Tom Ferguson: How Wall Street Hustles America’s Cities and States Out of Billions

Yves here. While the municipal swaps fiasco may seem like old news, this piece discusses a post-crisis type of swap which is even more appalling. The old scam was to talk local and state authorities who would have been far better served with old-fashioned fixed rate financing into doing floating rate financing and entering into a series of swaps to get a fixed rate deal, with a supposed improvement in funding costs. The problem is that many of those floating rate deals were auction rate securities, and when that market failed in early 2008, the borrowers were doubly hosed. The ARS went to penalty rates. In addition, payments on the swaps often kicked up shortly thereafter (due to the slow-motion failure of monoline guarantors, which was the hidden trigger behind both events. The downgrade of the monolines de facto downgraded the municipality, which led to increased payments on the swaps).

The latest scam is more of the same, but new focus is municipal transit authorities, who often have terrible governance and thus are particularly easy marks. The swap deals have left them locked into high fixed rates via swapping floating rates into fixed. They can’t exit (they’d have to pay huge termination fees on the swaps) when if they had done a regular bond deal with no swap, they could refinance at today’s super low interest rates.

By Tom Ferguson, Professor of Political Science at the University of Massachusetts, Boston. Cross posted from Alternet

Many powerful interests have jumped at the opportunity to use the crisis to eviscerate what’s left of the welfare state.

We all know that America’s cities and towns are in the throes of a deep financial crisis. And are told, over and over, what’s supposedly behind it: unreasonable demands by grasping state and municipal workers for pay and pensions. The diagnosis is a grotesque cartoon. Many of the biggest budget busters are on Wall Street, not Main Street.

In a country as big and locally diverse as the U.S., any number of wacky pay and pension schemes are likely to flourish, though some of the most outrageous turn out to cover not workers, but legislators. But overall state and local pay has not been growing faster than in the private sector for equivalent work for many years now.

What has driven cities and towns to the brink is not demands from their workforce but the collapse of national income and the ensuing fall in tax collections. Or, in other words, the Great Recession itself, for which Wall Street and the financial sector are principally to blame. But many powerful interests have jumped at the opportunity to use the crisis to eviscerate what’s left of the welfare state, roll back unionization to pre-New Deal levels, and keep cutting taxes on the wealthy. The litany of horror stories that now fills the media is ideal for their purposes.

The selective character of this press campaign became obvious last week. As the latest wave of stories started rolling in the wake of elections in California and Wisconsin, a striking piece of evidence surfaced that flies in the face of the conventional narrative. The Refund Transit Coalition, a coalition of unions and public interest groups, put out a study that documented in stunning detail how Wall Street banks have for years been hustling American cities, states, and regional authorities out of billions of dollars. But save for Gretchen Morgenson’s “Fair Game” column for the New York Times, the study drew almost no attention.

At a time when cities and states are taking hatchets to services and manically raising fees and fares, the group’s analysis merits a closer look and a much, much wider audience.

Its starting point will be familiar to anyone who recalls the debate over financial “reform” of the last few years. In the bad old days of pre-2008 deregulated finance, bankers started pedaling hot new “structured finance” products that they claimed were perfect for the needs of clients who had thrived for decades using cheaper, plain vanilla bonds and loans. The new marvels – swaps and other forms of so-called “derivatives” whose values changed as other securities they referenced fluctuated in value – were often complex and frequently not priced in any actual market. Their buyers thus had difficulty understanding how they really worked or how they might be hurt by purchasing them.

In many documented cases, buyers also had only faint ideas about how profitable these products were to the houses selling them. One befuddled Pennsylvania school board, for example, diffidently quizzed J.P. Morgan Chase: “The school-board official knew they were getting $750,000 for entering into a ‘swaption’ with J.P. Morgan Chase & Co. They wanted to know what was in it for the bank. They wanted to know the price. They seem like reasonable requests. ‘I can’t quantify that to you,’ the banker told them. ‘It is not a typical underwriting and I can’t quantify that for you and there’s no way that I can be specific on that.’”

