Weekend Economists Chart the Bradbury Chronicles, June 8-10,2012

[Demeter]

102. How (US) Banks Could Return the Favor By GRETCHEN MORGENSON

http://www.nytimes.com/2012/06/10/business/banks-could-return-a-favor-to-governments-fair-game.html?_r=1&ref=business

LIKE millions of homeowners, shrewd state and local governments are looking to refinance. Interest rates have hit rock bottom. So why not save some public money by replacing old debts with new ones at lower rates? The bad news for taxpayers is that such easy refis are out of the question for many governments and agencies short on cash. And that’s because these borrowers have been trapped by Wall Street.

Behind all of this is — you guessed it — derivatives. Bankers have embedded interest-rate swaps in many long-term municipal bonds. Back when, they persuaded states and others to issue bonds and simultaneously enter into swaps. In these arrangements, the banks agreed to make variable-rate payments to the issuers — and the issuers, in turn, agreed to make fixed-rate payments to bond holders. These swaps were supposed to save the public some money. And, for a while, they did. Then the financial crisis hit — and rates went south and stayed there. Now issuers are paying bond holders above-market rates as high as 6 percent. In return, they are collecting a pittance from banks — typically 0.5 percent to 1 percent.

Why not just refinance the old bonds? Well, if you think it’s costly to refinance a home mortgage, try refinancing a derivatives-laced muni. The price, in the form of a termination fee, can be enormous. New York State, for one, has paid $243 million in recent years to extricate itself from swaps-related debt. That money went straight from taxpayers’ pockets to Wall Street.

Corporations rarely do deals like these, because they generally avoid making long-term bets on interest rates. But bankers sold the idea to public borrowers. The total bill to terminate all of these swaps-related deals would run into many billions. Officials who have done such financing typically defend it. They say these deals were struck at lower rates than those associated with fixed-rate debt at the time. Therefore, the defenders say, the deals have saved money for issuers and taxpayers. But if states, cities and others had issued plain vanilla fixed-rate debt to begin with, they could have refinanced much of it by now at little or no cost. They would be paying significantly lower financing costs and would not be facing huge penalties to get out of the deals.

THE EVILS OF SECURITIZATION....IT WAS A DEAL LIKE THIS THAT GOT ME ON THE CONDO BOARD AND INTO THE ECONOMY SECTION OF THE DEMOCRATIC UNDERGROUND...WE HAD TO PAY A $3M PENALTY TO GET OUT OF OUR LITTLE PROBLEM...