One useful way to break down the research and investigative reporting about Wall Street's bilking of American cities is to establish a "before Bhatti/after Bhatti" marker. Prior to Saqib Bhatti's groundbreaking Dirty Deals report, many reporters and activists had been digging up and promulgating incidents of big banks and finance leading governments into risky projects, overcharging for financial services, or the plundering of pension funds. But Bhatti's report, produced by the Roosevelt Institute, was thoroughgoing, comprehensive, and focused and specific.
Bhatti's report came at the same time that the Chicago Tribune released a damning three-part report on Chicago Public Schools' disastrous bonds losses. In late 2014, a picture emerges of widespread predatory dealing on the part of big private finance, with cities and counties in the cross-hairs because, with a public mandate, municipalities are more vulnerable to promises of providential yield.
The best readings, the ones I've gathered from a variety of subtopics, explain the mechanics of financial fees, risky investments (eg interest rate swaps), and pension issues (the latter could be a separate article and probably should be). Many of these articles have specific "exigencies" -- a local crisis, or cluster of them -- that inspire their authors to tease out that specific subject matter from the larger mass of Wall Street shenanigans. Others, like the Bhatti report and David Sirota's fine work yield more systemic conclusions.
Saqib Bhatti, "Dirty Deals: How Wall Street’s Predatory Deals Hurt Taxpayers and What We Can Do About It," 2015, report and many other materials available at Refund Project.
According to the Executive Summary, banks have targeted state and local governments, intentionally lured them into deals that capitalize on borrowers' weaknesses and sap budgets where such cuts disproportionately hurt poor people of color (and in the larger scheme, poor people).
The financialization of the United States economy has distorted our social, economic, and political priorities. Cities and states across the country are forced to cut essential community services because they are trapped in predatory municipal finance deals that cost them millions of dollars every year. Wall Street and other big corporations engaged in a systematic effort to suppress taxes, making it difficult for cities and states to advance progressive revenue solutions to properly fund public services. Banks take advantage of this crisis that they helped create by targeting state and local governments with predatory municipal finance deals, just like they targeted cash-strapped homeowners with predatory mortgages during the housing boom. Predatory financing deals prey upon the weaknesses of borrowers, are characterized by high costs and high risks, are typically overly complex, and are often designed to fail.
Predatory municipal finance has a real human cost. Every dollar that cities and states send to Wall Street does not go towards essential community services.
Across the country, cuts to public services and other austerity measures have a disparate impact on the working class communities of color that were also targeted for predatory mortgages and payday loans, further exacerbating their suffering.The primary goal of government is to provide residents with the services they need, not to provide bankers with the profits they seek.
Bhatti is a proponent of public banking, seeing it one of many "common sense reforms."
We need to renegotiate our communities’ relationship with Wall Street. We can do this by implementing common sense reforms to safeguard our public dollars, make our public finance system more efficient, and ensure that our money is used to provide fully-funded services to our communities. Taxpayers do trillions of dollars of business with Wall Street every year. It is time we start making our money work for us.
Elsewhere, Bhatti writes:
We need to turn the municipal finance system into a well-regulated public utility, where banks provide financial services to cities and states as a public service rather than treating taxpayer dollars as a profit engine.
The initial groundbreaking investigation by Chicago Tribune is essential reading. The investigation found "that the Chicago Public Schools stands to pay tens of millions of dollars in extra interest payments after borrowing $1 billion through risky, complicated bond deals." A few months later, that's exactly what happened. Much recrimination, handwringing, and fingerpointing is going on, but only Amara Enyia and a few other Illinois activists are tying the conversation to public banks. Illinois even has active public banking legislation, but needs a larger, more vocal effort to get it passed. The Chicago Public Schools disaster remains an important--and still unfulfilled--point of conversation and consciousness-building on public banking and the democratization of finance.
This interview with Saqib Bhatti while the dust was still flying from the release of Dirty Deals contains some money quotes (sorry), particularly concerning the mindset of the public officials as they're entering into bad deals with the big banks.
One of the big problems is that often the banks really downplay the risks or misrepresent the likelihood of the risks occurring. Often, government officials are really not aware that the risks could actually materialize. One of the things that’s featured prominently in the report is interest rate swaps. With interest rate swaps, in particular, one of the big problems was that there’s all sorts of risks that were embedded in the deals, and in the paperwork there’s all these disclosures that say these risks exist, but when the banks actually pitched the deals the pitch said not to worry about those risks. Or they would make projections of all the money the city could save but those projections were all based on none of those risks materializing. Especially with products that are relatively new, that are not widely understood and where, frankly, in many cases they haven’t been around long enough to really understand what all the risks are, there is this huge problem that exists. The risks just are not disclosed on a level that they should be and in reality, that’s not just unethical, it’s also illegal and violates the Fair Dealing Standards of the Municipal Securities Ruling Board.
