MonkeyBusinessBlog

You Really Really Can't Make This Sh*t Up!

They really must want to see how much they can push the envelope before we have riots in the streets!  From Bloomberg News Fed Intends to Hire Lobbyist In Campaign to Buttress Its Image.

The Federal Reserve intends to hire a veteran lobbyist as it seeks to counter skepticism in Congress about the central bank’s growing power over the U.S. financial system, people familiar with the matter said.

Linda Robertson currently handles government, community and public affairs at Johns Hopkins University in Baltimore, and headed the Washington lobbying office of Enron Corp., the energy trading company that collapsed in 2002 after an accounting scandal. She was also an adviser to all three of the Clinton administration’s Treasury secretaries.

Robertson would help the Fed manage relations with lawmakers seeking greater oversight of a central bank that has used emergency powers to prevent Wall Street’s demise. While she wasn’t tied to Enron’s fraud, her association with the firm may raise questions, analysts said.

“Some members of Congress think there are votes in attacking the Fed” after it “unnecessarily and unwisely entangled monetary policy with fiscal policy,” said former St. Louis Fed President William Poole. “The Fed is going to have a tricky time of unwinding what has been done” and will need to “keep in touch with members of Congress more thoroughly,” said Poole, now senior fellow with the Cato Institute in Washington.

Robertson served under Treasury Secretaries Lawrence Summers, Robert Rubin and Lloyd Bentsen. She didn’t return calls seeking comment.

Enron!!  Well at least she didn't work for Goldman Sachs.  However she worked for Summers and Rubin so...yeah, she kind of worked there too!  Oh, and if you aren't mad enough....they were considering her for a senior Treasury post but the Adminstration stopped it because she's a lobbyist.

I feel like I'm living in a banana republic.....with no bananas!!

Has The President Read This? Has The President Watched This? Oh, Does He Know What His IRS is Doing?

Here are two things that you should watch and read.  The first is an article about Brooksley Born, the former head of the CFTC who tried in vain to regulate the Over-The-Counter derivative market in 1998 and failed.  Prophet and Loss  Ms. Born failed because a couple of guys named Greenspan and Rubin swatted her away.  As we are painfully aware, one of the first things President Obama did after his election was name two of Rubin's boys to the two most important financial posts in his Administration, Larry Summers and Tim Geithner.  People ask me sometimes, "Eric, aren't you kind of a liberal?  Why are you always coming down on the Prez?"  To that I say, "Because he should know better than to hire the very same guys that bear a great amount of the responsibility for the mess we are in.  He is either clueless or he is full of sh*t.  Either way, he's lost my respect."  Anyway, read the article.

Then, after you get upset reading the article, watch this. http://www.pbs.org/moyers/journal/04032009/watch.html

I welcome anybody to challenge what William Black says in this piece with Bill Moyers.  

Finally, after you get yourself really worked up, listen to this.  I was doing a little Monday morning bitching and moaning to a good buddy of mine about the IRS.  My friend, this fine American, did two tours of duty in Iraq.  The IRS has asked him to "verify his combat status" for 2003 and 2004.  They are interested to see if he owes them any back-taxes.

It's time to get mad and do something about what is going on.  Suggestions? 

"AIG Bonus Payments? Bailout Funds Used to Bailout U.S. and Foreign Banks???...Lets Go to WWW.FinancialStability.Gov !!

Wow!  So counterparties that received our money in the form of collateral postings, credit default swap tear ups (through the buying of the underlying securities), and return of cash from securities lending is finally out!  Also, we are dealing with the public schtupping that AIG is giving us in the form of $165 million in bonus payments, made yesterday, to employees in AIG's Financial Products Group because AIG was contractually obligated.  Anyway, upon hearing of this new transparency I rushed to www.financialstability.gov , Tim Geithner's cool, new website,  and here is what I found;

This site is coming soon.

On Tuesday, February 10th, Treasury Secretary Timothy Geithner outlined a comprehensive plan to restore stability to our financial system. In the address, Secretary Geithner discussed the Obama Administration’s strategy to strengthen our economy by getting credit flowing again to families and businesses, while imposing new measures and conditions to strengthen accountability, oversight and transparency in how taxpayer dollars are spent. And Secretary Geithner explained how the financial stability plan will be critical in supporting an effective and lasting economic recovery

Damn, still nothing there!  Where did all this transparency come from then?  It came from AIG!! Here it is AIG Counterparty Release.  How heinous is this??!!  To cover the stink of these outrageous bonus payments AIG releases the document that drops the dime on all the counterparties, the biggest being Goldman Sachs, to take our minds off the bonus payments! 

