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Matt Taibbi on muni finance scandals

By Mike Konczal

If you head to the south end of the Medina in Marrakesh in Morocco, for 10 dirham you can see a series of palaces built with money lent from French banks starting in the 1890s. This "prelude to the protectorate" period involved France using loans funneled through the Banque d'Etat du Maroc, a Moroccan bank that was actually a private bank based in Paris and wholly dependent on the Banque de Paris et des Pays-Bas, to prop up the failing finances of the Moroccan state, which in turn bought palaces it couldn't afford. (Morocco was broke in part because of an indemnity it had to pay for a war with Spain.) Essentially France lent money that it knew Morocco couldn't pay in part of a long-term strategy to bring Morocco under its control.

Now could you imagine how much easier it would have been for France had it known about synthetic interest rate swaps?

Matt Taibbi has a Rolling Stone article -- "Looting Main Street" -- about the experience between Birmingham, Ala., and J.P. Morgan that is pretty fantastic. It's about how how the town had "a sewer project that was originally supposed to cost $250 million, [and] the county now owed a total of $1.28 billion just in interest and fees on the debt." J.P. Morgan bribed city officials with chump change, and then got exclusive rights to sell the city debt-based derivatives that exploded over the town's balance sheet. The city officials went to jail. J.P. Morgan paid a small fine, and nobody is going to jail.

Given the [expletive] of money to be made on the refinancing deals, J.P. Morgan was prepared to pay whatever it took to buy off officials in Jefferson County. In 2002, during a conversation recorded in Nixonian fashion by J.P. Morgan itself, LeCroy bragged that he had agreed to funnel payoff money to a pair of local companies to secure the votes of two county commissioners. ...

The crazy thing is that such arrangements — where some local scoundrel gets a massive fee for doing nothing but greasing the wheels with elected officials — have been taking place all over the country. In Illinois, during the Upper Volta-esque era of Rod Blagojevich, a Republican political consultant named Robert Kjellander got 10 percent of the entire fee Bear Stearns earned doing a bond sale for the state pension fund. At the start of Obama's term, Bill Richardson's Cabinet appointment was derailed for a similar scheme when he was governor of
New Mexico. ...

Last November, the SEC charged J.P. Morgan with fraud and canceled the $647 million in termination fees. The bank agreed to pay a $25 million fine and fork over $50 million to assist displaced workers in Jefferson County. So far, the county has managed to avoid bankruptcy,
but the sewer fiasco had downgraded its credit rating, triggering payments on other outstanding loans and pushing Birmingham toward the status of an African debtor state. For the next generation, the county will be in a constant fight to collect enough taxes just to pay off its debt, which now totals $4,800 per resident.

It is worth reading the whole thing. Bond Girl and Naked Capitalism have more. A few additional thoughts:

(1) When it comes to stories like these, they quickly become a "do you blame the local corrupt government or the bank?" style debate. The answer is both! The citizens are the ones who lose here, and the only question is whether or not the local corrupt patsies that make up the city officials get caught or not, not whether anyone on the bank's end will go to jail or suffer real consequences.

(2) There are more disasters waiting to happen here. Rick Bookstaber walks through his worries on the muni market as being the next subprime disaster. He notes: "Oh, and just as homeowners took their income and locked it up via secondary loans, much of the tax base for municipalities is already mortgaged, through the sale of tax-related revenues streams like tolls and parking fees." That's a whole other scandal and disaster in the making to watch.

(3) I'm going to write more formally about this when financial reform is over, but this sure seems like a story where everyone has to pay a hidden tax out of their already stagnating wages to give J.P. Morgan and the rest of the upper 0.01 percent a giant wage and bonus boost. Are there any phenomena out there like that that could use extra explanations? This scam sure seems like an exceptional source of returns to education.

(4) Are there policy responses? From Felix Salmon, Illinois is considering a bill "that will restrict the state’s public pension funds from investments that trade derivatives in non-public markets." So pension funds will not be able to trade over the counter.

Looking at stories like these, the "basis risk" that comes from not getting a bespoke derivative is probably outweighed by the "corrupt officials and sociopathic banker risk" that munis dealing over the counter will encounter.

The ability for the CFTC and the SEC to ban "abusive" swaps was removed by the end of the Frank bill, HR 4173, coming out of the House, replaced with the ability to report abusive swaps to Congress instead. Also Treasury inserted language in August of 2009, saying, according to Michael Greenberger, "that neither a private party nor a state can seek to void an illegal swap in either state or federal court. Under this provision, if a swap does not satisfy the requirements of
the federal law under which the swap is governed, it nevertheless cannot be invalidated nor can damages be awarded on that swap."

Pushing for stronger derivatives regulation, what looks to be the next big battle for financial reform in the Senate, could make a real difference here.

-- Mike Konczal is a fellow with the Roosevelt Institute and the author of the Rortybomb blog.

By Washington Post editor  |  April 6, 2010; 11:24 AM ET
 
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Comments

Interesting article, thanks for the link.

A few quotes I'd add:
"the EPA sued the county to force it to comply with the Clean Water Act."

"In 1996, county commissioners signed a now-infamous consent decree agreeing not just to fix the leaky pipes but to eliminate all sewer overflows — a near-impossible standard that required the county to build the most elaborate, ecofriendly, expensive sewer system in the history of the universe."

"Originally projected to costs $250M But in a wondrous demonstration of the possibilities of small-town graft and contract-padding, the price tag quickly swelled to more than $3 billion. "

"officials would be faced with automatic rate increases that would p*** off their voters."

"the county now owed a total of $1.28 billion just in interest and fees on the debt. "

Who knows why they went overboard on the construction, but this is the current mentality. When the government buys something, most people aren't paying for it, so no one pays attention. Yes we all want to live in a magical ecofriendly wonderland, but we just can't afford it.

The $3B cost number doesn't square with the other numbers in the story. It looks like a remarkably low interest rate from that perspective.

All of this to try to secure a free lunch of putting off the tax increase until the next guy is in office, aka the Bush II strategy. After all, look what happened to Bush I. He responsibly tried to raise taxes and was dunked for being a pragmatist.

Of course, the federal government can print money, so the eventual explosion resulting from our current planned spending increases is going to be even more delayed, and even bigger.

Posted by: staticvars | April 6, 2010 1:06 PM | Report abuse

"corrupt officials and sociopathic banker risk"

Apparently this can no longer be considered a tail risk.

Posted by: KenInIL | April 6, 2010 1:26 PM | Report abuse

Why would treasury do something like that?

Geithner is looking more and more like a corrupt little slimeball.

Posted by: zosima | April 6, 2010 2:28 PM | Report abuse

I would put more blame on the banks. They have more money and more experience with such deals than the poor corrupt officials. If an honest town turns them down, they can just keep looking. And, apparently, they have immunity from any real punishment.

Posted by: paul314 | April 7, 2010 11:01 AM | Report abuse

If anything, Taibbi greatly underestimates the layers of kickbacks and skim attached to these deals. This is where the real dirty deal-making has always been hidden, and since it's too difficult for anyone to figure out what's going on, government officials have always been happy to take payoffs and contributions to look the other way.

Not to mention that when a municipal bond dealer runs for public office, it's just another way of announcing "Open for business."

Posted by: uberblonde1 | April 7, 2010 11:32 AM | Report abuse

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