Sirota's work came a few months after Bhatti's report, but resulted from his specific investigations of particular cities. In summary: "Private equity firms are raking in cash from municipal governments, and SEC officials are finally taking notice." He gives the numbers: "California’s report said $440 million. New Jersey’s said $600 million. In Pennsylvania, the tally is $700 million." And:
Currently, about 9 percent — or $270 billion — of America’s $3 trillion public pension fund assets are invested in private equity firms. With the financial industry’s standard 2 percent management fee, that quarter-trillion dollars generates roughly $5.4 billion in annual management fees for the private equity industry — and that’s not including additional “performance” fees paid on investment returns. If CEM’s calculations are applied uniformly, it could mean taxpayers and retirees may actually be paying double — more than $10 billion a year.
Sirota is particularly concerned with undisclosed costs:
Less than one-half of the very substantial [private equity] costs incurred by U.S. pension funds are currently being disclosed,” says the report from CEM, whose website says the financial analysis firm “serve(s) over 350 blue-chip corporate and government clients worldwide.
And he also reports that some concerned treasurers haven't been afraid to name names:
In Rhode Island, the new state treasurer, Seth Magaziner, a Democrat, recently published a review of all the fees that state’s beleaguered pension fund has paid. The analysis revealed that the former financial firm of Democratic Gov. Gina Raimondo is charging the state’s pension fund the highest fee rate of any firm in its asset class.
The impact of bad Wall Street fees and deals on public education cannot be overstated. This 2015 AFT release calling for a day of action quotes teachers' union leaders in Detroit, Chicago, Los Angeles, and Philly. It also quotes the Roosevelt Institute.
These deals are robbing schools and kids of desperately needed resources at a time when budgets have been cut to the bone and our schools are already being asked to do more with less," says AFT President Randi Weingarten. "Parents, educators and communities deserve basic transparency and accountability—both from the banks that continue to peddle these toxic deals, and from those officials who locked communities into spiraling debt and fees. Putting this money back into the classroom could mean more teachers, nurses and social workers; restoring art and music; creating community schools; and wrapping services for kids and families around schools.
"Urban America Can’t Seem to Break Off Its Codependent Relationship With Wall Street, No Matter How Much It Hurts," reads the subtitle of Cagle's October 2014 piece, that also recounts a dramatic 2012 protest against Goldman Sachs at an Oakland City Council meeting--highlighting the way Oakland has consistently led the nation in protests over debt, Wall Street, and financial corruption of all kinds.
The meeting came after months of public discussion about how to exit a 1998 deal — a fixed-rate swap agreement tied to debt issued to finance pensions — that wasn’t working out the way the city had envisioned. The 5.6 percent fixed rate would be a good deal, the city figured, if interest rates rose to 8 or 9 percent in good fiscal times. But they didn’t. The market crashed. Interest rates hit the floor. The swap deal soured. Oakland was stuck paying $4 million in annual interest to Goldman Sachs. By that year, the swap had a negative market value of approximately $15.5 million, the city treasurer informed the council in the lead-up to the July hearing.
This article is rich in other ways too. It explains pension bonds--a complicated piece of the financial puzzle, and a large reason why school districts and municipalities are in trouble. "Pension obligation bonds have proven to be one of the more popular lines of city credit," Cagle writes. "The premise of these bonds is that cities are able to postpone contributing to pension funds by borrowing from banks at a lower rate of interest than those invested funds will earn over the long term. As of 2009, Oregon, Illinois and Connecticut each have taken on more than 10 percent of their annual revenue on pension bonds."
Many people don't remember that Stockton, California ran out of "money" long before Detroit, but for much the same reason: In Stockton's case, it was Lehman Brothers.
In 2006, a Lehman Brothers representative came to town with an enticing offer: Make up that pension shortfall with $152 million in fixed-rate bonds. City officials weren’t sure they quite understood how the whole arrangement would work but they were desperate to keep parks open, police cars running and garbage men working; Lehman was offering a solution, even if nothing could be “guaranteed.” The bet didn’t work and Stockton never made up that pension shortfall. In 2012, the city filed for bankruptcy. The judge in the case is still considering whether employee pensions can now be cut along with the city’s other debts, calling the situation “a festering sore.” Lehman Brothers, meanwhile, went bankrupt before Stockton.
