How Wall Street and London Bank Scandal Are Bankrupting California Cities

by on July 17, 2012 · 10 comments

in Business, Editor's Picks, Government, Politics

Wall Street got bailed out. Cities got sold out. Federal policies keeping interest rates low are resulting in extracting wealth from cities and transferring it to Wall Street.

We blogged earlier about how traders from JP Morgan Chase and Goldman Sachs descended on European cities such as Casino, Italy and even nunneries selling them interest rate swaps. Interest rate swaps were also responsible for bankrupting Jefferson County, the county seat of Birmingham, Alabama. Now the same big banks are bankrupting California cities. Stockton, San Bernadino and Mammoth Lakes have already gone down. Oakland is fighting Goldman for its very life.

But what does this have to do with the LIBOR scandal, you say? A lot, it turns out. LIBOR stands for the London Interbank Offered Rate, a benchmark that most other interest rates are tied to including interest rate swaps, the very derivative financial instruments that are now bankrupting California cities. The LIBOR scandal has failed to attract the interest of many Americans because it’s so “over there” in London. What does that have to do with us here in the US? The same interest rate swaps that JP Morgan Chase sold to nunneries in Europe, they’ve sold to Stockton and San Bernadino and Oakland and many other US cities, school districts, hospitals and perhaps even to a few US nunneries.

It has recently come to light that the LIBOR has been fraudulently manipulated by London based Barclays bank and possibly quite a few others. CEO of Barclays, Bob Diamond, has been forced to resign and Barclays has had to pay a $456 million penalty. Diamond (unlike his US counterpart, Jamey Dimon, of JP Morgan Chase who sports Presidential cuff links) has had to eat humble pie in front of the English Parliament.

What this means is that interest rates for credit cards, mortgages, student loans and almost every other kind of loan imaginable including interest rate swaps have been fraudulently set for years. A trader at Barclays petitioned a submitter, whose job it is to report accurately on the interest rate, to lower the LIBOR on a certain day so that he could make a killing on his Credit Default Swap, a bet that the LIBOR would go down on that day. When it did and the trader cashed out, he phoned up the submitter and said, “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.”

It’s too late for Stockton, now that it’s surpassed Birmingham as the nation’s largest municipal bankruptcy, and for San Bernadino, but Oakland is fighting back demanding that Goldman terminate the interest rate swap deal without penalties. Recall that Casino, Italy took JP Morgan Chase to court and eventually won a settlement of a half million euros.  Oakland entered into an interest rate swap with Goldman in 1997. They convinced Oakland officials that it would protect taxpayers against the possibility that interest rates would rise on variable rate bonds that the city planned to issue the next year. Oakland’s deal with Goldman Sachs converted floating rates on $187 million of bond debt into a fixed 5.6 percent.

If the interest rate tied to the benchmark LIBOR went below 5.6%, then Oakland had to pay Goldman, and if it went above 5.6% Goldman had to pay Oakland. Since then, however, the Federal Reserve has kept interest rates near zero so Goldman had made out like a bandit and Oakland has had to pay through the nose taking money away from teachers, firefighters, policemen and garbage workers and funneling it to Goldman. This collapse in city finances is bankrupting the city. If rates stay artificially depressed due to the Federal Reserve’s decisions, Oakland will owe Goldman Sachs another $20 million between now and 2021. That’s on top of the $26 million the city has already paid.

In all fairness Goldman would say that nobody forced the city of Oakland to enter into the interest rate swap. Oakland made a bet that interest rates would rise and it lost. It’s as simple as that. However, Oakland wasn’t counting on manipulation of interest rates by the Federal Reserve and by the LIBOR so the deal sucks all the way around. In fact it stinks to high heaven. Leaders of some of Oakland’s largest churches are uniting with community organizers, Decolonize Oakland, and Occupy Oakland activists to focus on how “predatory” banks are draining Oakland’s budget and causing cuts to vital city services. Oakland can get out of the deal with Goldman by paying a $16 million penalty, but that seems unfair to Oakland’s leaders. They say that Goldman got bailed out by the TARP while government money has failed to bail out Oakland. Wall Street got bailed out. Cities got sold out. Federal policies keeping interest rates low are resulting in extracting wealth from cities and transferring it to Wall Street.

On top of that the state of California is taking monies back from cities’ Redevelopment Agencies to fund its own budget deficits. A controversial new law terminates all redevelopment agencies and authorizes the seizure of $1.7 billion of their property tax revenue to alleviate the state’s own budget deficit.

Oakland, however, uses redevelopment funds to cover at least some portion of city workers’ pay. Mayors and city councilmembers who oversee redevelopment projects may receive part of their salary from the agency. Funding police services is also consistent with redevelopment law as long as those services are used to mitigate gang activity, graffiti abatement and other causes of community blight. The Oakland Redevelopment Agency has funded full time police officers for five years. With the state clawing back Redevelopment Agency funds and property taxes, city workers including police officers are likely to be laid off.

What’s happening in Oakland and many other US cities is similar to what’s happening in Greece and all over the world. This is from Occupy Oakland Media:

“The banking deception hits close to home, as Oakland and San Francisco pay millions of extra dollars annually in inflated interest payments to Goldman Sachs and JP Morgan while cutting funding for education, after-school programs, healthcare and infrastructure. Oakland will pay nearly half the amount of its budget deficit to private banks over the next few years because of high interest rate obligations stemming from interest-rate swaps with banks such as Goldman Sachs. This is tantamount to redistribution of wealth from the poorest people in Oakland who will give up education and healthcare to millionaire bankers.