I'm not going to get into the whole counterparty thing.  We have an "AIG" category on the blog that has us explaining the types of trades Goldman was doing with AIG (negative basis trades....great writeup from Richie here from back in September 2008 Investigation Coming For Goldman and AIG? It Should. ) as well as our repeated calls for the government to reveal to the public just who was getting bailed out when we bailed out AIG.  If anything, when you check out the numbers, they still look light.  Additionally, what also needs to be addressed is who helped firms like Goldman "hedge" their AIG exposure through credit default swaps on AIG?  If I AIG was allowed to fail, would those counterparties be able to pay?  If not, who would be wearing the loss?

Other thoughts that strike me on the bonus payments.  AIG and Treasury say that they are contractually obligated to pay these bonuses, as contracts were signed prior to the September, November, December and March bailouts of AIG.  Larry Summers, resident White House economic Over-Lord, says,

"Every legal step possible to limit those bonus payments is being taken by Secretary Geithner and by the Federal Reserve System.  However, the government cannot just abrogate contracts."

Really?  The government just can't abrogate contracts?  I thought it had an entire branch of government that specializes in abrogating contracts.....Congress!!  Don't believe me?  Ask anyone who owns a bond collateralized by a residential mortgage loan!

Lastly in my morning rant. On the last page of the AIG release, you can see that $43.7 billion of our money went to pay off counterparties involved in AIG's securities lending business.  All the big names are there, Barclays, DB, Goldman, BofA, BNP Paribas, etc.  If you remember, securities lending is the business where a company like AIG, who holds lots of stocks and bonds, lends those stocks and bonds out to short-sellers, gets cash as collateral and then invests that cash in a risk free security that earns the lender (AIG) a spread.  Unfortunately, the window lickers at AIG took that cash and invested in AAA rated CDOs.  Ooooops!  I'm just curious about something.  What securities were all those big names borrowing?  Granted, the short selling of stocks is used for a variety of reasons and strategies.  However, much of those strategies are total or partial bets against a companies equity (they could be long bonds, short equities, etc) .  I wonder who all those entities were shorting, since there was such a furor last summer and fall about bear raids on our banks.  How interesting it would be to see how many of the above mentioned banks proprietary trading desks were involved in direct bets against our banks.  Just curious.

Bill Richardson Withdraws As Candidate For Commerce Secretary

Governor Bill Richardson, former presidential candidate and  Secretary of Commerce nominee has withdrawn himself from consideration today.  It turns out there is a investigation going on in New Mexico surrounding the relationship between the Governor's office, the New Mexico Finance Authority and a financial consulting company named CDR Financial Products.  Apparently, in 2004 CDR donated $100,000 to Governor Richardson's efforts to register Native American and Hispanic voters.  Shortly after, CDR performed advisory work for the New Mexico Finance Authority (the folks who raise financing for the state) and received $1.5 million in fees.

Bloomberg News is reporting that CDR also performed similar "advisory" work for Jefferson County Alabama.  Remember Jefferson County?  They almost became the largest municipal bankruptcy in our nation's history after advisers and Wall Street municipal and derivative desks turned their humble water and sewer works into the most expensive one in the country.  It didn't become the most expensive water and sewer works in the country because everyone in Jefferson County got a gold plated toilet.  No, it became the most expensive because the county was "advised" that rather than issue plain old fixed rate debt, they should issue floating "Auction Rate" debt (remember that little fiasco earlier in 2008 when the $300 billion Auction Rate market froze up and municipalities ended up having to pay penalty rates of 20%?), then convert that debt to fixed rate by paying on interest rate swaps and selling options on swaps.  Wall Street and advisers like CDR made millions in fees while the municipalities like Jefferson County not only had their clocks cleaned with regard to pricing of all these derivatives, but also cocked up their finances so badly that they faced bankruptcy.

Governor Richardson's office denies that anything improper took place and CDR says there definitely was no, "Pay for Play" scheme going on here.  Rather CDR, based in California, had a very strong desire to make sure Native Americans and Hispanics got out to vote and by sheer coincidence, they got to jump into bed with the New Mexico Finance Authority and got themselves paid $1.5 million in fees.  I really want to see all the transactions they advised New Mexico on.  I bet the amount of money that New Mexico was separated from was a lot more than $1.5 million.  Just ask Jefferson County.