One popular product involved an “interest rate” swap built into a bond deal. In these, as the Transit study explains, some hapless municipal authority brings out a bond and commits to making fixed payments to buyers. That sounds like any other old fashioned bond offer. But here’s the twist. In the swap version, the bank offers, for a handsome charge, to pay a variable fee to the issuer of the bonds. The idea was that the money could be used to make payments owed to the bond buyers. Payments were supposed to vary with the course of interest rates. The contrivances were heralded as protecting issuers against a rise in rates and saving them money on their payments.

But there was a catch: If rates fell, then banks could make out big, while issuers faced disaster, because the latter still had to make the fixed payments on their bonds, while the banks’ payments would shrink as rates fell. In effect, issuers were gambling on interest rates and betting they somehow knew better than the banks what was going to happen. And, ah, yes, the final touch: With old style bonds, you could refinance if rates fell; with the new fangled derivatives, the banks made sure to impose huge termination fees.

The result, for years now, has been literally billions of dollars of losses for cities, states, and other local authorities, including school boards and state college loan agencies. Locked in by the termination fees, they can stay in the swaps and pay and pay as the banks’ payments to them dwindle. Or they can buy their way out of the swaps at preposterous prices – Morgenson indicated that New York State recently paid $243 million dollars to get out of some swaps, of which $191 million had to be borrowed.

The Refund Transit study concentrated on local transit systems. Some of its numbers are stunning. The study pegged annual swap losses at the Massachusetts Bay Transportation Authority (Boston area) at $25.8 million and suggested that the MBTA will “lose another $254 million on these swaps” before they lapse. The study added that the MBTA was losing money on swaps even before the crisis, with total losses running in the “hundreds of millions” of dollars.

In Charlotte, site of the Democratic Convention, the study suggests that swaps with Bank of America and Wells Fargo cost the area transit system almost $20 million a year – something to think about as the President gives his scheduled acceptance speech at Bank of America Stadium.

Other localities that the study suggests are wracking up big annual losses include Chicago ($88 million), Detroit ($54 million), frugal Chris Christie’s State of New Jersey ($83 million), New York City ($113.9 million), Philadelphia ($39 million), and San Francisco ($48 million).

The study includes a useful table of the main banks benefiting from these arrangements. They include all the usual suspects: Besides Bank of America and Wells Fargo: Citigroup, Morgan Stanley, Goldman Sachs, J. P. Morgan Chase, UBS, and AIG, among others. Most were recipients of TARP funds, while all have profited from super cheap Federal Reserve financing, Fed, Freddie, and Fannie purchases of mortgage backed securities, and extended deposit guarantees as well as tax concessions granted by the Treasury in the wake of the 2008 disaster.

Given all the other advantages conferred on our Too Big To Fail Banks by the government and both major political parties, it would be a stretch to argue that the toleration of these swaps by federal, state, and local authorities – and the press, which in virtually all areas has defaulted on reporting the basic facts – constitutes the greatest outrage of all. But it is high time that they came in for full public scrutiny. These products were obviously very risky; few agencies that bought them appear to have understood this.

Despite some reforms aimed at eliminating crude “pay for play” deals, state and local finance remains a area rife with conflicts of interest. The whole series of deals needs to be investigated, the advisers who recommended them to the authorities need to be identified, the full losses added up, and responsibility fixed for the continuing series of bad decisions. Many State Attorneys General and general counsels also need to explain why they have not more aggressively publicized these arrangements and challenged them in court. (A New York court ruled that such deals were private contracts, not securities; that should have brought forth howls of protests and immediate legal fixes.) It is high time citizens, instead of banks, start occupying the transit authorities, school boards, and other state and local entities that are so vital to communities and real people.

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  1. LeonovaBalletRusse

    Yves, thanks for shedding light on this incredibly wicked scheme for profits for some. Might this be called “exponential wickedness?”

