Wall Street Swaps Haunting Cities: How Many Transit Agencies Hold Them?

The vast majority of Americans could not recognize the term "credit-default swaps" until 2008, when the obscure type of Wall Street deal was pinpointed as a leading cause of the U.S. financial meltdown. Now another type of swap, centered on interest rates, is making headlines as a growing number of urban governments start to regret their bets on borrowing costs.

nyc_subway_mta_walder_transit.jpgA rail car from the New York City MTA. (Photo: TreeHugger)

Pennsylvania’s auditor general has pressed the Delaware River Port Authority — which operates a commuter rail line and four bridges — to ban interest-rate swaps, calling them "nothing more than a form of gambling with public funds." The Wall Street Journal reported last week that "hundreds of municipalities" owe money to banks on the swaps, which were signed in a bid to lower borrowing costs by shielding cities from a future rise in interest rates.

The New York Times picked up the thread yesterday in a front-page story on the growing risk surrounding the swaps, neatly summing up localities’ current predicament:

The swaps
would indeed have saved money had interest rates gone up. But to get
this protection, the states had to agree to pay extra if interest rates
went down. And in the years since these swaps came into vogue, interest
rates have mostly fallen.

Several of the nation’s largest transit authorities have interest-rate swaps sitting on their books, according to their financial disclosures.

New York City’s Metropolitan Transportation Authority (MTA) reported outstanding swaps worth $3.9 billion in its most recent financial statement [PDF], released late last year. The counterparties, or trading partners, to MTA swaps include several recipients of government bailout money, including Citigroup, AIG, Morgan Stanley, J.P. Morgan, and UBS, which received indirect aid through the AIG rescue.

Los Angeles’ local transit authority, known as Metro, reported five outstanding interest rate swaps valued at $808,000 in its most recent financial statement. The largest of the swaps was with Goldman Sachs.

New Jersey Transit, which is planning to hike fares 25 percent to close its budget gaps, did not identify the counterparties to its interest-rate swaps in its annual financial statement. But Bloomberg reported in December that the state’s transportation trust fund, a key source of transit funding, was paying $1 million per month to Goldman Sachs as a result of a previous interest-rate swap deal.

The Southeastern Pennsylvania Transportation Authority, which runs transit networks in the Philadelphia metro area, reported interest-rate swaps with Citibank and Merrill Lynch in the amount of $340 million on its 2008 financial statement, the most recent available.

One transit system that does not appear to have used swaps to lower its interest rates, based on its financial statements, is San Francisco’s Bay Area Rapid Transit (BART).

  • Larry Littlefield

    “The swaps would indeed have saved money had interest rates gone up…New York City’s Metropolitan Transportation Authority (MTA) reported outstanding swaps worth $3.9 billion in its most recent financial statement, released late last year.”

    The financial geniuses at the MTA also put the agency in variable rate debt, meaning that if (actually when) interest rates go up the MTA will be clobbered. The campaign contributors of Wall Street made out on both ends of the transactions, compared with just issuing fixed rate bonds. Or better yet, paying for ongoing normal replacement with current revenues, and not issuing 30 year bonds.

  • J:Lai

    This is just fear-mongering — swapping floating into fixed rate liabilities is a common practice as it allows for transforming unknown exposure to market moves in interest rates into known liabilities with fixed interest payments for the life of the bond. Public agencies should not be in the business of taking naked market risk, so entering into these swaps is the right thing to do.

    The fact that they would have benefited from falling rates had they not entered into the swap contract is something that can be known only in hindsight. It’s like being mad you didn’t play lotto because you would have picked the winning number. Rates are all but sure to rise in the future, and when they do it will be a good thing that these public borrowers have got these swap contracts.

    As to the question of whether they should borrow money at all – I think it is foolish to say that they shouldn’t. You can’t get big projects financed without revenue bonds. The problem occurs when sources of funding for normal maintenance of existing plant, and even for operation, start to disappear. Then the agency ends up borrowing just to stay in place.

    Debt financing should be used for project which will increase the size, efficiency, and capacity of the system. It should not be used just to keep the current system running.

  • Robert

    Another aspect of these credit default swap deals is the large fees that the people who arrange them get. This should be investigated as well.

  • Zach

    +1 to J:Lai. People like to pretend anything with “swap” in the name is a sin now, but if you learn a little about finance, it’s very obvious. A very similar case is that of airlines that buy commodity swaps for fuel — regardless of the bumps that fuel prices take, the bank absorbs the losses (or profits), allowing the airline to be on-budget every-time by cutting their margins.

  • JK

    On top of the usual reasons for bonding, the MTA has an incentive to bond every possible revenue stream to put that money outside of the legislature’s control. If the MTA had piles of operating cash around, it would either be stolen or lost in imposed labor contracts. It’s hard to see how pay as you go capital spending (PAYGO) can work with Albany the way it is. The MTA has no legal “lock-box” to keep its money safe other than bond contracts and MOUs with the feds. Albany can start stealing more and more from “dedicated” taxes.


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