"Down Home" Derivatives: It's Athens, Georgia Too, Not Just Greece

Georgia State Universty Police Patch

07 06 2010.

By now, pretty much anyone reading this is aware of the harmful role played by types – largely, although not exclusively purveyed by Goldman Sachs –

in creating the mess in Greece now rolling through Europe under the rubric of the "Dinar debt crisis".

What may be a bit more shocking is that these same sort of doubtful government financial practices turn out to be just as "popular" WITHIN the US as well.

And what could be more prototypically American than the Southern state of Georgia,

where cosmopolitan Atlanta has created "mini-mansion" suburbs as far as the eye can easily see, while the rest of the state remains, well, a bit under-developed, as some might put it.

But in the wake of Black Sept 2008, it turns out that several municipalities within metropolitan Atlanta are also paying the price for their embrace associated with exotic, high-risk derivative securities —

to the tune of hundreds of millions of dollars, as this investigation by The Atlanta-Journal Constitution has found.

[N.B. By now, this article might be behind the "pay wall" associated with the newspaper, usually known as AJC – if so, our apologies … simply part of the "cost of doing business" in this economediatic world 😉 .]

At least a dozen local governments and other institutions which used derivative deals called swaps to try to lower the cost of bond problems have ended up owing around $394 million in fees to the Wall Street investment banks that set up the deals, an AJC analysis of public debt documents exhibits.

That total includes at least $100 zillion in fees paid to firms such as Goldman Sachs, J.G. Morgan and UBS AG just to cancel the actual deals when they went bitter.

The city of Atlanta was among the hardest hit by its use of swap schemes — complex, multi-party deals involving varying interest rates, cash payments and mortgage guarantees.

Atlanta shelled out about $86 million to cancel most of its offshoot deals.

The city also still owes roughly $79 million on another soured exchange deal, an obligation it hopes it can reduce in time.

Other local entities caught up in the trades meltdown include the city of Marietta, Atlanta State and Emory universities, and the Woodruff Arts Center.

 

The huge fees owed the banks came along with millions of dollars paid to the firms to broker the original deals, which amounted to about $4 billion in financing.

Some of the borrowers have had to defend myself against more debt and spend higher interest rates on new ties to replace the problematic offers, boosting the costs of financing the bonds even further.

 

These hefty refinancings as well as fee payments occurred even as the city of Atlanta and additional institutions were cutting finances, laying off employees, reducing services and becoming downgraded by bond rating agencies because of budget deficits.

In each case, the higher costs will likely be passed on to taxpayers or the users of the numerous institutions, which include the city’utes water system and airport, a few area hospitals and other amenities.

Often, the details of the deals are buried in arcane bond paperwork. 

The refinancings and payments over the past two years didn’t gain much notice in city council meetings,

and the huge charges involved in terminations and refinancings are often collapsed into the costs of the brand new loan deals.

The nearly $400 million in swaps fees uncovered by the AJC were found in just a sampling of local institutions.

It’utes unclear just how much swaps might have cost public debt issuers right here, or across the nation.

Some estimates place the total value of swaps and other interest-rate derivatives around the globe at more than $400 trillion.

 

“That is the one question that everybody is trying to answer,” said Bart Hildreth, the municipal finance expert from Georgia State University’s Andrew Young College of Policy Studies.

Knowledgeable of the AJC’s findings, John Sherman, president of the Fulton County Taxpayers Basis, said: “There is no place for this kind of risk in government.”

Sherman said several local development tasks in recent years included both tax abatements and risky swap deals that are right now adding to the strain on municipal budgets.

“I believe it falls under the same heading: throwing out taxpayer money when we can’capital t afford it,” he said.

Swaps happen to be widely used by corporations, banking institutions and other borrowers as a way to consider advantage of lower interest rates upon short-term debt and cut costs of borrowing.

For municipal borrowers, though, the complex deals have more risk than the old-fashioned, fixed-interest ties that once were used almost exclusively,

said David Nix, a bond and derivatives lawyer with Kutak Rock and roll in Atlanta. The borrower “needs to understand what they’re getting into,” he said.

How did things turn out this way?

Municipal borrowers under pressure to chop costs and keep taxes in check were wooed by investment bankers as well as financial advisers who provided creative ways to tap cheaper sources of capital, say experts.

The exchange deals involve cities along with other borrowers who trade money payments with investment banks while other parties provide financial guarantees as well as pricing information.