When is this going to end?  How many people do we have in this country, 250 million?  Why is it that most of the people you meet are honest, decent people who wouldn't sell themselves out for a dollar or a position of power and yet it seems 90% of the folks we have running things would sell themselves out at the drop of a hat?   Anyway, I guess thats how things are.  It kind of reminds me of this great Al Pacino performance in "Scent of a Woman".  The whole scene is great, but pay particular attention to the 1:30 to 3:00 segment, "Conscience is dead".

"How Cerberus Stole Christmas." The Sad Story of Kimberly Wisconsin

Story on Bloomberg today about the sad aftermath of a private equity takeover of a paper mill in Kimberly Wisconsin.  Feinberg Despised in Wisconsin.  It must be real hard to explain to a fellow human being that he was just a piece of "Free Cashflow" to you. Here's some of the story;

Dec. 23 (Bloomberg) -- Just about everyone in Kimberly, Wisconsin, hates billionaire Stephen Feinberg.

“This is a greedy, extremely greedy guy who doesn’t care about other human beings,” said Jeffery Wyngard, a third- generation Kimberly mill worker with 30 years on the job. “Feinberg has no morals,” said paper mill workers union local president Andy Nirschl. “There won’t be a lot of Stephen Feinberg Little League fields,” said Bob Brukardt, who also worked at the mill for 30 years. “He sold his soul to the devil.”

Feinberg inspires this reaction in Kimberly because Cerberus Capital Management LLC, the company he founded in 1992, owns NewPage Corp., which closed the town’s 119-year-old paper mill that Local 2-9 of the United Steelworkers says was profitable when NewPage bought it nine months ago. Six hundred people are out of work in the town of 6,200 at the same time Cerberus’s money-losing Chrysler LLC automotive unit was seeking a taxpayer loan.

 As a special added bonus, here's a clip on private equity that Richie and I made around this time last year;

Wal-Mart Associate Killed in Black Friday Stampede

I'm sorry but we have some serious issues.  A Wal-Mart worker is reported dead after being run over by hundreds of shoppers at a Long Island New York Wal-Mart.  This is sickening.  Our hearts go out to the Walmart associate's family.  Here is the story on Bloomberg Wal-Mart Worker Killed in Stampede

This is The Business We Have Chosen

Remember when Barlcays bought Lehman's broker-dealer operation in New York?  We knew there was going to be a lot of people losing their jobs because Barclays already had a New York operation, doing many of the same things Lehman was doing.  We heard that Friday, many Barclays employees were laid off in favor of their Lehman counterparts.

According to our sources, which are impeccable, "They put a bunch of cardboard boxes in the middle of the trading floor, then after they put the boxes out, they brought in guys one by one to fire them.  Meanwhile, the new guys (Lehman guys) were brought onto the floor to learn the systems."

What kind of animals do things like this?  Think about Barclays running like a bunch scared little girls to Mervyn King and Gordon Brown to save them at the same time as they are committing this infamnia.  I would like to say that the management teams who do things like this, and they exist at every firm, should lose their jobs and suffer humiliation too.  Unfortunately, they are nothing but roaches.  They survive by stealing from their employees and they survive by any means necessary. 

Screw you Bob Diamond.  You and the horse you road in on.

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.

Dirty Deeds Not Done Dirt Cheap- Jefferson County Alabama

Yesterday a resident of Jefferson County Alabama sued JP Morgan Chase and eleven other banks, advisors and insurers for essentially destroying the county's finances through the underwriting and "risk managing" of the county's essential service (in this case water and sewer) bond issuances.  And so it begins.

I am going to give a recap of what was done to the poor people of Jefferson County, and the operative word here is "done".  In the mortgage crisis I have a hard time calling every defaulting borrower a victim.  A lot of people saw cheap money and missplaced their common sense.  However, save a few local politicians, the people of Jefferson County got used, screwed and tattood by their government and Wall Street.  Here is an exerpt from a Bloomberg article May 22, 2008;

"As nightime temperatures plunged in Birmingham, Alabama, last October, Dora Bonner had a choice: either pay the gas bill so she could heat the home she shares with four grandchildren, or send the Birmingham Water Works a $250 check for her water and sewer bill.  Bonner, who is 73 and lives on Social Security, decided to keep the house from freezing.  'I couldn't afford the water, so they shut it off,' she said."

