Pennsylvania Auditor General Jack Wagner is calling for a state ban on interest-rate swaps after Bethlehem and other upstate cities lost millions of dollars signing complex financial contracts with Wall Street firms. Swaps are contracts where a municipality (or other client) bets an investment bank that interest rates will stay above (or below) a certain point. Swaps were profitable for PA towns before the 2008 credit crisis; since then many have lost millions.
Says Wagner, "Swaps have no place in public financing and should be banned immediately" because, by risking losses, they violate "the fundamental guiding principal" that public funds "should never be exposed to the risk of financial loss."
He also wants towns' financial advisor contracts put up for bid.
Wagner blames a 2003 law, passed by the General Assembly and signed by Gov. Rendell, for expanding the use of swaps by unsophisticated local officials, and for enriching JPMorgan Chase & Co. and other Wall Street firms at the expense of Pennsylvania towns. He says the law, Act 23, "was written primarily for the benefit and protection of the financial services industry," and noted New York is also weighing a swaps ban.
Wagner says interest rate swaps ("Qualified Interest Rate Management Agreements" under Act 23) worth $15 billion were signed by PA local governments since Act 23 passed. Wagner says a "case study" of two of the first swaps to be completed, by the Bethlehem school district, ended up costing taxpayers $10 million more than a fixed-rate bond, or $15 million more than a traditional variable-rate bond, would have cost, due to "excessive fees and other charges," including a $12 million fee to the city's investment bankers.
The swaps are "highly risky and impenetrably complex transactions that, quite simply, amount to gambling with public money," Wagner added. "They are susceptible of being marketed deceptively, and they principally benefit the investment banks" and "intermediaries who sell them to relatively unsophisticated public officials."