The losing bets

How interest rate swap deals are causing local government agencies to pay millions of dollars to the biggest banks

Activists demonstrate outside Bank of America in San Francisco on Feb. 21.

By Darwin BondGraham

Wall Street's massive taxpayer funded bailout, initiated by the Bush administration and carried forward under President Obama, never really ended — it just shifted from federal to local sources of funding. Even while local and state governments have been forced to cut back on crucial services, wealthy banks and investment firms are being padded with enormous cash flows sucked directly from the already strained budgets of cities, counties, and public agencies.

That's the message a growing chorus of activists in the Bay Area are bringing before the boards, councils, and commissions that entered into complex financial deals with Wall Street banks, deals that turned toxic in the crash of 2008. Activists want elected officials and the banks to cancel the contracts and refund the public.

The Bay Area is the epicenter of this renewed movement for financial justice. Last week, teachers from Peralta College, organizers with the Alliance of Californians for Community Empowerment (ACCE), Oakland religious leaders, and Occupy Oakland activists organized four protests contesting what they say is bank predation on local communities.

At issue are arcane financial instruments called interest rate swaps. Sold by banks to virtually every sizable government and local agency in the US through the 2000s, rate swaps promised governments the ability to "swap" their potentially costly variable rate payments on bonds into a synthetic fixed rate. Seeking to protect local taxpayers during the volatile 2000s, when floating interest rates were rising, local leaders eagerly signed on.

But the economic meltdown turned those tools into golden handcuffs for local government agencies. Taxpayers are now forced to regularly pay millions to the banks simply because variable interest rates, at the urging of the Federal Reserve, have fallen far below the synthetic rates. These deals might seem numbingly complex, but the effects on local communities are clear and painful.

"The Metropolitan Transportation Commission is paying upwards of $53 million a year on rate swaps," said Alia Phelps of ACCE at a protest on Feb. 21 outside of the former Bank of America building at 555 California Street. "This is money that isn't going to keep routes in service, that isn't paying drivers, nor going to repair buses, or to keep fares lower. We need these swaps renegotiated."

That protest included visits to half a dozen banks. Activists demanded branch managers fax a letter to their corporate headquarters calling on the banks to voluntarily renegotiate swaps signed with the Metropolitan Transportation Commission (MTC), the Bay Area's regional transportation authority, which has lost over $100 million on toxic swap deals.

In 2002 the Bay Area Toll Authority (BATA), a state-level agency operated by the MTC, issued more than $1 billion in bonds to pay for repairs and seismic upgrades of regional toll bridges. Three financial giants stepped forward promising to lower MTC's long-term borrowing costs on these bonds by using interest rate swaps. Ambac, Solomon Smith Barney and Morgan Stanley signed deals with the MTC to cover $300 million in debt.

"With this transaction, we are getting the peace of mind of a fixed debt payment at a significant discount from traditional price levels," MTC's Chief Financial Officer Brian Mayhew said at the time of the deal.

Basically the swap agreement had the MTC paying a fixed interest rate of 4.1 percent to the banks, while the banks paid 65 percent of the London Interbank Offered Rate (LIBOR), a key benchmark used in global financial markets. Whichever party's sum happened to be higher when payments came due would pay the difference. The advantage of the deal, in the eyes of the MTC's managers, was that it would lock-in a low interest rate on MTC's debt, potentially saving as much as $45 million.