Sickening isn't it?  The really infuriating thing is that none of this had to happen.  A long link of scumbags, from the President of the Jefferson County Commission, to small regional broker dealers, to larger regional broker dealers, to larger Wall Street Banks put Mrs Donner and the rest of the county in this position, making money all the way.  Since Jefferson County starting listening to these "advisors" back in 2003 they have managed to essentially bankrupt the county while giving themselves the highest water and sewer bills in the country.  The fees and trading profits that were extracted along the way are in the $100 millions.  We've written about this situation before so I will just give a little bullet point layout of what was done:

• Jefferson County needs to rebuild it's sewer system back in the late 1990's, so they look to issue municipal debt.  The debt will be serviced by the water and sewer fees the county charges its residents.
• The fees are pretty straight forward and relatively stable.  Normally a county could easily issue, with the help of a bond underwriter (Wall Street bank, regional broker dealer, etc..), thirty-year fixed rate debt.  If they wanted a AAA rating they could go to one of the municipal bond insurers and pay a fee for the credit enhancement (Jefferson County used FGIC and XL).
• Instead, Commission President Larry Langford turns to his buddy William Blount, Chairman of Blount Parrish & Co.  Blunt steers Langford to JP Morgan, Bear Stearns, Bank of America and Lehman Brothers.  These firms tell Langford about the wonders of the new "Auction Rate Debt" market.  The Street runs an auction every week to provide a floating rate for potential issuers like Jefferson County.  Because short term interest rates were so low and there was such incredible demand for AAA short term assets, the county could save $100's millions issuing into this program.  It's like free money right?  The Street of course got a fee for each auction.  Meanwhile, Blunt is get paid thousands in fees from the county everytime he "advises".  He in turn is kicking money back to President Langford.
• Then the real fun starts.  The Street firms advise the county that just to be safe, since the rate they pay on the auction is floating, they should "hedge themselves" by entering into interest rate swaps with the them (The Street firms).  The county pays a fixed rate for thirty years and the dealers pay the county a floating rate...Libor.
• Now at this point, someone who wasn't on the take like President Langford, could have thought, "why didn't we just pay a fixed rate on the bonds without all this extra nonsense?  At this point, The Street would have said, "{Smart person}, don't you see? This auction rate debt is AND probably ALWAYS WILL BE lower than the floating rate we pay you (LIBOR).  It's an arbitrage man!!!"
• It is estimated that the county paid in "fees" about $120 million on $5.8 billion of interest rate swaps with the above mentioned Street firms.  I don't know what "fees" are for a simple interest rate swap.  I assume that "fee" is what the county paid ABOVE the prevailing market rate.  If we assume that these swaps were thirty-year swaps, then to make $120 million on $5.8 billion, the county would have had to pay about 15 basis points above the prevailing market rate.  That's .15 of 1%.  Small number?  Unfortunately the interest rate swap market trades (Bid/Offer) in .0025 of 1% (a quarter of a basis point)!!  That is what we call "serving the customer".
• The rest is history.  The credit crisis hit, the auction rate debt market seized up when the bond insurers blew up and suddenly Jefferson County is paying 10-15% on its floating rate debt while only getting 2-3% on their interest rate swaps.  Game over.  Mrs. Donner has to chose between keeping the heat on or keeping the water running.

Now the people of Jefferson County are suing everybody involved, as they should, and the Department of Justice is investigating what went on with the interest rate swaps, which means there could be criminal charges against the banks and individuals.  Lets see what happens.

"Hey Boys....Bring That Pitchfork Toting Mob Over Here!"

This little story will be categorized under "Revulsion".  Today, Countrywide President David Sambol will retire instead of running the combined home lending operations of Bank of America and Countrywide.  Sambol ran the "day to day" of running of Countrywide into the ground, while Angelo tanned.  In a classic move that only an executive named Ken (I really have a thing with that name, Ken Lewis, Ken Thompson, Ken Lay) could pull off, Sambol was given a $28 million compensation package to stay on when the aquisition was announced.  However, he could have said yes, and then no a little later......and still collected his $28 million!  It appears that he did just that.

So Bank of America paid Sambol a kings ransom to stay.  Where on earth was Dave Sambol going to go?  The market for overpaid, nasty and incompetent financial executives was/is shall we say.....fully offered. Bank of America  said today that they are sending Barbara Desoer, BOA's Chief Technology and Operations Officer to take over.  ``We felt it was very, very important that we have someone who is rooted in our culture and the way we do business and who has relationships throughout the company. That's why we are sending one of our most senior executives to California.''   Good point.  I bet they could have done that without paying Sambol $28 million.