    1. Rehabber

      Be silent Ovid, of Cadmus and Arethusa;
      For if him to a snake, her to fountain,
      Converts he fabling, that I grudge him not;
      Because two natures never front to front
      Has he transmuted, so that both the forms
      To interchange their matter ready were.
      Together they responded in such wise,
      That to a fork the serpent cleft his tail,
      And eke the wounded drew his feet together.
      The legs together with the thighs themselves
      Adhered so, that in little time the juncture
      No sign whatever made that was apparent.
      He with the cloven tail assumed the figure
      The other one was losing, and his skin
      Became elastic, and the other’s hard.
      I saw the arms draw inward at the armpits,
      And both feet of the reptile, that were short,
      Lengthen as much as those contracted were.
      Thereafter the hind feet, together twisted,
      Became the member that a man conceals,
      And of his own the wretch had two created.
      While both of them the exhalation veils
      With a new colour, and engenders hair
      On one of them and depilates the other,
      The one uprose and down the other fell,
      Though turning not away their impious lamps,
      Underneath which each one his muzzle changed.
      He who was standing drew it tow’rds the temples,
      And from excess of matter, which came thither,
      Issued the ears from out the hollow cheeks;
      What did not backward run and was retained
      Of that excess made to the face a nose,
      And the lips thickened far as was befitting.
      He who lay prostrate thrusts his muzzle forward,
      And backward draws the ears into his head,
      In the same manner as the snail its horns;
      And so the tongue, which was entire and apt
      For speech before, is cleft, and the bi-forked
      In the other closes up, and the smoke ceases.
      The soul, which to a reptile had been changed,
      Along the valley hissing takes to flight,
      And after him the other speaking sputters.

      Inferno, Canto 25

  2. F. Beard


    How much more will it take before people seriously consider that to save our civilization we must KILL BANKING!

    What part of usury for counterfeit money sounds safe?

  3. Anchard

    And of course, the contracts that embody these rapacious deals are seen as ironclad while pensions are “unaffordable promises” that must be renegotiated immediately.

  4. Pith Helmet

    Do these “side agreements” have *any* advantage to the public bond issuers? It seems more like the banks were selling “rust protection coating” like a new car salesperson.

    1. jake chase

      The difference I fear is that you had bottomless corruption on both sides of these municipal deals. Those in control of the “public authorities” are also routinely engaged in endless milking operations for themselves and their cronies. Who knows how extensive the kickbacks were that fostered these lunatic swap schemes? Once we create the category of “other people’s money”, the very worst vipers will rise up to grab it.

  5. Rehabber

    Ground zero is Jefferson County, AL. JPM hired local investment bank partner (the way these deals have always been done) Bill Blount. Blount funnels money through a lobbyist to Birmingham’s mayor and the former JeffCo Commissioner, who uses his poltical influence to steer the county into the arms of JPM.

    In connection with a $3B bond offering, the County entered into 18 swap agreements, with a notional amount of $5.6 billion.

    These stooges take the fall, with Langford getting hammered.

    JPM settled with the SEC.

    JeffCo filed for bankruptcy.

    The creditors, including JPM, fought the right of JEffCo to file for bankruptcy protection.

    Credotrs are appealing.\

    BONY took funds from the JeffCo outside of the Chapter 9 process.

  6. James Cole

    This is an area with which I am rather familiar.

    A big part of the scandal here in my view is that the municipalities hired financial advisory firms to advise them on these swap-bond deals (structure and pricing), and these advisory firms betrayed their customers for the sake of getting fees. Some of those folks should be in jail, but I guess that is a now-common refrain. And it is partially the munis own fault for hiring financial advisory firms on a contingent fee basis (i.e., they only got paid if the deal closed) rather than on a fee-for-advice model–which to my knowledge has yet to be rectified in the industry.

    Dodd-Frank would have imposed fiduciary duties on the financial advisors, but they successfullly fought to get that out.

    Also important (for crisis historians, if no one else) is the point made in the post that the monolines were the main vector by which the credit crisis spread to the public sector, due to their commingling of RMBS and muni debt risk in the same insurance portfolio.

