The debt that keeps on taking
Mike Shane of Moratorium Now! talks about the role banks have played in Detroit’s fiscal crisis.
PUBLISHED: MAY 8, 2013
Back in the 1920s, some clever marketing guy first came up with the catchphrase “The gift that keeps on giving” to help sell phonographs. As we here at the Hits sat in a meeting Saturday, listening to an analysis of the credit swap deals that are costing the city of Detroit hundreds of millions of dollars, a spin on that slogan came to mind:
“The debt that keeps on taking.”
Held at the Central United Methodist Church downtown, the meeting attracted about 140 people willing to forgo the pleasures of a spring day to sit inside and watch a PowerPoint presentation delving into the arcana of complex financial instruments.
The information was presented by members of the Moratorium Now! coalition, which is in the process of analyzing some 3,000 documents obtained from the city through a Freedom of Information Act request.
Formed in 2007 to fight home foreclosuresand evictions, the group is now looking into the causes of the city’s debt crisis as well. The link is easy enough to see: the same banks that marketed predatory loans are now reaping massive profits as the result of bad bets made back in 2005, when Kwame Kilpatrick was still mayor and the city needed to borrow $1.5 billion to cover pension obligations.
As explained by Moratorium Now! Member Mike Shane, the deal worked like this: Under normal economic conditions, interest rates rise and fall in cyclical patterns. To guard against those fluctuations, units of government issuing bonds — which is another way of saying they are borrowing money — can enter into what are known as interest rate swap agreements.
Lest your eyes begin to glaze over, we’ll dispense with the textbook explanation of what those are and simplify it (oversimplify, actually) and just say these swaps are like a bet. If you think interest rates are going to go up — which, in 2005, seemed like a distinct possibility — then a swap would work to your benefit. If the rate goes up, the bank eats the loss.
If the rate drops, however, the city has to pay the difference to the bank. Which is why the institutions that bought those pension obligation certificates are getting a return on their investment of less than 1 percent, but the city is paying banks a rate of somewhere between 5 and 6 percent — on a $1.5 billion debt!
Members of the coalition, working with outside experts, are still trying to figure out exactly how much this bad “bet” is costing the city. Shane tells us that it is certainly tens of millions of dollars a year. And that’s just in interest payments.
Add to that so-called triggering events — such as the downgrading of the city’s credit rating, or the appointment of an emergency manager (both of which have occurred) — and attempts could be made to force the city into paying fees of more than $400 million immediately. And that’s only for this one deal involving those pension obligation bonds.
The problem for the debt collectors is the city, which is on the verge off insolvency, doesn’t have the money to cough up. If the creditors tried to force the issue, the city would be forced into bankruptcy.
So there’s a dance of sorts under way, with the question being how much blood can be wrung from Detroit without completely driving it under.
The threat of bankruptcy is the cudgel EM Kevyn Orr says he has hanging over the heads of the big creditors. There’s no telling what might happen if all this ends up in the hands of a federal judge.
It’s worth mentioning here that the city of Stockton, Calif., was declared eligible for Chapter 9 bankruptcy just last month. Its projected deficit for the next fiscal year, according to published reports, is somewhere between $20 million and $38 million. To put Detroit’s situation into perspective, its projected deficit could be as high as $380 million. Even so, folks here are keeping a very close eye on what happens in Stockton.
What the Moratorium Now! folks are saying is that focus needs to be kept on the banksters responsible for creating the crisis. They pushed predatory loans (often targeting minority communities) with low introductory rates that would balloon in a few years, knowing that the people taking out the loans wouldn’t be able to repay them. Then they bundled those “toxic” mortgages and, with the collusion of ratings agencies, sold them to investors who believed them to be low-risk. The scheme fell apart when the housing bubble burst, and the economy collapsed, resulting in massive foreclosures that devastated the tax bases of cities like Detroit (and, for that matter, Stockton). The banks got bailed out, the homeowners got kicked out, and cities across the country were left facing huge deficits.
That’s not to say that this caused all of Detroit’s problems, but there is no denying that it was a significant factor. And then, compounding the problem, were credit and interest rate swaps.
For an explanation of that, we turn to Rolling Stone magazine’s Matt Taibbi, who recently wrote a piece that begins:
“Conspiracy theorists of the world, believers in the hidden hands of the Rothschilds and the Masons and the Illuminati, we skeptics owe you an apology. You were right. The players may be a little different, but your basic premise is correct: The world is a rigged game. We found this out in recent months, when a series of related corruption stories spilled out of the financial sector, suggesting the world’s largest banks may be fixing the prices of, well, just about everything.
“You may have heard of the Libor scandal, in which at least three — and perhaps as many as 16 — of the name-brand too-big-to-fail banks have been manipulating global interest rates, in the process messing around with the prices of upward of $500 trillion (that’s trillion, with a ‘t’) worth of financial instruments. When that sprawling con burst into public view last year, it was easily the biggest financial scandal in history — MIT professor Andrew Lo even said it ‘dwarfs by orders of magnitude any financial scam in the history of markets.’”
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