SHAME

Bloomberg News reported today that according to RealtyTrac Inc. housing foreclosures in towns where members of THE UNITED STATES ARMED FORCES live are increasing at a pace four times the national average. "We've never faced a situation like this, not in the Vietnam War, World War II or the Korean War, where so many military are in danger of losing their homes," said Paul Sullivan, executive director of Veterans for Common Sense.

Of course the government is right on top of it.  Since lenders are not required to keep records on the status of non-government program(unlike VA loans) loans, there are no official figures.  Mike Frueh, the VA's assistant director for loan management says, "My data comes from those that have VA loans, and we haven't seen, as I understand it, a big jump."  So there you have it.  Perhaps someone at the VA should look into RealtyTrac Inc's data, then do an estimate of how many military families inhabit these particular towns and come up with some real freaking numbers to identify the problem so they can do something about it!  Maybe for once, somebody besides a soldier a sailor or an airman can go above and beyond to solve a problem without having a congressional hearing to "incent" them.

There is a pact between the United States Armed Forces and their civilian leadership.  The military accepts and is subservient to it's civilian leadership.  In return, the military is entitled to expect that our country's civilian leadership will use them and care for them in a intelligent and conscientious manner.  We continue to fail  them disgracefully.  This is a national shame.  If we are going to have a housing bailout, lets start here.  Retire these loans, paid in full.  I bet it would pass the congress 535-0.  It is the least we can do, and right now we aren't even close to "the least".

Spring Cleaning!

On March 7th we told you the sorry tale of Jefferson County Alabama. Here was how we opened it:

An article by Joe Mysak of Bloomberg News titled “Moody's, S&P Help Push Alabama County to Insolvency” really shows to paraphrase Hillary, “It takes a village to wreck a county’s finances.” A village of dullards, thieves and shiftless boobs. What really pisses me off is I pushed the idea that municipalities don’t default, certainly not on “essential purpose debt”, and I was wrong. Granted though, it takes a real concerted effort to bugger it all up on the part of everyone involved….but it can be done! From the Mr. Mysak’s article;

“Jefferson County, Alabama, the municipality that was going to teach America how to use swaps and derivatives, says it is running out of money and isn't sure it can pay its bills. And you can blame swaps and derivatives. While you're at it, you can also blame the subprime crisis, the downgrades of AAA rated bond insurers and the failure of Wall Street securities firms to backstop bond auctions. On Feb. 27, the county put out a material event notice regarding its $3.2 billion in sewer revenue warrants, saying it could `provide no assurance' that it could come up with the money needed to honor its obligations. `The County is working with its advisors to identify and analyze all feasible means to address the current difficult situation,' the notice said.”

Long story short, the county was caught up in multiple disasters caused by silly short term financing arrangements and highly unnecessary interest rate swaps (graciously served to the county by major Wall Street firms) and essentially turned a simple essential purpose debt raise into a bankrupting disaster (go to the March 7th post, “It takes a Village” for the exciting details!)

Anyway, today the real fun started. Here is the story as reported by Bloomberg:

Birmingham, Alabama’s mayor accepted more than $156,000 in cash and benefits from the head of a regional underwriting firm that reaped more than $6.7 million in fees from bond offerings and interest rate swaps, the U.S Securities and Exchange Commission said. Mayor Larry Langford got the payments when he was president of the Jefferson County commission from William Blount, chairman of the bond underwriter Blount Parrish & Co., according to a complaint filed by the SEC in U.S. District Court in Alabama. Langford selected the Birmingham-based company to participate in every county municipal bond offering and swap agreement in 2003 and 2004, the SEC said.

So for $156,000 Mayor Larry sold his entire county into insolvency (sounds biblical!). Now, none of the Wall Street firms were named in the suit, but I have a funny feeling the mighty firm of Blount Parrish & Co. knew about as much Mayor Larry did when it came to high finance. Somebody put those ideas in these good ole boys heads and I bet that somebody (or some bodies) made a lot more than 156k or $6.7 million. Let’s just wait and see what happens. Something tells me that the sad tale of Jefferson County is not an isolated incident.

I guess the only good thing about a full blown crisis is it exposes every slimy creature from under every rock. Let’s call it a good old spring cleaning!

It Takes A Village

Fantastic article written on Wednesday by Bloomberg News Reporter Joe Mysak. Joe covers the municipal finance markets for Bloomberg. He has been on top of the drama for quite sometime now. You really need to check these Bloomberg reporters out on www.bloomberg.com because they know their stuff cold. Anyway, on with the show.