All in all, an incredible piece of investigative journalism very early in the game.
Even earlier in the game--arguably before the game even started, is Ann Larson's prescient 2012 article, where she warns:
Municipalities across the country are grappling with declining local tax revenue and reduced federal funding in an era when growth and development are equated with prosperity. This toxic mix has produced a $3.7 trillion municipal debt market, a revenue juggernaut for Wall Street. Municipal bonds are issued by virtually every city, county, and development agency in the United States. The number of taxpayer-backed bonds in circulation is five times higher than only ten years ago. This means that the world’s largest financial firms now hold the purse strings for everything from essential services like sewage treatment plants to large-scale developments such as sports arenas. Municipal bonds are extremely profitable for investors because they are tax-exempt and, like mortgages, can be packaged into securities.
Larson also goes into some fascinating history about municipal debt. In 1975, she writes, New York City avoided bankruptcy by "issuing guaranteed bonds backed by public pension funds. As a result, the Emergency Financial Control Board, the municipal body that controlled the city’s bank accounts, was in the position of rewriting the social contract, exerting control over labor at every level."
In other words--and this comes to play later in Detroit in full force--keeping the city indebted to Wall Street, financed through debt, scares unions away from militant organizing, because private loans are more volatile than public debt. "[T]he fiscal crisis of 1975 inaugurated a new funding paradigm for distressed municipalities: taxpayer-backed debt is issued to service the debt already on the books."
Taibbi's groundbreaking expose and case study of, among other things, Rhode Island's ill-fated pensions experiment that started the rest of the country down the road to ruin, is definitely essential reading. Of special interest is Taibbi's citation of a key study by Dean Baker, of which Taibbi concludes:
The states that engage in this activity may also be committing securities fraud. Why? Because if a city or state hasn't been making its required contributions, and this hasn't been made plain to the ratings agencies, then that same city or state is actually concealing what in effect are massive secret loans and is actually far more broke than it is representing to investors when it goes out into the world and borrows money by issuing bonds.
Taibbi, who was a keynote speaker at the 2013 Public Banking Institute conference in San Rafael, California, is not in the habit of suggesting solutions. As I have written elsewhere, there's a certain hazard to this kind of "economic corruption porn" writing:
There’s a larger conceptual problem in withholding talk of solutions in favor of comprehensive skewering of the villains. The risk is that readers–and citizens–will convert their outrage to a general pessimism about the state of humanity. If every actor described is depraved, if there are no counterexamples of good people doing good things (and such examples are not in short supply), then we are left . . . distrusting all institutions and, by extension, all efforts at collective governance.
So I think we need to read Taibbi's work, but through the lens of our own movement, and the solutions we are exploring.
Janis interviews Bhatti and his research partner Sloan, and asks specific questions about the Baltimore water scenario. This is a terrifying, enraging example of how dirty Wall Street deals--interest rate swaps specifically--are contributing to the depletion, privatization, and enclosure of the commons: public resources like water. Sloan says:
Baltimore currently has 17 interest rate swaps on which they are paying the banks about $12 million a year on net interest costs. So that's money that the banks are basically collecting from Baltimore that could otherwise be spent on things like infrastructure. That's just the tip of the iceberg in terms of what these things have cost. So the cost so far on these swaps includes payments since 2005 totaling $152 million. They've also paid tens of millions of dollars to terminate some of the swaps, and we can get into why they did that. But they have spent over $40 million so far just to terminate swaps, to get out of these bad deals.
It turns out that some of Baltimore's Water Department bonds were "auction rate securities," which are "another example of a tricky, complicated deal that banks pitched to cities like Baltimore as a way to save money on borrowing costs." As it turns out, the banks did not disclose they were participating in the "auction rate bond market," and that lack of disclosure made the deals seem to the city to be more stable than they actually were.
The same phenomena was partially responsible for the ongoing Detroit water crisis, as Bhatti points out in the interview:
So in Detroit there were a number of interest rate swaps. The water--the Detroit water and sewer district a swap had entered into. And these things really went haywire. And in 2012, they actually had to terminate all of their swaps that the water system had, and they paid over half a billion dollars in termination penalties. $547 million dollars. Of course they didn't have that money at the time so they had to issue new bonds to be able to pay it back. And so now 40% of the water bill that the residents are paying is actually going directly to paying off the loans that they had to take out in order to pay off these termination penalties. And one of the things that really did become a financial burden on Detroiters was the fact the water bills rose precipitously after 2012. The undisclosed--or the part that's not as well known and not as well publicized is that a big part of the reason why water bills went up was because they had to pay these half a billion dollar in termination penalties on the swaps.
