Swaps and other complex financial arrangements used to be off-limits to local governments. But in the late 1990s, "the financial-services industry lobbied Washington to deregulate these instruments," center executive director Sharon Ward said. "Then they came to Harrisburg and lobbied in 2003 for legislation that removed the ban."
Swaps "were heavily marketed" by bankers who stood to profit from the sales, Ward said. Schools and local governments that bought swaps were effectively betting on the future direction of U.S. interest rates. The banks helped the governments that bought swaps borrow money at competitive rates. But the swaps required that, if market interest rates fell below certain low levels, the governments had to pay the banks the difference. When interest rates fell instead of rising, governments owed millions.
According to the center's report:
The School District of Philadelphia paid a net $161 million to Morgan Stanley, Goldman Sachs, and Wells Fargo Bank on 10 interest-rate swap contracts connected to bonds the district sold, starting in 2003.
The City of Philadelphia paid a net $34 million to Royal Bank of Canada to settle swaps connected with city general-obligation bonds, plus up to $59 million for swaps still in force. The city has paid millions more to terminate swaps contracted with JPMorgan, Citigroup, and Merrill Lynch; the center says it lacks data to estimate the net cost of those settlements.
Borrowers using the Philadelphia Authority for Industrial Development paid $33 million to JPMorgan Chase Bank and Merrill Lynch Capital Services on swaps sold in connection with a series of bond issues, and owe up to $111 million on swaps still in force.
