The losing bets - Page 2

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

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Activists demonstrate outside Bank of America in San Francisco on Feb. 21.
PHOTO BY LUKE THOMAS/FOG CITY JOURNAL

"We think it's a good time to lock in these low rates," Mayhew said in 2002.

Fast forward to 2009. A year into the financial crisis, interest rates collapsed. LIBOR, which had been fluctuating around 5 percent and reached a peak of 5.8 percent in September of 2007, plummeted to virtually zero. The flow of payments became entirely one-sided, from MTC to banks that offered this deal. The advantage of the swap evaporated, and it became a toxic asset. While the Federal Treasury would offload similar toxic assets from the "too big to fail banks" using the TARP program, local governments were stuck with them.

As Ambac careened toward bankruptcy in 2010 due to its absurdly over-leveraged portfolio of credit default swaps, the MTC was forced to terminate its swap agreement with the company, paying the exorbitant sum of $104 million, after already having paid out $23 million in interest. All of this was essentially bridge toll money, surrendered by drivers crossing the seven state-owned bridges administered by BATA: the Bay, Antioch, Benicia-Martinez, Carquinez, Dumbarton, Richmond-San Rafael, and San Mateo bridges.

The drain on MTC funds indirectly affects all of its programs, including operational support for AC Transit, Muni, and other regional bus and train services. According to its most recent Comprehensive Annual Financial Report, MTC and its transit agency partners are on the hook for another $235 million in interest rate payments due on swaps with a rogue's gallery of banks including Wells Fargo, Morgan Stanley, Citigroup, Bank of America, JP Morgan, Bank of New York, and Goldman Sachs. All of this money will be diverted from the MTC's various transit infrastructure, planning, and operations accounts.

"The big picture is service cuts, pay cuts, work speed ups, fare hikes, route eliminations, and other things that harm working people who ride transit," said retired Muni worker Ellen Murray.

The MTC's quarter-billion dollar rate swap nightmare is only the most obvious part of a more systemic problem. Until at least 2030, given current conditions, San Francisco's Airport Commission must make costly rate swap payments to numerous banks, including JP Morgan Chase, Goldman Sachs, Depfa, Bank of America, and Merrill Lynch, on agreements associated with more than a half-billion in debt. Much of this is linked to commercial paper issued to pay for infrastructure at the Airport (SFO).

Unlike the MTC, SFO's financial managers were more prudent in entering swap agreements, and therefore secured better terms that have produced a net savings. "The Airport has saved about $92 million to date," Assistant Deputy Airport Director Kevin Kone told us, referring mostly to gains made between 2005 and late 2007.

But since 2008, SFO's swaps have been losing money. When Lehman Brothers collapsed, and Bear Stearns imploded and was absorbed into JP Morgan, SFO was forced to terminate swaps with both companies, costing $6.7 million. Last year SFO paid $6.65 million to terminate a rate swap agreement with Ireland's Depfa Bank. In September, the Airport paid another $4.6 million to end yet another rate swap with JP Morgan. These specific swap agreements, Kone says, "were functioning as they should have early on, providing savings," but now they're draining public funds.

SFO's seven remaining swaps have a negative value of $67 million, according to San Francisco's 2011 Comprehensive Annual Financial Report. As with the MTC, SFO's debts will ultimately be paid by passengers and taxpayers. Kone says nobody really knows how much these swaps could ultimately impact the airport, either in terms of cost or savings.

"If interest rates rise, they could have a positive cost savings impact on the airport," he said.