A article titled “Moody's, S&P Help Push Alabama County to Insolvency” really shows to paraphrase Hillary, “It takes a village to wreck a county’s finances.” A village of dullards, thieves and shiftless boobs. What really pisses me off is I pushed the idea that municipalities don’t default, certainly not on “essential purpose debt”, and I was wrong. Granted though, it takes a real concerted effort to bugger it all up on the part of everyone involved….but it can be done! From the Mr. Mysak’s article;

“Jefferson County, Alabama, the municipality that was going to teach America how to use swaps and derivatives, says it is running out of money and isn't sure it can pay its bills. And you can blame swaps and derivatives. While you're at it, you can also blame the subprime crisis, the downgrades of AAA rated bond insurers and the failure of Wall Street securities firms to backstop bond auctions. On Feb. 27, the county put out a material event notice regarding its $3.2 billion in sewer revenue warrants, saying it could `provide no assurance' that it could come up with the money needed to honor its obligations. `The County is working with its advisors to identify and analyze all feasible means to address the current difficult situation,' the notice said.”

Lets breakdown what happened here.

Jefferson County issued debt to be serviced by sewer revenues. Now, they could have issued fixed rate debt, meaning that the interest rate that drives the payment they must service is fixed. They could have done this for 30 years.

However, since someone in Jefferson County felt that sewer revenues must move in lock-step with short-term interest rates (I don’t think they do), they went down the yield curve where the rates were lower and issued floating rate debt. This is the whole Muni Auction Rate Debt you have been hearing about. You know, the auctions that are failing, causing municipal borrowers to pay double digit penalty rates? Yes those ones. Anyway, the first risk the county decided to take was interest rate risk by eschewing fixed rate debt for floating.

Now the real fun begins. The nice Wall Street firm that is “helping” Jefferson County says, “You know, you have a nice little arbitrage opportunity here. These floating rates you pay on the auction rate debt are a lot lower than 1m Libor (a short term rate that banks lend to each other.) You can ‘monetize’ this ‘arbitrage’ by entering into an interest rate swap with us. We pay you 1m Libor, you pay us a fixed rate, say 30yr Treasury +.5%. See, now you will take advantage of this great floating auction rate you are getting (because it is a law of nature that the auction rate will always be lower than 1m Libor right??) and get rid of the interest rate risk by paying us a fixed rate. All good?” So the second risk the county took was “basis risk” (the difference between the floating auction rate debt and 1 month Libor).

Now, if your not a derivatives professional, that might not be easy to understand. There is no shame in that. None at all. If this is not your full time profession its not easy to follow the flows. Let me ask a question though. Do you think the Jefferson County Treasurer could understand it? You think he knew that what started out as a simple debt raise for essential services turned into a trading position that would make the savviest derivatives pro’s hair fall out? Of course not. You think he even knew if he was getting a competitive market rate on the interest rate swap? You think that the treasurer at least put the swap dealer in comp? I can’t say yes or no but I can tell you that I have worked on a few derivative desks in my day and when one of these muni swap deals would come about, balloons and confetti would come falling out of the ceiling! “Chinese food for the whole trading floor courtesy of the swap desk…get involved!!!!!”

Anyway, it’s a complete disaster. Today the county was notified by the banks that it has the swaps on with to come up with $184mm to collateralize the mark to market loss the county has on the swaps. They have till……tomorrow! This is a case where

County officials got in way over their heads and took risk they didn’t even know they were taking.
The swap dealers took the county to the cleaners. According to Mr. Mysak’s piece, “In 2005, Bloomberg News found that the county was overcharged for swaps; last April, the new financial adviser said the county might have paid $100 million too much.” I did a bit of back of the envelope work and assuming 5bb of 30yr swaps, to “overpay” by $100mm the swaps would have to be about 14 basis points off market (0.0014). This is a market that trades in half basis points (0.00005)!!!

The rating agencies completely ignored or misunderstood what was going on in the county. Again quoting Joe’s article, “Not least among the culpable are the credit-rating companies. Jefferson County has piled on swaps and derivatives for years now, and yet this appears to be the first time that one of these companies has uttered a word about just how risky and speculative such a strategy has been. `Unique, risky structure'? How nice of Moody's, at long last, to acknowledge the problem. Couldn't they have said something, anything, last year? Or the year before?

And now Jefferson County is faced with the real possibility of default. How are they going to pay? How are they ever going to be able to borrow again? I really have no idea but there is gonna be a world of hurt for the folks in Jefferson County, as if they didn’t have enough problems to begin with. Like “Bunk” from “The Wire” says, “That is some shameful sh*t.”