Best of the Week
Most Popular
1.Crude Oil Price Trend Forecast 2016 Implications for Stock Market - Nadeem_Walayat
2.Odds of Winning Walkers Crisps Spell & Go olidays K, C and D Letters - Sami_Walayat
3.Massive Silver Price Rally During The Coming US Dollar Collapse - Hubert_Moolman
4.Pope Francis Calls For Worldwide Communist Government - Jeff_Berwick
5.EU Referendum Opinion Polls Neck and Neck Despite Operation Fear, Support BrExit Campaign - Nadeem_Walayat
6.David Morgan: There Will Soon Be a Run to Gold Like You've Never Seen Before - Mike Gleason
7.British Pound Soars on BrExit Hopes Despite Remain Establishment Fear Mongering - Nadeem_Walayat
8.Gold Price Possible $200 Rally - Bob_Loukas
9.The Federal Reserve is Not Going To Raise Interest Rates and Destroy Gold - Michael_Swanson
10.Silver Miners’ Q1’ 2016 Fundamentals - Zeal_LLC
Free Silver
Last 7 days
David Cameron Questioned on Out of Control Immigration at TEN TIMES Conservative Election Pledges - 30th May 16
Bitcoin Price Skyrockets And Is Now Up More Than 100% This Jubilee Year - 30th May 16
This Is Not The America My Parents Immigrated To In 1957 - 30th May 16
“Debt, Not The Economy, Reaches Escape Velocity” With Graham Mehl - 29th May 16
EU Referendum, Black Vote LEAVE or REMAIN? Which is Worse for Racism for Britain's Ethnic Minorities? - 29th May 16
Billionaire Gross: Jubilee Debt Relief as Prelude to New Global Economic Order - 29th May 16
Wargaming North Korea - Assessing the Threat - 29th May 16
EU REMAIN Population Forecasts - England 4.1 million Explosion, London Migration Crisis - 28th May 16
A Guide to the Trump-Sanders Debate - 28th May 16
Gold And Silver – At Significant Support. New “Story” Developing - 28th May 16
The Next Systemic Lehman Event - New Scheiss Dollar & Gold Trade Standard - 27th May 16
Energy and Debt Crisis Point to Much Higher Silver, Metals Prices - 27th May 16
Gold Junior Stocks Q1 2016 Fundamentals - 27th May 16
These Crisis Markets Are Primed to Deliver Big Gains, Platinum Never Cheaper! - 27th May 16
Operation Black Vote BrExit Warning for the Wrong EU Referendum - 27th May 16
UK Immigration Crisis Hits New Extreme, Catastrophic ONS Migration Stats Ahead of EU Referendum - 27th May 16
Many of the World’s Best Investors Made Their Fortunes This Way…And You Can Too - 27th May 16
The Ugly Truth About Stock Market Manipulation and Gold Prices - 27th May 16
Gold Price Looking Vulnerable While Gold Stocks Correct - 27th May 16
The 5 Fatal Flaws of Trading - 27th May 16
The Next Big Crash Of The U.S. Economy Is Coming, Here’s Why - 27th May 16
A New Golden Bull or Has the Market Gone Too Far Too Fast? - 27th May 16
It Feels Like Inflation - 26th May 16
Negative Interest Rates Set to Propel the Dow Jones to the Stratosphere? - 26th May 16
S&P Significant Low has Occurred – Not Likely! - 26th May 16
Statistics for Funeral Planning in UK Grave - 26th May 16
Think Beyond Oil And Gold: Interview With Mike 'Mish' Shedlock - 26th May 16
Hard Times and False Mainstream Media Narratives - 26th May 16
Will The Swiss Guarantee 75,000 CHF For Every Family? - 26th May 16
Is There A Stocks Bear Market in Progress? - 26th May 16
Billionaires Are Wrong on Gold - 26th May 16
How NOT to Invest in the Gold Market - 26th May 16
The Black Swan Spotter...Which Saw the Oil-Crash coming; now says the “Invisible Hand” will push Brent to $85 by Christmas - 26th May 16
U.S. Household Debt Still Below 2008 Peak - 25th May 16
Brexit: Wrong Discussion, Wrong People, Wrong Arguments - 25th May 16
SPX is at Strong Resistance - 25th May 16
US Dollar, Back From the Grave? - 25th May 16
Gold : Just the Facts Ma’am - 25th May 16
The Worst Urban Crisis in History Could be Upon Us - 24th May 16
Death Crosses Across The Board Are IRREFUTABLE Stock Market Sell Signals - 24th May 16
Bitcoin Trading Alert: Bitcoin Price Stays below $450 - 24th May 16
Stock Market Crash Death Cross Doom Prevails - 23rd May 16
Did AMAT Chirp? Implications for the Economy and Gold - 23rd May 16
Stocks Extended Their Rebound On Friday - Will They Continue Higher? - 23rd May 16
UK Treasury Propaganda Warns of 3.6% Brexit Recession, the £64 Billion Question? - 23rd May 16
Stock Market Support Breached, But Not Broken! - 23rd May 16
George Osborne Warns of 18% Cheaper House Prices - BrExit for First Time Buyers - 22nd May 16
Gold Bull-Phase I Continues to Confound (The Trek to “Known Values”) - 22nd May 16 r
Avoiding a War in Space - 22nd May 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Why 95% of Traders Fail