    1. Nathanael

      I’ve come to the realization that one should never, ever hire financial advisors at all, unless they have an non-financial reason to be trustworthy (like being your son, or married to your son, or something).

    1. LeonovaBalletRusse

      Just so. DB was JPM’s pusher in Europe, as the Night Line show revealed. RICO!

  7. Mark P.

    ‘Given all the other advantages conferred on our Too Big To Fail Banks by the government and both major political parties, it would be a stretch to argue that the toleration of these swaps by federal, state, and local authorities – and the press, which in virtually all areas has defaulted on reporting the basic facts – constitutes the greatest outrage of all.’

    To the contrary.

    It’s the state, municipal and local level that is the real, specific realm where the pedal hits the metal — where the looter elite make its claims, and grabs real tangible community wealth and assets for itself.

    Sure, the financial industry can create money based on deals made and then pay themselves bonuses based on that. But their notional claims of wealth have to be translated into real claims on real assets. The local, community level is where much of that happens.

    So, thanks for this post. Michael Hudson is good on this —

  8. MyLessThanPrimeBeef

    If cities and states with professions at their disposal can not defend themselves against Wall Street, what do small people have?

  9. stripes

    It is true …. Wall Street are the deadbeats and the biggest tax evaders on the planet. Imagine if we, the Corporation of the American people didn’t have to pay tax and we could borrow other peoples money for free and make gagillions from it and never have to pay any body back..and if we couldn’t pay our debts….we could just keep borrowing more and pocketing it all!

  10. damian

    Complexity creates its own gross margin – seperate and apart from any specific instrument –

    the people approving these transactions must ask questions- one would think – but they must be getting opaque answers in a short general presentations in compressed meeting schedules where no one is tracking the flow of funds line by line under various scenerios

    selling crack in proximity to a school is less dangerous to children than these bond guys with the local school board

  11. William Neil


    Thanks for this. I went back down memory lane to my early writings on this topic, from one of my first essays on the history of the financial crisis, “The End of an Era, Part One,” from June 2008: Here’s what I found under the heading
    “The Slaughter of the Innocents.” Please note that some of the early predatory activity was unleashed, with the unanimous help of the Pennsylvania legislature, upon the old deindustrialized towns of the state, which, it almost goes without saying, didn’t have much money having lost their tax base to places much further to the East. So hear it is from exactly four years ago:

    The Slaughter of the Innocents

    Thanks to the fine reporting of Martin Z. Braun and William Selway of , and to Pam Martens who steered me to their February 1, 2008 article “Hidden Swap Fees by JPMorgan, Morgan Stanley Hit School-Boards,” at, we know the Pennsylvania legislature passed a law in the fall of 2003 (by votes of 197-0 and 45-0 in the two houses!) authorizing its cities, local school districts and counties to engage in derivative purchases, specifically interest rate swaps, with the rationale that they could reduce their borrowing costs from the traditional long term fixed bond rates. The pitch was: the new financial products meant you didn’t have to get stuck for 30-40 years in rates that were too high, so get with the latest the private sector offers. Don’t let the terminology scare you off: derivatives are financial instruments “derived” from some underlying asset, security, or benchmark(s). Interest rate swaps have been around for a long time, starting in the 1970’s with corporate attempts to manage and hedge risk from changes in interest rates and currency differences across national borders (and evade national regulations too). Since then, they have evolved into many different forms and can serve as both a hedge against abrupt shifts in rates, or unfavorable long range trends. They also can serve, even at the same time, depending on how the swap is arranged, as speculative instruments. The major banks named in this article have long experience in arranging these derivative products on terms favorable to themselves, and have the models to predict and control their risks. The school districts, like Erie, had to rely upon their own advisors, and their knowledge and independence, such as it was, to guide them. The appeal to old industrial regions that had lost their manufacturing base and sizeable parts of their population since the early 1970’s is that the banks would offer some cash upfront. However, they also structured their undisclosed feeds into their calculations and by privacy agreements prevented the local government from comparison shopping with similar deals made with other governments. The municipal hope was also that the variables in the deal – which way interest rate spreads went on certain specified benchmarks – would save them money from the high interest rates that they seemed to be locked into for their bonds if they followed traditional financing routes. But the wild card – the interest rate spreads – went the wrong way for the locals, in this case the Erie School District and they had to spend $2.9 million to break the deal and cut their losses, after collecting only $750,000 from JPMorgan Chase. According to the article, banks have “pitched” some 500 deals putting $12 billion in play. Fortunately, only 15 PA school districts went for interest rate swaps in deals worth “just” $28 million. Governor Ed Rendell, who signed the bill in September of 2003, setting all this in motion, now says that “‘the school districts are getting fleeced.’” Readers should beware, because a total of 40 states have also gone this route.

