Case Study: Libor Crime Kills Pennsylvanians
July 14, 2012 • 10:04AM

In 2009, local press exposes alerted Pennsylvania Auditor General Jack Wagner to examine the use of interest-rate swaps by Pennsylvania's Bethlehem School District. He found that the district had entered into 13 swaps between 2003 and 2009, related to $272.9 million in debt. Only two of those swaps had terminated — and as is typical, the school district had had to pay off JPMorganChase to the extent of $12.3 million to escape from one; the other had apparently been retired.

Wagner found that those two swaps alone had cost the District $10-15 million above normal financing charges; he said he could not make a final evaluation of the others because they were still running — and still sucking money from Bethlehem's schools!

Criminal practices of all sorts abounded on the side of the Wall Street banks which tricked the Bethlehem board into sinking itself into these swaps. JPMorgan refused to disclose to the district the amount of the "spread fees" (like "points" in a mortgage) it was tacking onto at least two of the deals up front. Further, "fees that were characterized as being paid by the investor banks were ultimately charged to the District. The intermediaries involved in the deals had aparent conflicts of interest as a result of representing the interests of counterparties [banks] as well as the District.

"At least two of the transactions were structured to provide the District with substantial up-front cash payments at the inception of the agreement as an additional inducement, totaling $5.8 million, while failing to disclose to the District that the investment bank was making a huge and immediate profit on the deal that was far in excess of the cash paid to the District."

But further, Wagner found that of the 500 school districts in Pennsylvania, 107 of them had entered into interest-rate swaps between 2003 and 2009, as had another 86 local government units in Pennsylvania. Altogether they had contracted 626 swaps, relating to $14.9 billion in debt during that period.

See Case Study in Use of Swaps by Local Government Units in PA (Nov. 2009)

The Pennsylvania Budget and Policy Center issued a January 2012 report entitled, "Too Big to Trust?—Banks, Schools, and the Ongoing Problem of Interest Rate Swaps." It reported that Philadelphia and its school district, which Wagner had said had $1 billion in swap contracts already in testimony in 2010, had already lost $331 million in net interest payments and cancellation fees relating to swaps negotiated with bailed-out institutions such as Wells Fargo, Morgan Stanley, Goldman Sachs and others, and stood to lose another $240 million in net interest rates alone.

See Too Big to Trust? Banks, Schools and the Ongoing Problem of Interest Rate Swaps.

This was the context in which Reading, Pennsylvania, was forced to pay a $21 million swap "termination fee" to JPMorganChase and fell into state receivership. Harrisburg, the state capital, was placed into receivership in 2011 after an incinerator project spiralled out of control into $300 million of unpayable debt, with the help of multiple interest-rate swaps.