“This has been happening in states all over the country says economist Michael Hudson, “Because what’s happening in Greece is a dress rehearsal for what’s going on in the United States. … What’s happening in Greece in the last week is exactly what’s happened in Minnesota with the close-down of government. And the demands of privatization – thatGreece sell off its roads, its land, its port authority, its water and sewer – is just what Illinois’s been doing, what Chicago’s been doing, what Minnesota’s been told to do, and what American cities are trying to do.

“What if the United States had bailed out the states instead of the multi-national banks? We could have retained funding for education, infrastructure and social programs that could have stimulated local economies and kept people in their homes, where the majority of the people’s wealth is held, since the banks that would have foreclosed upon them would have been stuck in bankruptcy court.”

So to recapitulate, California cities are being bankrupted by Wall Street largely due to interest rate swaps which are tied to the LIBOR which we now know has been fraudulently manipulated by the big banks on Wall Street and in London. The result is austerity for the people of Oakland just as it has been for the people of Greece. LIBOR, the rate at which banks borrow from one another, is the basis for roughly $800 trillion worth of loans, financial instruments and derivatives including interest rate swaps. When banks manipulate LIBOR rates lower, they are borrowing money for less while their counterparties in interest rate swap contracts are stuck paying them much higher rates.

John Lawrence publishes his own blog, Will Blog for Food.

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John Lawrence

John Lawrence graduated from Georgia Tech, Stanford and University of California at San Diego. While at UCSD, he was one of the original writer/workers on the San Diego Free Press in the late 1960s. He founded the San Diego Jazz Society in 1984 which had grants from the San Diego Commission for Arts and Culture and presented both local and nationally known jazz artists. His website is Social Choice and Beyond which exemplifies his interest in Economic Democracy. His book is East West Synthesis. He also blogs at Will Blog For Food. He can be reached at j.c.lawrence@cox.net.
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{ 10 comments… read them below or add one }

avatar Nico July 17, 2012 at 10:51 am

So basically a bookie comes along and says, “I’ve got a great deal for you.” The city signs up, then the bookie fixes the game and the city gets its legs broken for not paying. But it’s all perfectly legal…

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avatar RB July 17, 2012 at 11:47 am

The LIBOR rate fixing did not bankrupt California cities. These fixes involved small daily changes both up and down and not in any one long term direction. Rates are low because of Fed policy not bank policy. These cities are in bankruptcy because they promised 7-8% risk free returns for employee pensions when the risk free bond yields are at 1%. Since cities can’t cover pensions with low risk bonds they have turned to riskier investments (like real estate) rather than reducing pension returns. Pensions are the root of the problem not LIBOR rates.

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avatar Frank Gormlie July 17, 2012 at 2:41 pm

Hey RB – ya getta around! Hey, talk about bankrupt cities, the City of San Bernadino went bankrupt because it recklessly invested in a mall that was losing ground daily. Pensions are only one of many factors causing cities to declare themselves in the “red”. You are wrong however to continue to repeat your mantra that you have exercised a great deal over at the OB Rag – “pensions are the root problem” of just about everything. You and Carl DeMaio should make a deal …. wait! maybe you have. Oh, well, nice to hear from ya.

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avatar RB July 17, 2012 at 6:06 pm

Frank, do you have a reference for mall spending as the cause of the problem? I think not.

This article lists no ‘mall’ problem but does point out that pension spending has doubled since 2006 in San Bernadino.
http://www.huffingtonpost.com/2012/07/15/san-bernardino-bankruptcy-political-feuds-denial_n_1674936.html?utm_hp_ref=business

Also, I believe the mayors of San Jose and Scranton PA who filed for bankruptcy are Democrats……..not DeMaio followers.

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avatar Frank Gormlie July 18, 2012 at 7:57 am

RB – see LA Times July 15, 2012, front page.

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avatar John Lawrence July 18, 2012 at 6:06 pm

RB says: “These fixes involved small daily changes both up and down and not in any one long term direction.” Small daily changes on trillions of dollars of derivatives can add up to real bucks really fast. Just ask some of the counterparties who were on the short end of the deals. Those daily bets were not averaged out as you suggest, but were realized on a daily basis. Why else would you break out a bottle of Bollinger on a particular day?

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avatar RB July 19, 2012 at 7:17 am

I understand you are politically motivated and want to blame government failure on the rich rather than on union pensions (as documented in the LA Times and Huff Post, etc.), but undocumented links to LIBOR is ivory tower fiction. The cities and counties in California are not making daily, trillion dollar bets on the direction of LIBOR rates.

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avatar John Lawrence July 19, 2012 at 8:07 am

“The cities and counties in California are not making daily, trillion dollar bets on the direction of LIBOR rates.” Yes, but others are. Like the guy who broke out the bottle of Bolinger to celebrate.

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avatar John Lawrence July 19, 2012 at 8:18 am

As far as union pensions go, RB, many of the California public pension funds such as CalPERS have been counterparties to the rigged bets and screwed out of millions of dollars. That’s why they’re in such bad shape.

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avatar RB July 19, 2012 at 11:45 am

From Oct 2007 to Jan 2009 CalPERS lost $80 billion or about a third of asset value as the stock market declined. It was not due to rigged bets or LIBOR gambling.
http://www.capitolweekly.net/article.php?_adctlid=v&issueId=xp2rbq48fwdfqv&xid=xp2ynbmjbr9vsy

Years ago when pension systems worked, they were 60% invested in bonds and 20-30% in blue chips (dividend paying stocks) and they promised employee members 4-5% returns. Now CalPERS gambles with asset allocations of 60+% stocks, 20% bonds, 20% real estate and they promise employee members 7-8%. THESE NUMBERS DON’T WORK.

Some have reported that CalPERS is $800 Billion in the hole when compared to their promises.

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