    Now the main line of defense for the promoters seems to be the surprising reversal in the direction of interest rate spreads. It should serve as a warning, though, for any local or county official contemplating going down a similar route and reading this review: there is no riskier time to play this game of guessing interest rate direction than just now in the summer of 2008, with the Federal Reserve torn between fighting inflation and a recession. The Fed’s interest rate actions can go either way and the continued turmoil in international financial markets abroad means there is no certainty from the private rate direction either. So don’t do it, because from what I read in this and the following article, all the safety clauses and terms for the options that the banks have built in if the rates don’t go the way they are betting – means the local end of the swap or swaptions will have to pay more than they understood – or bargained for. And it appears to be very difficult to get truly independent evaluations. If these deals didn’t work for the locals in the relatively quiet and predictable interest rate sea of 2004-2006, placid waters indeed in comparison to the rip tides we are currently negotiating, then this is no time to set sail.

    And if there ever was a time for market surprises, this is it too. Didn’t think interest rates would defy convention and go the wrong way? How about a nationwide decline in home prices, which again, no one eve thought could happen (local markets yes, nation as a whole, no. That premise is one that made the designers of the new mortgage packages, CDOs, especially the synthetic ones, so confident that they were reducing risk by creating pools of 5,000 from around the nation…Soros, Pages 117-118). Of course, the memory of 1929-1933, when nationwide declines did actually happen, has been virtually erased from the conventional wisdom. If we are really at the end of an era, and standing at the equivalent to the end of the 1920’s, predictions “into the 1930’s” will be pretty tough, even if we manage to evade something that drastic. Soros believes 1929 will be averted, thanks to the lessons learned and Fed Chairman Bernanke’s academic focus on them. Morris, Kuttner and Phillips give a range of possibilities, some of which, if not the equivalent to 1929 – make for pretty grim “unwindings.” It’s clear conventional thinking is going out the window pretty fast in 2008. (Stay tuned for Part II and more on these broader themes).

    Things were shaky enough for these Pennsylvania school districts, but now Jefferson County, Alabama is poised at the edge of becoming the nation’s largest municipal bankruptcy ever – $5.8 billion, based on interest rate swaps and adjustable rate bond agreements they entered into with JPMorgan, Bank of America, Bear Stearns and Lehman Brothers Holdings Inc., between 2001-2004, all done to help save them money in financing a new sewer system. Once again, it’s an old industrial area, including the “Pittsburgh of the South,” Birmingham. What went wrong? Reporters Selway and Braun put it this way: “Like homeowners who took out mortgages they couldn’t afford and didn’t understand, Jefferson County officials rejected fixed-rate debt and borrowed instead at rates that varied with the market.” (My emphasis.) But just as we have seen from Phillips’ and Soros’ perspectives on the subprime crisis, we again have fee-driven proposals, with the fees here collected by the banks (and layers of intermediaries) and the independence of the brokers pushing the deals being questioned – in this case really questioned – by the FBI, the SEC and the Justice Department. And this story does loop back into the subprime mess, because of the collapse of the adjustable rate bond auction market and the fact that Jefferson County’s bond insurers, Financial Guaranty Insurance Co. and XL Capital Assurance Inc., were badly hurt by losses in securities connected to subprime home loans and were downgraded by Standard and Poor’s and Moody’s. This downgrade, according to Selway and Braun, then led to Moody’s cutting the county’s sewer bonds themselves to Baa3, “one step above junk. The downgrade triggered clauses in the county’s swap agreements. Bank of America, Bear Stearns, JPMorgan and Lehman Brothers now had the right to cancel the deals – at a cost of $277 million to the county.” Read it here for all the gory details, and weep too, because the phrase that kept coming into my mind as I went through it – over and over – was “the slaughter of the innocents.” Here is the link:

