Auditor general looks to ban swaps
Interest-rate swaps are supposed to provide a hedge against big changes in interest rates. But as they've gone sour, regulators are taking a closer look at these exotic products. Joel Rose reports.
Pennsylvania Auditor General Jack Wagner (auditorgen.state.pa.us)
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Kai Ryssdal: There was a point back in the thick of the financial crisis where we had all heard more than we wanted to about some of those fancy financial products. Things like auction-rate securities and collateralized-debt obligations. Private investors weren't the only ones who were seduced by 'em, though.
Plenty of school districts and municipal governments got involved with things known as interest-rate swaps. They're supposed to provide a hedge against big changes in interest rates. But borrowers from Harvard University to Jefferson County, Ala., lost billions of dollars on them. And now a Pennsylvania official wants to ban them altogether, as Joel Rose reports.
JOEL ROSE: The school district in Bethlehem, Pa., tried to use interest-rate swaps to lower the cost of borrowing for its building projects. But those bets backfired because interest rates dropped. And the district wound up owing investment banks more than $10 million.
JACK Wagner: It's almost as if the school district took public money and went and gambled that public money at a casino.
Pennsylvania auditor general Jack Wagner says hundreds of schools and local governments in the state made similar bets. He wants to see those deals terminated and a ban on interest rate swaps. Tennessee has already passed far-reaching restrictions, and other states are considering regulation too.
Robert Doty advises state and local governments on financial securities.
ROBERT Doty: The municipal bond market is littered with bodies of local governments that have had to pay enormous amounts to terminate their swaps. They didn't understand the risks. They thought nothing could go wrong. They found out otherwise.
But not everyone agrees that a total ban is the answer.
David Davare is research director for the Pennsylvania School Boards Association.
DAVID Davare: There are some districts that have done these successfully. They haven't all gone bad.
Instead of a ban, Davare says he'd like to see more enforcement of Pennsylvania's current law, especially the part that requires school districts to hire independent financial advisers. He says too many advisers had an incentive to steer their clients into risky deals.
In Philadelphia, I'm Joel Rose for Marketplace.
Comments
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From Napa, CA, 11/24/2009
This is one of the most irritating stories I've ever heard on Marketplace. For people like the auditor general of PA to say that school districts entering into rate swaps is akin to casino gambling is ridiculous. Swaps serve a totally legitimate purpose- they remove the uncertainty of future interest rate fluctuations (i.e. they are a hedge). They are no different than a borrower entering into a fixed rate loan, except that under GAAP an underwater swap has to be treated as a liability...which is the real reason people are complaining.
If the borrowers in question had truly gambled and stayed in floating rate debt obligations, and rates had gone up (they do go up, by the way), I would be the first in line calling for their collective heads!
From Monkton, VT, 11/20/2009
Interest Rate Swaps should not be considered "exotic" products. They fill a real need in helping an entity "fix" a rate on variable rate debt and establish a predictable cash flow. The same people who were considered "smart" for reducing interest costs when the market was in their favor, are now complaining that "they didn't know the risks" now that interest rates moved against them? I agree that seeking the advice of an independent financial advisor is always wise, but it would also be prudent to understand the ramifications of your Credit Support Agreements before entering into any Swap contract.
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