Going for the big kill

Municipalities

Municipalities fair game

Becoming Wall Street prey
Not only homebuyers are tricked by the banks. When a municipality needs to finance a common project, it can go through a bank and issue a fixed rate municipal bond. This does not generate much money for the banks so they can suggest what they claim are better alternatives. For example Variable Rate Demand Bonds, letters of credit, Interest Rate Swaps. The result can be disastrous.
Variable Rate Demand Bonds (VRDBs) are securities resold regularly, perhaps once a week. In case the banks cannot sell the VRDBs, it offers an alternative, a letter of credit; to convert the variable interest to a fixed interest, the bank includes an Interest Rate Swap (IRS). The securities, VRDBs or municipal bonds, are often insured with a monoline insurance company.
Tellingly, few (if any) banks or corporations use similar structures. Unfortunately, these products do not always work as advertised and a result is that public funding costs have exploded.

Reward for failure
With the subprime crisis in 2008, investors did not want bank credit and much of the VRDB market disappeared. Monoline insurers lost a lot of money and were downgraded by the credit rating agencies; although municipalities were better risks than subprimes, they were downgraded because their monoline insurances were downgraded. The downgrade could trigger some clause, forcing municipalities to convert to letters of credit. Nasty surprise. They had to pay a penalty interest rate. Normally, penalty interest rates are used to protect creditors from borrower's shortcomings; here the municipalities were punished and the banks rewarded for the bank's failure to sell.
The Interest Rate Swaps didn't make out much better. As the bank could not sell the VRDBs, the communities did not need any IRSs but they still had to pay. It's like paying insurance for years after your house burnt down. With old style bonds, you could refinance. With IRSs, the banks made sure to impose huge termination fees.

Libor abuse
London InterBank Offered Rate (Libor) is the average interest rate used by some major British banks when borrowing from each other. Or it is supposed to be. In the US, Libor is used extensively as reference, affecting the interest rate of many financial institutions; Libor manipulations have tremendous effect on loan profits and losses. In 2012, extensive Libor manipulations were revealed to the public, around 20 major banks in at least 10 countries have been named. Several institutions were fined; Citigroup received immunity for one infringement but was fined EUR 70 million for others, JPMorgan was fined EUR 80 million.
IRSs were often depending on Libor. In the first quarter of 2009, Citigroup had $14 trillion in IRSs while Bank of America and JPMorgan Case each had $49 trillion. It has been estimated that Libor manipulations cost municipalities at least $6 billion in artificially low Libor rates, totaling $10 billion if you include costs to get out of IRS deals.
With Jefferson county paying $3.14 billion for a sewage system planned to cost $250 million (see below), a $10 billion total sounds very little. Still, that extra cost might have been due to more than Libor manipulation; some of it might even be legit.

Stupid to believe in competition
A federal court dismissed claims that 16 banks had broken federal anti-trust laws by manipulating Libor. The court found that if the municipalities were stupid enough to believe that the banks were competing instead of collaborating, it was their own fault.
I don't get this. Should fraud be condoned because if you are stupid enough to believe the fraudster, it is your own fault? This is invalidating all laws against fraud. Well, with this being the practice of law for years, maybe surprise is unwarranted. Besides, as I understand it, the banks have been delinquent on at least 2 more accounts. 1) By collaborating on Libor manipulation, they have put those other banks that did not collaborate at disadvantage. 2) They misrepresented their product, by manipulating Libor they delivered a defective product. Like those who delivered those Ford Pintos that turned into fireballs when rearended, they should have a responsibility for the wares they deliver.

Municipalities tricked by advisers
A municipality embarking on a big project typically does not need all the money at once; the project might go on for years and money is put in a stash for later expenditures. To get the best terms for the money, they use agents. Although the agents are hired by the municipalities, they are ultimately paid by the banks. The result is what you should expect. The advisers are colluding with the banks to keep the bids low and they are being paid additional undisclosed fees for their assistance.

Jefferson County breakdown
Jefferson County, Alabama, needed a new sewer system. To finance it, JPMorgan was commissioned to make a deal with county bonds and Interest Rate Swaps (JPMorgan paid Goldman Sachs $3 million to keep out, probably a violation of anti-trust laws). The deal was so full of corruption that 20 local officials including the mayor were sentenced. No banking employee was convicted. What happened, did the local officials bribe each other?
In 2008, the housing crash took down the insurance companies underwriting the county's bonds, making the insurance worthless. This triggered clauses in the contracts requiring Jefferson to pay $800 million in four years instead of forty. From 2008 to 2009, the county's annual payment jumped from $53 million to $636 million.
The Interest Rate Swap deal was meant to even out interest payments by swapping variable interest rates against fixed interest rates. The variable and the fixed payments were supposed to match but did not; the "fixed" payments from JPMorgan were based on the Libor rate while the variable payments were based on a municipal-bond index and suddenly Jefferson was getting far less from JPMorgan. In 2012, Jefferson County could no longer pay its swap payments. So JPMorgan canceled the deal and charged the county a termination fee of $647 million, to be added to the debt.
Surprisingly, the SEC did act. JPMorgan was charged with fraud and had to cancel the $647 million termination fee, pay a $25 million fine and $50 million to the displaced workers. $647 million might look like a lot of money. It is a lot of money; I am sure the JPMorgan people cried all the way to the bank. Still, they made billions of dollars; clearly, there is no talk about reimbursing for wrongs done or crime mustn't pay. The debt, for a sewage system planned to cost $250 million, was $3.14 billion.

© Anders Floderus