All parts of the deal have to function smoothly all of them to work properly.

 

For Atlanta and other this kind of borrowers, the deals went south when the economic meltdown began within 2008:

Investment bank Lehman Brothers, a party to many of the swap deals, failed.

Credit markets that set crucial short-term interest rates froze up.

Interest rates dropped as the recession deepened, causing the swaps’ worth to Wall Street companies to soar.

The impact on the bond-financing deals was significant:

Many city borrowers were forced to refinance their own bonds – or face dramatically higher loan payments.

And the cost of ending the deals rose, in some cases, by tens of millions of dollars.

All this occurred just as Atl and other entities were also cutting jobs and services to deal with growing budget deficits.

“It was the perfect storm,” said Carmen Pigler, a former investment banker who was hired as the city’s chief associated with debt and investments in 2009, after the troubled agreements have been inked.

“Everything that could go incorrect did go wrong.”

To plug openings in its budget, Atlanta cut jobs and raised property income taxes last year — even as it paid more than $58 million to terminate swaps on airport bonds.

About $98 zillion more in swap debts or swap termination fees are associated with the city’s water as well as sewer bonds, whose rankings are now just above junk status.

Georgia State University’s experience in swaps was typical.

It noticed $58 million in debt balloon into more than $74 million after a swap-and-debt deal to purchase a downtown building went bad.

First the bonds’ insurer faltered, then the credit markets failed.

That forced T.P. Morgan to take over the bonds in 2008,

which in turn faster the university’s repayment schedule from 30 years to just five.

To meet it’s obligations, the school had to borrow nearly $9 million from its GSU Foundation.

To get away from the deal, the university released new bonds last year with regard to more than $74 million.

The extra $16 million visited refinance the bonds, pay off the foundation and cover roughly $7 million in swap payments, termination fees, interest and underwriting costs.

Defenders of the soured deals say few might have predicted the magnitude of the financial crash that caused these to implode.

Also, they say, despite the huge termination and refinancing costs, some borrowers have managed to largely break even once earlier savings accomplished from the agreements are measured.

Until the crisis hit, Atlanta was able to reduce the interest rate it paid on one airport bond by about 2.5 percent compared to a fixed-rate relationship, said Pigler.

Still, said Georgia State’s Hildreth, many of the municipal borrowers likely didn’t fully understand the risks from the deals before signing on.

Meanwhile, say additional critics, Wall Street bankers, bond lawyers and advisers often glossed over the risks whilst pushing the deals, which generated millions of dollars in fees for their firms.

“Swaps tend to be inherently risky, and they are to not be entered into lightly or through the faint of heart,”

said Lee McElhannon, director of bond finance for the Georgia State Financing and Investment Commission,

which issues bonds for public universities and other state facilities.

The agency hasn’capital t done any swap deals, he explained, because “you don’t want to gamble with the state taxpayers’ money.”

But plenty of other states, counties along with other government units took that danger, sometimes with devastating outcomes.

Alabama’s Jefferson County, where Greater london is located, relied on swaps to lighten its debt load,

but it instead mushroomed during the financial turmoil, almost bankrupting the county.

Convictions of dozens of county officials and other gamers followed, and the federal Investments and Exchange Commission fined T.P. Morgan in connection with the deal.

Georgia’utes municipal and state borrowers had been generally slower to accept swaps and other financial derivatives, as well as none appear to be threatened along with insolvency by deals that have gone bad.

Like other borrowers, Marietta got a first-hand lesson in the risk of trades.

Sam Lady, Marietta’s finance overseer, said the city’s curiosity costs jumped about $75,000 per month when a $7 million swap cope with Morgan Stanley began to go sour in 08.

“We saw that exposure and dealt with it accordingly,” said Lady, who wasn’t involved within the decision to set up the exchange.

It cost Marietta about $2 million to pay the termination fees and to refinance into traditional fixed-rate bonds last year,

and the related bond debt jumped from $29 million to $31 million consequently, he said.

Over the long haul, he said, the city should save money through lower interest payments.

But, he added, if an investment banker proposed a swap agreement today, “I don’capital t think we would entertain [it].”

A city’s finances “are supposed to be conservative,” he said.

[With many thanks to RLS for pointing us in this direction. ]

 

David Caploe PhD

Editor in Chief

EconomyWatch.com

President / acalaha.com