Wall Street Confidence trick: interest rate swaps are bankrupting local governments

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http://www.nationofchange.org/wall-street-confidence-trick-interest-rate-swaps-are-bankrupting-local-governments-1332571419

The “toxic culture of greed” on Wall Street was highlighted again last week, when Greg Smith went public with his resignation from Goldman Sachs in a scathing oped published in the New York Times. In other recent eyebrow-raisers, LIBOR rates—the benchmark interest rates involved in interest rate swaps—were shown to be manipulated by the banks that would have to pay up; and the objectivity of the ISDA (International Swaps and Derivatives Association) was called into question, when a 50% haircut for creditors was not declared a “default” requiring counterparties to pay on credit default swaps on Greek sovereign debt.

Interest rate swaps are less often in the news than credit default swaps, but they are far more important in terms of revenue, composing fully 82% of the derivatives trade. In February, JP Morgan Chase revealed that it had cleared $1.4 billion in revenue on trading interest rate swaps in 2011, making them one of the bank’s biggest sources of profit. According to the Bank for International Settlements:

nterest rate swaps are the largest component of the global OTC derivative market. The notional amount outstanding as of June 2009 in OTC interest rate swaps was $342 trillion, up from $310 trillion in Dec 2007. The gross market value was $13.9 trillion in June 2009, up from $6.2 trillion in Dec 2007.

For more than a decade, banks and insurance companies convinced local governments, hospitals, universities and other non-profits that interest rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools. The swaps were entered into to insure against a rise in interest rates; but instead, interest rates fell to historically low levels. This was not a flood, earthquake, or other insurable risk due to environmental unknowns or “acts of God.” It was a deliberate, manipulated move by the Fed, acting to save the banks from their own folly in precipitating the credit crisis of 2008. The banks got in trouble, and the Federal Reserve and federal government rushed in to bail them out, rewarding them for their misdeeds at the expense of the taxpayers.