How Interest Rate Swaps Are Crushing America's Cities

Interest-Rates / Banksters Sep 23, 2013 - 12:54 PM GMT

By: Money_Morning

Interest-Rates

Garrett Baldwin writes: It's something you may not even have heard of, but the massive financial burden of interest rate swaps is pressuring city budgets and pinching taxpayers more every year.

But before I tell you what interest rate swaps are, let me show you how they've affected life in America's largest city - New York.


Last week, I drove through the Lincoln Tunnel. The cash fare to travel the 1.5 miles from New Jersey into Manhattan was a whopping $13 - more than 50% more than the last time I was there.

When I jumped on the subway a few hours later, a one-way fare was $2.50, more than 60% more than when I lived in the city in 2008. And my water at the hotel? Shut off in the morning because the water authority was struggling to handle maintenance requests due to being short-handed.

These increases are not the result of the expansion of the transit system or increases in union salaries (common misconceptions).

Ultimately, the explosion in costs and slashing of budgets in New York and many other U.S. cities in recent years are happening because of a little-known type of financial contract - known as an interest rate swap.

You see, U.S. cities and their agencies have been on the wrong side of bad bets with the Big Banks. Now, these municipal agencies are struggling to cover their losses.

Interest rate swaps are costing American taxpayers billions all across the nation as Wall Street rakes in taxpayer money years after the financial crisis.

Interest Rate Swaps: The Big Banks Are the Big Winners

The idea behind interest rate swaps seems logical enough. Interest rate swaps are financial contracts meant to protect borrowers from drastic increases in costs related to the yield of their debts.

All across the country, cities and local agencies got into bed with Wall Street in the hopes of reducing their financial burdens on borrowing costs.

Now, those plans have backfired...

To understand what went wrong, you need to know how interest rate swaps work.

In the case of the MTA, the transit agency pays the bank (for example, JPMorgan) a fixed rate on a bond in the form of interest. That rate is prearranged and is typically just a bit higher than the going market rate at the time of the contract as a means of "locking in" the best deal. In this case, that rate might be 4.5%.

Meanwhile, through the interest rate swap agreement, the bank returns a payment of interest on a variable rate (which floats according to the global debt markets). If the going market rate is above the 4.5%, the MTA would make money. If it is lower than 4.5%, they will end up losing money on the deal. In most cases, it is sold on the premise that both entities will break even over time.

Unfortunately, Wall Street has a funny way of being right all the time. Following the financial crisis, low interest rates have meant that the banks still pay the higher fixed rate, but low variable rates driven by the Federal Reserve's policies have meant lower payments from the banks to the municipal borrowers of these swap agreements. So if the variable rate is 1.75%, but the fixed rate is 4.5%, the borrowers have to somehow cover the difference.

