Wall Street Confidence Trick: The Interest-Rate Swaps That Are Bankrupting Local Governments

[Skwmom]

The "toxic culture of greed" on Wall Street was highlighted again last week, when Greg Smith went public with his resignation from Goldman Sachs in a scathing op-ed published in The New York Times. In other recent eyebrow-raisers, LIBOR rates - the benchmark interest rates involved in interest-rate swaps - were shown to be manipulated by the banks that would have to pay up; and the objectivity of the ISDA (International Swaps and Derivatives Association) was called into question, when a 50 percent haircut for creditors was not declared a "default" requiring counterparties to pay on credit-default swaps on Greek sovereign debt.

Interest-rate swaps are less often in the news than credit-default swaps, but they are far more important in terms of revenue, composing fully 82 percent of the derivatives trade. In February, JP Morgan Chase revealed that it had cleared $1.4 billion in revenue on trading interest-rate swaps in 2011, making them one of the bank's biggest sources of profit. According to the Bank for International Settlements:

"nterest rate swaps are the largest component of the global OTC derivative market. The notional amount outstanding as of June 2009 in OTC interest-rate swaps was $342 trillion, up from $310 trillion in Dec 2007. The gross market value was $13.9 trillion in June 2009, up from $6.2 trillion in Dec 2007."

For more than a decade, banks and insurance companies convinced local governments, hospitals, universities and other nonprofits that interest-rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools. The swaps were entered into to insure against a rise in interest rates; but instead, interest rates fell to historically low levels. This was not a flood, earthquake or other insurable risk due to environmental unknowns or "acts of God." It was a deliberate, manipulated move by the Fed, acting to save the banks from their own folly in precipitating the credit crisis of 2008. The banks got in trouble, and the Federal Reserve and federal government rushed in to bail them out, rewarding them for their misdeeds at the expense of the taxpayers.

"In an interest rate swap, two parties exchange payments on an agreed-upon amount of principal. Most of the swaps Wall Street sold in the municipal market required borrowers to issue long-term securities with interest rates that changed every week or month. The borrowers would then exchange payments, leaving them paying a fixed-rate to a bank or insurance company and receiving a variable rate in return. Sometimes borrowers got lump sums for entering agreements."

http://www.truth-out.org/news/item/8016-wall-street-confidence-trick-the-interest-rate-swaps-that-are-bankrupting-local-governments