    1. Paul Tioxon

      For those of you who missed today’s links, there is a long running scandal in the bankruptcy of the state capital, Harrisburg and a whistle blowing by a major Philly bond lawyer that is being picked up in the papers and the public, but of course, dismissed by the current administration.

      Additionally, another city in the state, Scranton, faces bankruptcy:

      But the bad faith of corporate America does end with Wall St and its enablers. Mercer, a consulting firm for management and human capital departments provided the city of Philadelphia, among many other large municipalities, the retention strategy for key managers knows as DROP. A retirement program which would allow high value talent to stay on and be well compensated for remaining a public servant. The problem with actual operational details is that DROP cost much more money than the cost benefit sales pitch indicated. And the political fall out was so bad, that city council was wiped out and replaced with a wholesale turnover rarely seen. The sight of large lump sums of cash going to elected officials as well high profile appointed department heads while they remained on the payroll, double dipping, was too much for people to bear. And that was before the economy crashed. Other cities have sued the consultants for their financial innovations that lost money and caused political havoc, further destroying the credibility of public officials. Like they needed any more help.

    2. LeonovaBalletRusse

      Pennsylvania: for the sport of child abuse, place of Roman Catholic hegemony:

      “NOBILITY and Analogous Traditional Elites in the Allocutions of Pius XII” was published in York, Pennsylvania.

      1. LeonovaBalletRusse

        Let’s not forget Tom Ridge of Pennsylvania, ENRON fraud enabler, first Director of Homeland Security, ever the servant of iniquitous profits for the Bush Dynasty.

  12. bhikshuni

    “In Charlotte, site of the Democratic Convention, the study suggests that swaps with Bank of America and Wells Fargo cost the area transit system almost $20 million a year – something to think about as the President gives his scheduled acceptance speech at Bank of America Stadium.”

    And only cost the Dems $40+ trillion in BoA grease on the backs of the public/FDIC.

  13. PQS

    These municipalities ought to just refuse to pay the outrageous obligations above and beyond what is reasonable.

    What are TBTF going to do? Repo a new bridge? Put a chain on the door of a new school?

    Sue? For what? And how many gory details will get publicized during those hearing?

    Take a page from the RW and looters everywhere: Refuse to pay. Refuse to play along.

    The problem is that the honest brokers are trying to play by the rules of a different game.

    1. Nathanael

      They can’t repo the bridges, but they *can* prevent the cities from paying their firefighters.

  14. izziets

    Here are a couple of my favorite articles compiled in the years since the financial crisis dealing with the souring of these swaps deals and the corruption surrounding their inception:

  15. rotter

    “This is tantamount to the owner of a candy store borrowing money at a fixed rate from his bank to finance an expansion of his business, then betting at the racetrack to try to lower his costs”

    Hey that sounds like a SWELL idea, especially since im an irresponsible, alchoholic, internet-porn obsessed, gambling addicted, morally deformed, intellectual dwarf – in other words the average finance sector, wal street gnome of the kind western civ produces in these declining latter years.

  16. quark

    As the banker who plays a feduciary role to their clients the bank should be forced to buy the bond back at the rate in which it was issued. That said the financial officers of the municioality should be fined and fired for not executing their financial responsibility to the citizens.

    But we live in a time of weak character from the bankers down to the last citizen.

  17. Elliot

    Even Paypal recognizes sales “not as advertised” and forces the seller to cough up the money fraudulently gotten. I see no reason the banks shouldn’t be forced to cough up the money they stole from the cities and the deals be voided.

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