Who is the “muppet” now?

October 22, 2012

The media is filled with reports and reviews of a book by former Goldman Sachs employee Greg Smith, which disparages his former employer. Smith alleges that traders on his London equity derivatives desk treated their clients harshly and would glibly refer to them as “muppets.” They secretly despised their clients as they ripped them off, according to Smith, especially the “muppet” clients that were mainly pension funds and non-profits. The Guardian reports (emphasis mine):

Getting an unsophisticated client was the golden prize,” he told the [60 Minutes] programme. “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.

“What Wall Street will do is they will approach one of these philanthropies or endowments or teachers’ retirement pension funds in Alabama or Virginia or Oregon and they’ll say to them: ‘We have this great product that is going to serve your needs’. And it looks very alluring to these investors, but what they don’t realise is that upfront they are immediately paying the bank $2m (£1.2m) or $3m because of their lack of sophistication.”

How fast can you say “muniland muppet”? There happens to be a big derivatives controversy brewing in in the “City of Brotherly Love,” right now. Some background from the Philadelphia Inquirer:

Urged on by private-sector financial advisers, approved by bond lawyers, the city took advantage of a 2003 state law approved by then-Democratic Gov. Ed Rendell and Republican legislative leaders to “swap” interest-rate risk on the next several years’ borrowings with clients of JPMorgan, Goldman Sachs, Wells Fargo, and other big Wall Street banks…

…How much did we lose? City officials have been vague about that. This past spring, the union-aligned Pennsylvania Budget and Policy Center totaled a string of payout and obligation reports by city agencies and announced that Philadelphia’s swaps losses approached $500 million. Auditor General Jack Wagner said towns have no business doing such “complex” transactions.

According to the Inquirer, Philadelphia City Treasurer Nancy Winkler doesn’t know how much interest rate swap exposure the city currently has. She is in a conflicted position because she previously worked at the financial advisor firm – PFM – that advised the city on many of these deals. She has been asked to testify at hearings organized by city Councilman Jim Kenney (D) on losses from these products.

Although Winkler doesn’t know the interest rate swap exposure, the Pennsylvania State Auditor General Jack Wagner reported on it in 2010:

The true extent of potential losses to taxpayers remains unknown, but could be catastrophic. For example, all Pennsylvania taxpayers are exposed to enormous liabilities from swaps entered into by public entities in Philadelphia alone, according to recent financial reports.

  • City of Philadelphia – 6 active swaps with a net “negative fair value” (the cost if the swaps were terminated as of the date of the financial report) of $122.6 million; swaps related to $1.25 billion in total debt
  • School District of Philadelphia – 12 active swaps with a net negative fair value of $124.7 million; swaps related to $682.6 million in debt
  • SEPTA – 3 active swaps with a net negative fair value of $52.4 million; swaps related to $345.5 million in debt
  • Philadelphia Authority for Industrial Development – 3 active swaps with a net negative fair value of $27.7 million; swaps related to $588.2 million in debt
  • Philadelphia Intergovernmental Cooperation Authority – 4 active swaps with a net negative fair value of $45.3 million; swaps related to $253.1 million in debt

Was Philadelphia the only city in Pennsylvania to get muppified? No. Actually, there were a lot of cities and municipal entities that had bought complex products that didn’t work out:

Wagner has sounded the alarm about swaps for months. A 2009 special investigation conducted by the Department of the Auditor General found that 107 school districts and 86 local governments had financed $14.9 billion in debt tied to interest-rate swaps. This debt equals an amount that is more than half of the commonwealth’s budget.

There are stories all across America like these (see Detroit, in particular).

Greg Smith is not very popular among the financial media now, because he didn’t name the names of those who were damaged by the aggressive selling of complex and unsuitable products. In muniland we do not have enough information to link Goldman Sachs or other big banks to specific interest rate deals. But a cluster of banks just plowed a long row of unsuitable deals through muniland and planted some really bad seeds. We need a muniland Greg Smith to give us a little more insight into all these bad crops.

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