People are literally going without clean water because of dirty Wall Street deals that hold municipalities hostage.
Hutchinson recounts a "recent famous case involved a waste incinerator constructed by Harrisburg, Pennsylvania that suffered a two-fold cost overrun. It caused the city to default on $280-million worth of debt."
Ed Walker, "How Wall Street Used Swaps to Get Rich at the Expense of Cities," Naked Capitalism, March 25, 2015
This is a great, instructive walk-through of the risks and mechanics of these dirty deals. Walker points out several important facts that anyone having a discussion of this issue should commit to memory. First, the big financiers "downplayed" or in many cases did not mention risks at all. Second, pension obligation bonds were important "traps" in the deals: The municipalities would borrow money necessary to make up shortfalls in pension payments, "with the idea that the pension plan would invest the funds at a higher rate of return than the bond after expenses." It obviously didn't turn out that way. Third:
. . . was Auction Rate Securities. These are short-term securities that have to roll over every month or two. If an investor in ARS wants out, but the city can’t roll the ARS over, the city is stuck with huge interest rate bills. This happened to the Port Authority of New York and New Jersey, which saw interest rates jump from 4.3% to 20% in one week.The Capital Appreciation Bond works just like a negative amortization home loan. The city doesn’t pay interest or principal for a few years, then starts paying the debt off, with interest on interest. Chicago and the Chicago Public Schools have a bunch of these, with lifetime interest rates ranging from 141% to 459%.
Want a contemporary example of the way big private finance continues to behave even after being exposed? This is just a short release, which reads in its entirety:
The Securities and Exchange Commission charged 36 municipal underwriting firms, including units of Citigroup Inc. C, +0.45% and J.P. Morgan Chase & Co. JPM, +0.50% with making false statements or omissions in bond documents, the first penalties under the agency’s voluntary self-reporting program targeting inaccuracies in those documents. Between 2010 and 2014, the firms violated federal law by selling municipal bonds with offering documents that “contained materially false statements or omissions about the bond issuers’ compliance with continuing disclosure obligations,” the SEC said in a news release Thursday. The firms also failed to conduct due diligence to identify those inaccurate statements or omissions before selling the bonds, the agency said.
Another contemporary example: Edward Jones & Co. now has to pay $20 million to settle U.S. Securities and Exchange Commission claims that EJ and its former head of municipal underwriting overcharged customers in new bond sales:
In its first case against a muni-bond underwriter for pricing-related fraud in the primary market, the SEC accused Edward Jones and Stina R. Wishman of improperly offering securities to customers at higher prices after taking them into its own inventory. Investors paid at least $4.6 million more than they should have, the SEC said in a statement Thursday.
The integrity and efficiency of the municipal securities market is critical to state and local governments,” Andrew Ceresney, director of the SEC’s enforcement division, said Thursday in a conference call with reporters. “The actions filed today shine a light on areas of the market that have traditionally had little enforcement attention.”Ceresney declined to say whether the regulator was looking at similar practices among other underwriters.
This very recent editorial takes proponents of pension overhaul to task for missing the obvious pitfalls of private financing. Hiltzik cites a vital "rule of thumb" that everyone in the financial democracy movement should already know:
One reliable rule of thumb about municipal fiscal crises is that wherever you find a large retirement liability, you can be sure that the rot originates much deeper. In Stockton, it encompassed ill-advised investments in downtown amenities, as well as a costly pension debt refinancing into which the city was snookered by the ill-starred investment firm Lehman Bros. Similarly, the 2012 bankruptcy of the city of San Bernardino reflected the housing bubble and crash, along with fiscal mismanagement that included years of allegedly faked books. The statewide pension shortfall likewise flowed from the top down. When state pension funds fattened up on rich stock market returns in the 1990s, lawmakers bestowed retroactive pension increases on state workers, while CalPERS and the other major public pension funds gifted government employers with contribution "holidays." CalPERS told the Legislature that these arrangements would be almost cost-free, thanks to "the booming stock market." But when the markets crashed, the pension funds landed deeper in the hole than anyone had anticipated.
On August 31, In These Times will release an online version of Saquib Bhatti, "How Cities Can Beat Wall Street--And Why they Must." This should make for interesting reading in light of Bhatti's and others efforts to garner state-specific information from places such as Wisconsin (a state with a remarkably high rate of wasteful financial despotism).