Interest Rate-Fixing Scandal Swindles Baltimore, Other Municipalities Out Of Millions Of Dollars

NOAH GIMBEL: I'm standing in front of the headquarters of the Washington Metropolitan Area Transit Authority in Washington, DC, where administrators have recently announced a new round of fare increases following a massive 2010 hike that pushed rates up as much as 33%. Similar stories abound throughout the country - from Boston to San Jose, New York to San Francisco. In 2011, rate hikes cost DC public transport riders over $109 million, and much of that money is going straight to major Wall Street banks. But only recently have observers begun to find out why. According to a recent report from the Refund Transit Coalition, more than 100 government units nationwide - transit agencies, pension funds, and municipalities - are currently tied into more than 1,100 different debt-swap-deals with major banks. And a large portion of those deals pegged the interest rates paid out to public-sector investors to the London Interbank Offered Rate, or Libor. Ongoing investigations into Barclays and other major financial institutions have found that banks conspired to manipulate Libor as far back as 2005, resulting in massive profits for some insider-traders and massive losses for thousands of investors around the world.The city of Baltimore is taking all 19 of the banks responsible for setting Libor to court, alleging that the suppression of Libor lost the city millions on its debt-swapping agreements.To explain how these agreements work, the Real News spoke with Peter Shapiro, head of the Swap Financial Group. His firm is the leading swap advisory firm in the country, and has had the city of Baltimore as a client for about a decade.

SHAPIRO: Public agencies in the US, one of their responsibilities is building and maintaining infrastructure. Whether we're talking about a city government like Baltimore, or a transportation agency or an airport authority, they all have big capital plants. They borrow all the time, the cost of capital, the cost of borrowing, is a big ingredient in their cost. They could borrow using conventional fixed-rate bonds, by issuing normal municipal bonds, tax-exempt bonds, at one rate, or they could use a swap to produce a significantly lower rate in most markets. Most big cities that do swaps, which is probably 75% of them, have swap advisors, and we advise most of the very biggest cities, the ones that are bigger than Bmore - NY, Chicago, Houston, Philadelphia are all customers.Here's how it works - instead of issuing normal fixed-rate bonds, they issue floating-rate bonds. Those floating-rate bonds are bought by investors who eagerly gobble them up, and they receive a floating rate of interest from the city, and that obligation from the city is directly to the bondholders, it's an absolute pledge. The swap is separate from that. They enter into a separate agreement, a swap agreement, with a bank. It has nothing to do with the obligation they have with the bondholders, except it helps to convert the financial obligation they have to live with from a floating rate into a fixed rate. They don't really want to be on the hook for a floating rate because they're volatile - they go up and down unpredictably. They'd prefer to be in fixed-rate form, but they want to do it cheaper. By entering into the swap, the bank will pay them a floating rate, and that floating rate can be used to offset the floating rate they have to pay to the bondholders. And in return for getting that floating rate from the bank, they pay the bank extra. Think of it as three flows: a floating rate paid by the city to bondholders, a floating rate received from the bank on the swap, and a floating rate paid to the bank on the swap. If you have two floating rates - one in, one out - they're supposed to neutralize each other, and what you're left with is the fixed rate. And that fixed rate is typically 50-100 basis points lower than the fixed rate they'd be paying in the conventional fixed-rate bond market.

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