Pensions of Millions Could Vanish

MrBill · Expert Joined: Sep 15, 2005 Posts: 5220 Location: Eurasia

MOCKBA floating rate debt based on LIBOR combined with interest rate swaps (IRS) are not terribly complicated. They just swapped fixed rate debt for floating rate debt, and then covered their interest rate gap exposure by buying an IRS. This asset swap lowered their overall cost of borrowing (5.25 to 4.40%) and should have been very straight forward had they just left well enough alone.

But this is government at work. BIC Syndrome - bureaucracy, incompetence and corruption. State or county officials wined and dined by fast talking salesmen, and the ever present boys from the backroom, pushing these public clerks into deals they do not fully understand, and then collecting outsized fees along with the kickbacks for the good ol' boys in the backroom. They probably felt very flattered that Wall Street were paying so much attention to them? JPM's name pops up again and again in these deals gone sour.

However, as the County bypassed the competitive bid system to do bilateral deals they violated probably rule number one of any competent purchasing manager or State Treasurer, and that is to establish a market and choose the best price. Usually the best of three quotes at least. This is just incompetence on the part of local authorities.

So a la Orange County the Prosecutor or whoever will simply try to prove that these Wall Street firms sold complicated products to end users that did not fully understand them. It is really a bullshit defense. The products themselves are very straight forward, and of course had they worked the way they were supposed to the County would have reaped the benefit of paying lower interest costs. Never the less as there has been fraud committed no doubt the prosecution will have an easier time pointing to the smoking gun of overpaying for those swaps and the allegation of collusion amoung firms.

Unlike marked to ~~model~~ myth CDOs and CLOs that are hard to value in the absence of secondary market trading these simple FRAs and IRSs are easy enough to accurately value with one caveat. They are based on LIBOR (or sometimes FED funds) and banks have been systematically under-reporting LIBOR lately as they are rue to admit how much they themselves have to pay for interbank loans. Good if you're paying floating rates and receiving fixed payments. Bad if you're on the otherside and paying fixed while receiving floating rates.

But where these states and counties really got screwed is when the public auctions failed and no one stepped in as buyer of last resort. I cannot really blame the local authorities for that as it is a small probability event and hard to plan against versus the immediate need of having to secure low-cost financing for projects. Local authorities are always under pressure to do more with less. However, this illustrates how careful they should have been when negotiating these contracts. Now the taxpayer is on the hook and money going out to settle these deals is money not available to pay other expenses. The taxpayer always loses from BIC Syndrome, so I am at a loss why so many clamour for more government.
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The organized state is a wonderful invention whereby everyone can live at someone else's expense.

pedalling_faster · Intermediate Crude Joined: Dec 10, 2005 Posts: 767

BigTex

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