MuniLand

Pennsylvania may have suffered more damage from municipalities using interest rate swaps than any other state in America. Many cities and school districts were sold these “hedging” instruments after former governor Ed Rendell pushed legislation allowing their use in 2003. The fallout for the state has been devastating.

Small communities, large cities and school districts have suffered substantial losses from their use. Bloomberg reported in March 2008 how a school district suffered deep losses:

James Barker saw no way out. In September 2003, the superintendent of the Erie City School District in Pennsylvania watched helplessly as his buildings began to crumble. The 81-year-old Roosevelt Middle School was on the verge of being condemned. The district was running out of money to buy new textbooks. And the school board had determined that the 100,000-resident community 125 miles north of Pittsburgh couldn’t afford a tax increase. Then JPMorgan Chase & Co., the third-largest bank in the U.S., made Barker an offer that seemed too good to be true.

David DiCarlo, an Erie-based JPMorgan Chase banker, told Barker and the school board on Sept. 4, 2003, that all they had to do was sign papers he said would benefit them if interest rates increased in the future, and the bank would give the district $750,000, a transcript of the board meeting shows. “You have severe building needs; you have serious academic needs,” Barker, 58, says. “It’s very hard to ignore the fact that the bank says it will give you cash.” So Barker and the board members agreed to the deal.

What New York-based JPMorgan Chase didn’t tell them, the transcript shows, was that the bank would get more in fees than the school district would get in cash: $1 million. The complex deal, which placed taxpayer money at risk, was linked to four variables involving interest rates. Three years later, as interest rate benchmarks went the wrong way for the school district, the Erie board paid $2.9 million to JPMorgan to get out of the deal, which officials now say they didn’t understand.

Detroit is standing on the precipice of fiscal collapse. The Detroit Free Press reported on Friday:

The city of Detroit will run out of cash a week from today if a lawsuit challenging the validity of a consent agreement is not withdrawn, city officials said this morning.

Jack Martin, the city’s new chief financial officer, said the city will be broke by June 15, but it should be able to make payroll for its employees. He said the city will be operating in a deficit situation if the state withholds payments on a portion of the $80 million in bond money needed to help keep the city afloat.

A huge win for muniland was finalized last week when the SEC approved new rules that will shine light on the municipal bond underwriting process. This Bloomberg headline says it all: “Bond-Disclosure Rules Backed by SEC to Protect States From Banks”:

The rules were proposed by the Municipal Securities Rulemaking Board last year and are aimed at preventing Wall Street underwriters from steering public officials toward complicated debt financing without disclosing the risks. They were approved May 4 by the SEC, which will enforce them.

The disclosures are part of the effort to reshape financial regulations to prevent a repeat of the credit-market crisis of 2008, and stem from Congress’s decision to provide added protections for state and local governments. The economic crisis hit taxpayers with billions of dollars in unexpected costs when complex bond deals, once pitched as money savers, backfired as credit markets seized up.