that for you.
You can’t regulate the owners of the world, like it can’t be illegal if the president does it.. I call it self-ownership plus. Hurray for 10yrs of Gitmo.
Bron,
“That is just plain baloney. I never made that argument and wouldnt.”
Actually you did make that argument by implication. You did it when you said “Most of the elected government officials in this country along with the general population know nothing about money and finance” the implication being that government should be run by people who understand finance because they are allegedly financial professionals. Financial professionals such as Henry Paulson and Lil’ Timmy – the champions of socialized losses/private profits and “Too Big to Fail”. See, that’s the thing about speaking without thinking, Bron. You invite unintended consequences.
Elaine,
“I wouldn’t want a private company to be responsible for my water and services.”
So noone else should have the option available to them?
As for Dodd Frank it’s just more beauracracy, which considering the financial state of the US is blatantly unessecary. The idea that we can simply pass more and more laws to combat every issue is misguided. Fraud and bankruptcy laws are on the books, new laws are rarely needed. If the govt didn’t privatize profits and socialize losses as it did these financial companies would have gone bust and the economy would have likely corrected by now. However because of the govt’s role has become so massive in the economy these proper corrections are not happening, it’s beauracracy that’s the problem, not the private sector.
Dave,
I agree with rafflaw. A responsibility of the government is to provide essential services. The purpose of businesses is to earn profits.
We’ve seen what the wizards of Wall Street did to the world economy because of their greed. I wouldn’t want a private company to be responsible for my water and services.
I would argue that virtually all govt programs are bankrupt, social secuity being a prime example. The notion that it is more cost feasible to have govt run services is fool hardy at best. There is no competition which is what drives costs down, cell phones and televisions continually get cheaper and better. Because govt’s only compete with itself there is no incentive to lower costs. Govt unions continually push wages and costs up because monopolies have no competitors, I would say this is economic law. I would agree there is room for some gov’t services, roads, police lisceningaybe a few others. But as I said with no competition costs will only rise and servies rarely improve.
Dave S.,
That is just wrong. The services provided by many Government agencies rivals and exceeds profit driven corporations. Medicare is just one prime example of that. The financial markets didn’t fix themselves by going out of business, but instead demanding federal bailouts and secret loans that helped crash the economy. This bill that was being discussed is an attempt to reduce the effectiveness of the Dodd-Frank bill.
That’s why these services should be left to the private sector, if this was a company, it would go bankrupt and another financially responsible company would buy up the valid assets. The jobs may change hands may pay more or less but there would not be the inherent moral hazard that govt’s have when they control services. The incentives are only to line pockets and get re-elected there is no concern for the public, and because it isn’t a private company there are no concerns for ensuring the service is financially feasible. People should not blame bankers for trying to make money, this is life, it is the state, federal and local politicians that believe it is a proper role of govt to provide services to the public which in virtually all cases it is not.
Elaine,
I doubt the Senate will pass the swaps bill exemptions. At least I hope not!
Gene H:
“But to make arguments that they should have control because “they know better”?”
That is just plain baloney. I never made that argument and wouldnt. You are making that argument.
And as far a paternalism? Teaching finance and economics makes a lot more sense than teaching sex-ed. For christ sake, the little kids are there because their parents know a little something about sex. Most people dont know much about finance. As evidenced by your many posts on the subject.
The ad posted above was made by Gingrich’s super pac.