Local Governments Which Entered Into Interest Rate Swaps Got Scalped



But who are the biggest victims?





Ellen Brown adds:







Elk wrote:














Bond-Graham writes:


Bloomberg’s Darrell Preston writes:


















And Darwin BondGraham notes:

























Wagner concluded:





Category: Derivatives, Legal, Think Tank


10 Responses to “The Big Losers in the Libor Rate Manipulation”

  1. [...] The big losers from Libor [...]

  2. buyerbeware says:

    The real point of this article is not that all these counterparties have a good case for damages (so far as I can tell, very few do) but that the rush to try to get out of bad contracts will submerge banks’ compliance / legal departments for years, distract senior management and (for those cases with merit) damage the reputation of banks even further such that they not trusted even when they are trying and are able to help counterparties.

    Three points on all of these losses

    * misselling is misselling. But a straight interest rate swap is not a complicated product. Something along the lines of “your interest rate is fixed and will not reduce if prevailing market rates reduce. If you wish to break this arrangement early, for example as rates have fallen below your expectations, you may be liable to pay break-cost payments to [bank] which will be calculated according to prevailing rates at the time. You have the right to review and dispute our calculation of this break cost”

    * comments such as those in the Bloomberg article “The markets were pricing in serious falls in the prime interest rate. . . . So it would have been clear that this was not going to be a good deal over the life of the contracts.” – it is worrying this came from a professor of finance. An interest rate swap that prices in a falling or low future rates can still be a good deal – quite easy for this to have zero MTM on day 1. All new swaps are based on current market conditions. It is the unexpected falls in interest rates that are not priced in.

    * the supposition that banks were taking naked positions on rates falling and needed guillible borrowers to enter into swaps to make this work – this misunderstands how a bank should manage its risk. Think of it like a bookmakers: the bookie makes his money not by being right when you are wrong, but by managing and laying off his risk such that he makes money whatever the outcome. Similarly, any position a bank takes on interst rates will be limited by risk limits so typically a bank that enters into pay floating- receive fixed interest rate swap will also enter into an offsetting transaction on the other side.

    More generally, low rate environments are the most difficult for a bank to make money in as it squeezes net interest margin.

  3. cewing says:



    An interesting choice of words. From what I’ve seen the last decade the only people banks have been trying to “help” is themselves. Laying that aside, I’m not sure what your description of how banks SHOULD act is helpful here. What matters is how banks DID act, and it wasn’t in the theoretical, rational manner you describe. It would have been nice if they did do it that way, instead of gaming every part of the system to maximize profit.

  4. beezle says:

    I’m sorry but this is the reverse of what happened in the early 90s when municipals like Orange county not just ‘had a view’ on rates but actively speculated on the direction of rates and got buried when they went abrubtly higher.

    If a borrower can issue floating cheaper than fixed but wants the latter why is it a problem if they use a swap? Why should you or anyone else for that matter be moaning about the eventual direction of rates? The point of a swap is *not* to get lower rates in the future. It is to take advantage of a relative disparity between participants ability to lend fixed or floating.

    I really am sick of people wanting things both ways. We want protection if it goes up! We want to have protection if it goes down! We want to make money if it goes up! We want to make money if it goes down! Sorry that is not the way it works. If you want to trade your balance sheet to take advantage of moves in rates (lower in the case of borrowers) well then you take the full risk of it going against you. If you lock in fixed term money so you and your constituents can sleep at night don’t come crying if three years later you could have done the same at a lower rate. And lets not forget that there are things like swaptions, caps, collars, floors etc which can give the issuer some combination of all of it.. at a price which they probably weren’t willing to pay.

  5. [...] vicitims were in the LIBOR mess, just look at your local municipality. As Barry notes, a host of local governments got hosed on interest rate swap deals which were tied to LIBOR.  Gaming the LIBOR market is one of several [...]

  6. lifeafterdebt says:

    Really good piece which clarified a fair few points for me, especially just exactly how the banksters made obscene profits out of their own misdeeds. I wrote this in digust at more revelations of banking fraud in the UK.

  7. DeDude says:

    So in order to get rid of this despicable predatory behavior we need a simple rule.

    Any financial transaction signed by public entities must provide full and complete disclosure of all risks and benefits to all involved parties, explained in a language that ensures that it can be fully understood by an average high school graduate from the area.

    Who can be against the idea that a contract should be fully understood by the people signing it?

    End of getting away with playing the “muppets” to rob local taxpayers.

  8. buyerbeware says:

    @ cewing: I am a banker. I behave the way I described, as does everyone that I come across in my bank. I don’t sell products to people who don’t understand what they’re buying. I do sell derivatives that help people manage their risk across a range of asset classes. I try to make money for my shareholders by helping my clients. I like to be able sleep at night.

    And DeDude: I entirely agree with you. I would also note that vanilla interest rate swaps are as simple as I described. They are far far less complicated than your average house insurance policy (which is also a derivative). They are pretty similar in many respects to sports spread betting. Certainly any finance representative on a schools board should be able to understand exactly how they work, given how much capital they control on a day to day basis.

  9. citizen1 says:

    to Buyerbeware: Please explain how you can defend banks/financial corporations when they are working with a loaded deck:

    The way that I understand it is that in the rate swaps discussed the problem is that as interest rates decrease large penalties accrue should a local government decide to exit the swap and then enter into a lower fixed rate agreement. That new agreement would also require additional fees and expenses to be paid to banks/financial corporations and other financial advisors. The cost to exit the agreements are in many cases prohibitive. The article is making the point that when the rates were manipulated artificially it forced governments to exit agreements that resulted in penalty revenue to the banks because of the manipulation and/or if the governments do not exit then the banks stand to reap large gains (the banks win either way). This is inherently unfair since the manipulation caused by the banks themselves was the cause of the penalties (the fox guarding the hen house) .

    in this situation it is even worse since it is caused by the banks due the the underlying scam the banks perpetrated by selling securitized mortgage obligations after having fraudulently obtained positive investment ratings. The banks then hedged on the sale of those mortgage obligations because they had the knowledge that the underlying mortgages were junk although highly rated and therefore in many cases ensuring that the banks would gain. However because of the huge scale of the scam even with the deck stacked in their favor many banks lost. However the banks did not suffer the losses as they were bailed out by the USA. The article makes the point that while the banks were rescued from their errors state and local governments (ultimately the taxpayers) have not been.

    The unregulated nature of the derivatives market (the hedge market) is the next bubble to burst and is the next fraud that the financial marketers have perpetrated on the public. A hedge was historically intended to minimize losses however it is has been used through fraudulent means to ensure profits at all times except in disaster mode like in 2008. The crime is that no one has been put in prison for all of these frauds.