Failure of Municipal Swaps Cost Taxpayers $4 Billion

According to Bloomberg.com, taxpayers have had to pay over $4 billion because of insurance companies and banks’ failed promise to nonprofits and governments that financial engineering would bring down interests on bonds sold for public projects. Since 2008, hundreds of borrowers throughout the US have had to pay Wall Street to end their agreements. Citigroup, JP Morgan Chase & Company, Morgan Stanley , and Bank of America are a few of the other firms that have received payments from borrowers.

For example, California’s water resources department paid $305 million to Morgan Stanley-led banks to unwind interest-rate bets that backfired, while the Bay Area Toll Authority gave bond insurer Ambac Financial Group Inc. $105 million to terminate $1.1 in billion interest-rate agreements. In August, The state of North Carolina shelled out $59.8 million.

Interest-Rate Swap
In this type of transaction, two parties exchange payment based on a principal amount that has been agreed upon. Most municipal market swaps require borrowers to put out long-term securities with interest rates that change every month or week. The borrowers are to exchange payments, resulting in a fixed-rate paid to an insurer or bank, while a variable rate in return is received.

The swaps drew a lot of interest because nonprofits and governments could pay lower rate than if they had sold conventional fixed-rate securities. According to the Financial Crisis Inquiry Commission senior researcher Randall Dodd, prior to the credit crisis, there were up to $500 billion of the deals done were in the $2.7 trillion municipal bond market.

Unfortunately, the credit market did collapse and Wall Street’s payments dropped and could no longer cover the municipalities’ debt costs. Still, under the agreements, borrowers had to keep selling adjustable-rate securities.

Bloomberg reports that there aren’t many taxpayers that are familiar with how much it cost to untangle municipal swaps. (Payment disclosures to Wall Street are usually noted somewhere in the documents given to investors by borrowers when the bonds are sold.) In many instances, investment firms that receive payments aren’t clearly identified and government officials usually don’t draw notice to payments made to terminate contracts.

Related Web Resources:
Wall Street Takes $4 Billion From Taxpayers as Swaps Roil Public Financing, Bloomberg, November 10, 2010

Making Use of Muni Swaps (PDF)

Municipal Securities, Stockbroker Fraud Blog

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