Dr. Susmit Kumar
Let us discuss the cases of two cities, one in the US and another in Europe, to see how the lives of common people have been affected for the next several years by the games played at the Wall Street’s casinos.
Jefferson County, Alabama’s largest county with 659,000 residents, is on the verge of bankruptcy because of losing bets on interest rates. Since mid-2008, the county is fighting to stave off what would be the largest municipal bankruptcy in the country over its $3.2 billion debt. JPMorgan Chase persuaded the county to convert its debt from fixed interest rates to adjustable rates. They also recommended that the county use interest-rate swaps that would protect it if interest rates rose. Larry P. Langford, the local official who signed off on the deals, said in a deposition in June, 2008, “I still don’t understand 99 percent of it [the deals].” The county paid JPMorgan Chase, Bank of America, Bear Sterns, and Lehman Brothers Holdings Inc. $120 million in fees – six times the prevailing fees for the amount of county’s debt for interest rate swaps. During the last few years, Jefferson County entered into a series of complex transactions, called swaps, worth a staggering $5.4 billion. Of 11 swaps and similar contracts Jefferson County went into from 2001 to 2003, eight were with JPMorgan Chase. JPMorgan, Bank of America, Bear Stearns, and Lehman Brothers Holdings Inc. charged Jefferson County about $50 million above prevailing prices for 11 of the interest-rate swaps the county bought between 2001 and 2004. None of the fees were disclosed to the commissioners, records show. Porter, White & Co., the Birmingham-based financial advisory firm later hired by the county to analyze its swaps, said the banks raked in as much as $100 million in excessive fees on all 17 of its swaps. The swaps are contracts in which the county and the banks agreed to exchange periodic payments based on the size of the outstanding debt and changes in prevailing lending rates. 
The worst came when Jefferson County’s two bond issuers, Financial Guaranty Insurance Co. and XL Capital Assurance Inc., suffered hundreds of millions of dollars in losses on securities tied to home loans. This led to the downgrading of credit ratings of these two by Standard & Poor’s and Moody’s Investors Service. When a bond insurer is downgraded, so do the bonds it has guaranteed. Hence the interest rate of $3.2 billion Jefferson County debt increased to 10 percent in February and March 2009 from 3 percent in January 2009. The monthly debt payment increased to $23 million from $10 million. The county is paying this extra money, i.e. taxpayers’ money to the banks instead of building schools, hospitals and public housing or hiring police officers. To pay for this ill-fated deal, the residents’ sewer rates have quadrupled. Several cities in Massachusetts have been facing the situation similar to as the Jefferson County. In mid-2009, Secutiries and Exchange Commission (SEC) decided to take action against JPMorgan Chase for the violation of rules, created by the Municipal Securities Rulemaking Board, the main regulator for the municipal bond market.
The situation of Jefferson County can be described by a scenario like this – the county was recommended to gamble or bet on the interest rate rather than get the loan at a fixed-rate. They entered into an agreement with banks in which periodically complex mathematical and statistical equations, involving several factors which were beyond the control of the county, would churn out a number for the interest rate for the massive debt. It was same as an amateur playing poker in a casino where he has no idea what will be the next deck of card.
Let us discuss the second case in which some cities in Norway lost almost all their money due to casino capitalism. Four small cities (Norway Narvik, Rana, Hemnes and Hattfjelldal) in Norway lost heavily in U.S. credit derivatives in 2008. Narvik is a close-knit community of 18,000. People in Narvik fear that the loss will hurt local services like kindergartens, nursing homes and cultural institutions. These cities are struggling to make up with losses. Streetlights were turned off during the dark Arctic night in far-northern Narvik. Town halls in several communities lowered the temperature to cut back on heating bills during the frigid Norwegian winter. In one city, the budget was scaled back so much that some of the elderly were sleeping in hallways at the local retirement home. The invested money was borrowed on revenue anticipated from electricity sales over the coming decade. Terra Securities told them that it was a low-risk investment, tied to municipal bonds but cleverly insulated by several layers of funds to hedge against further losses. Terra Securities, an investment firm owned partially by Terra Group, a union of 78 Norwegian savings banks. In fact, as events showed before the end of the year, the risks were high -- far higher than people in these towns understood. It was unclear whether those risks were ever communicated. Some town council members suggested that Terra Securities, in translating the Citigroup material into Norwegian, may have left out the parts that raised doubts. The fact is, they explained, these cities had been working with Terra representatives for several years and felt inclined to accept their advice. It was like buying a Volvo: You don't inspect the new car carefully; you rely on Volvo's reputation. Terra, the Norwegian securities firm that was the go-between with Citigroup, was forced into bankruptcy. In August 2009 on its behalf a prominent Oslo lawyer, Jon Skjorshammer, filed a case against Citigroup in U.S. District Court for the Southern District of New York seeking over $200 million for violations of the United States securities laws. Skjorshammer said, however, that the Terra brokers probably did not understand the scheme themselves. Citigroup's oral and written descriptions inadequately portrayed the risk, he charged, and used a faulty mathematical demonstration to prove how one fund would hedge against losses by the other. Moreover, he said, the way the instrument was constructed called on the Norwegian towns to provide additional funds if Citigroup's tactics lost money, in effect insuring Citigroup against losses of its own. One important point to note was that by investing through the complex system of derivatives, these cities were getting only marginally better return than traditional investments. But in this gamble, they lost almost their entire investments.
These examples show that the multi-million dollar bonuses of executives at Wall Street and other financial institutions are mostly taxpayers’ money. One has to just connect the missing dots. If a doctor would have done a similar thing, i.e. prescribed a medicine with such a disastrous effect, then not only he would have lost his entire wealth he would have been in prison for several years also.
1 Selway, William and Braun, Martin Z., “JPMorgan Swap Deals Spur Probe as Defualt Stalks Alabama County,” Bloomberg.com, May 22, 2008; Whitmire, Kyle and Walsh, Mary Williams, “High Finance Backfires on Alabama County,” The New York Times, March 12, 2008.
2 Selway, William and Braun, Martin Z., “JPMorgan Swap Deals Spur Probe as Defualt Stalks Alabama County,” Bloomberg.com, May 22, 2008; Whitmire, Kyle and Walsh, Mary Williams, “High Finance Backfires on Alabama County,” The New York Times, March 12, 2008.
3 Landler, Mark, “U.S. Credit Crisis Adds to Gloom in Arctic Norway,” The New York Times, December 2, 2007.
4 Cody, Edward, “Norwegian Hamlets Seek Wall Street Amends,” The Washington Post, August 25, 2009.