That's where the taxpayers (or users of the agency's services) come in. Fees they pay are being raised to pay for that difference.

The New York MTA, which controls the subway, bus, and other transit systems, has interest rate swap agreements with a number of banks, including JPMorgan, Citigroup, Morgan Stanley, and UBS.

Interest Rate Swaps Have Cost Taxpayers Millions

In December 2011, Michael Stewart of United NY prepared a report on the staggering cost of interest rate swaps to New York City and its agencies alone. In it, he highlighted the impact of these swaps on every major utility and authority in the city.

Just look at the accumulated costs for New York's MTA.

From January 2000 to December 2011, the MTA paid out a net sum of $658 million, thanks to cheap monetary policy in Washington. In order to cover those losses, the MTA is now forced to raise fares or cut jobs and services.

In 2010, the MTA had to cut more than 1,000 transit jobs and steeply cut subway and bus service lines. A city that was already difficult to get around became all that more difficult.

According to United NY, the annual net payments in 2012 for the MTA sit at $117.6 million. The Port Authority, in charge of the Lincoln Tunnel and other crossings into the city, owed $27.7 million. And the water authority, which is struggling to keep the water flowing at all hours, paid $6.2 million. Another $80 million to $85 million on interest swap payments was paid by other entities, including the state, city, and local libraries.

And there's no easy way out.

To terminate these contracts, the city and taxpayers would be on the hook for more than $1 billion. For customers and workers, the results have been devastating.

These weapons of financial destruction have been detrimental all across the country as interest rates have remained low:

  • The Bethlehem School District in Pennsylvania has faced immense cuts across the board.
  • Oakland, which found itself on the wrong side of the bet, had been forced to cut back on police services at a time that crime is on the rise.
  • Harvard University lost millions on a faulty investment by its leadership.
  • And Baltimore, my hometown, is locked in a massive legal suit after banks manipulated the LIBOR rate and led to the city losing millions on swap payments.

A Looming Multi-Trillion Dollar Crisis

In 2012, the Office of the Comptroller of the Currency reported that U.S. banks held $183.7 trillion in interest rate swap contracts on their balance sheets.

Only four financial companies owned 93% of total derivative holdings.

As you may have suspected, those companies are JPMorgan Chase, Citibank, Bank of America, and Goldman Sachs, all four of which received billions in bailout money following the U.S. financial crisis.

Now, they've been raking in billions on these interest rate swap agreements thanks to a little help from their pal Ben Bernanke at the U.S. Federal Reserve and his cheap money policies.

It's bad enough that taxpayers will have to foot the bill on interest-rate agreements and pay the short-term-minded banks the difference between these agreements.

But the real problem isn't the banks making money on the lower interest rates.

It'll be incredibly worse if interest rates rise significantly and the payments start to come from the banks into the coffers of the towns, and for one reason: Banking leverage.

If anything causes interest rates to rise significantly, the contracts could begin to implode on the banks. That could recreate the 2008 crisis all over again with one hook.

And this time, it would be way, way bigger.

If interest rates spiked due to a default by the U.S. government on its debt, or the Federal Reserve were unable to maintain its grip on lending interest, the result would lead to banks being unable to meet all of their obligations on the higher variable rates set forth in their swap agreements.

With these contracts spanning decades, it's uncertain whether this would be sustainable.

This situation was exactly the type of issue that the Dodd-Frank Act was supposed to fix. But bank lobbying and government's inability to foresee any crisis has left American taxpayers vulnerable to these contracts and the nation vulnerable to yet another Wall Street meltdown.

Note: Wall Street's bubbles are everywhere. And we have plenty of reasons to fear any number of them bursting. But there's one that dwarfs all the others. Here's how to prepare for "the mother of all bubbles"...

Source :http://moneymorning.com/2013/09/19/how-interest-rate-swaps-are-crushing-americas-cities/

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife