MonkeyBusinessBlog: JPMorgan Chase Will No Longer "Market" Interest Rate Swaps to Municipalities

Yesterday JPMorgan Chase announced that it will no longer market interest rate swaps to municipal clients. Matt Zames, JPM's head of interest rates, foreign exchange and municipal bonds stated,

"The risk/return profile of this business is such that the returns no longer justify the level of resources we have allocated to it."

According to Bloomberg News, "At least seven former JPM bankers are under scrutiny in a Justice Department criminal investigation of whether banks conspired to overcharge local governments on swaps and other derivatives." To paraphrase Otter, president of Delta House at Faber College, "The question here is not whether we took liberties with our municipal clients.....we did!" I worked on a few derivative desks in my day and it was a tough business. Interest rate swaps had become such a commoditized business by 2000 that the huge customers like Fannie Mae, Freddie Mac, GMAC, etc, barely allowed interest rate swap desks to make a thin dime. Swap traders and "marketers" (in derivatives salesmen are called "marketers" to distinguish them from the cash-bond sales rabble) spent most of their days scratching and clawing out a few thousand dollars on large size (hence large risk) trades with heartless clients who prided themselves on getting dealers to execute trades at mid-market or worse. It was grim.

However, every couple of months or so the mood would lighten up considerably on the swap desk. In fact, the mood on the floor would go from that of a funeral parlor to that of Mardi Gras in Rio! What had happened to make everyone so jubilant you ask? The muni and swap desks just teamed up to take $3 million out of a $100 million 30-year interest rate swap with some poor municipality, whose debt the bank was underwriting. The first time I was dumb enough to ask, "How can you make $3 million on a 30-year swap with those guys, when we just did the same exact trade with XYZ and the payout was $37,500?" The trader or marketer would say, "Umm, because your client knows where the market is and puts us in competition with five other guys. These guys have no idea where the market is and not only do they not put us in competition, they don't even check away." In banking parlance, "checking away" means at least checking with another dealer or two to make sure that you're not getting completely rolled by the swap desk. This is when it dawned on me that the municipalities were completely subsidizing The Street's interest rate swap desks. The entire business-line was exposed to it's most prized clients, "checking away!" That's the "risk/reward profile" Mr. Zames at JPM was talking about.

Now, due to the heinous things done to Jefferson County Alabama, such as marking up interest rate swaps that they shouldn't have been doing in the first place by A-Gazillion percent, the jig is up. We've written a lot about the sad story of Jefferson County. These stories can be found on the blog under the category, "Revulsion". JPM is going to have to answer for these gross mark-ups and due to the fact that many of these swaps were very liquid instruments, its going to be pretty easy for anyone who can discount a cashflow to figure out how much Jefferson County and many other municipalities were over-charged. And I guarantee you, JPM ain't alone! The entire Street is going to get called on the carpet for this decade long pilfering and, like JPM they really aren't going to have a lot of answers other than "thank you sir may I have another." Oh, remember the little firm called Bear Stearns? They, like everyone else did these deals in abundance. Those are JPM's problem too now.