July 17, 2012 |
Wall Street banks have hollowed out our communities with fraudulently
sold mortgages and illegal foreclosures and settled the crimes for
pennies on the dollar. They’ve set back property records to the early
1900s, skipping the recording of deeds in county registry offices and
using their own front called MERS. They lobbied to kill fixed pension
plans and then shaved a decade of growth off our 401(K)s with exorbitant
fees, rigged research and trading for the house.
When much of Wall Street collapsed in 2008 as a direct result of their
corrupt business model, their pals in Washington used the public purse
to resuscitate the same corrupt financial model – allowing even greater
depositor concentration at JPMorgan and Bank of America through
acquisitions of crippled firms.
And now, Wall Street may get away with the biggest heist of the public
purse in the history of the world. You know it’s an unprecedented crime
when the conservative Economist magazine sums up the situation with a one word headline: “Banksters.”
It has been widely reported that Libor, the interest rate benchmark
that was rigged by a banking cartel, impacted $10 trillion in consumer
loans. Libor stands for London Interbank Offered Rate and is supposed
to be a reliable reflection of the rate at which banks are lending to
each other. Based on the average of that rate, after highs and lows are
discarded, the Libor index is used as a key index for setting loan
rates around the world, including adjustable rate mortgages, credit card
payments and student loans here in the U.S.
But what’s missing from the debate are the most diabolical parts of the
scam: how a rigged Libor rate was used to defraud municipalities across
America, inflate bank stock prices, and potentially rig futures markets
around the world. All while the top U.S. bank regulator dealt with the
problem by fiddling with a memo to the Bank of England.
Libor is also one of the leading interest rate benchmarks used to
create payment terms on interest rate swaps. Wall Street has convinced
Congress that it needs those derivatives to hedge its balance sheet. But
look at these statistics. According to the Office of the Comptroller of
the Currency, as of March 31, 2012,
U.S. banks held $183.7 trillion in interest rate contracts but just four firms represent 93% of total derivative holdings: JPMorgan Chase, Citibank, Bank of America and Goldman Sachs.
As of March 31, 2012, there were 7,307 FDIC insured banks in the U.S.
according to the FDIC. All of those banks, including the four above,
have a total of $13.4 trillion in assets. Why would four banks need to
hedge to the tune of 13 times all assets held in all 7,307 banks in the
U.S.?
The answer is that most swaps are not being used as a hedge. They are being used as a money-making racket for Wall Street.
The Libor rate was used to manipulate, not just tens of trillions of consumer loans, buthundreds of
trillions in interest rate contracts (swaps) with municipalities across
America and around the globe. (Milan prosecutors have charged
JPMorgan, Deutsche Bank, UBS and Depfa Bank with derivatives fraud and
earning $128 million in hidden fees.)
Rigging Libor also inflated the value of the trash that Wall Street was
parking in 2008 and 2009 at the Federal Reserve Bank of New York to
extract trillions in cash at near zero interest-rate loans from the
public purse. When rates rise, bond prices decline. When rates decline,
bond prices rise. The Federal Reserve made loans to Wall Street based
on a percentage of the face value of their bonds and mortgage backed
securities that they presented for collateral. By pushing down interest
rates, the banks were getting a lift out of their collateral, allowing
them to borrow more.
The banks that cheated on Libor were also perpetrating a public fraud
in terms of how the market perceived their risk. The Libor rate they
each reported every morning to compile the index was based on the rate
they would pay to borrow from other banks, thus the name London
Interbank Offered Rate or Libor. So, for example, even though
Citibank’s credit default swap prices were rising dramatically during
the 2008 crisis, suggesting it was in trouble, it was reporting low
borrowing costs to the Libor index.
Because interest rates impact the price movement of stocks, the rigged
lowering of the Libor rate put a false prop under the stock market as
well as inflated individual bank stocks. There is also a very strong
suggestion that there was insider trading on futures or swaps markets
based on the spread between the one month and three month Libor
rates. One trader’s email to the Libor submitter reads: “We need a 4.17
fix in 1m (low fix) We need a 4.41 fix in 3m (high fix).”
In simple terms, Wall Street and its colleagues in the global banking
cartel have left us clueless as a nation about the validity of our
markets, how much hidden debt liability our local and state governments
really have, and where the stock market would actually be if interest
rates had not been rigged.
Let’s explore the almost incomprehensible rip off of our now struggling
communities. Here’s how the swap deals typically worked, although there
were Byzantine variations called constant maturity swaps (CMS),
swaptions, and snowballs. These complex machinations pitted the brains
of county treasurers or school boards against the deceptive wizards of
Wall Street.
Municipalities typically entered into an interest rate swap because
Wall Street’s fast talking salesmen showed up with incomprehensible
power point slides wearing $3,000 suits and assured municipal officials
it would lower their overall borrowing costs on their municipal bond
issues. A typical deal involved the municipality issuing variable rate
municipal bonds and simultaneously signing a contract (interest rate
swap) with a Wall Street bank that locked it into paying the bank a
fixed rate while it received from the bank a floating interest rate tied
to one of two indices. One index, Libor, was operated by an
international bankers’ trade group, the British Bankers
Association. The other index, SIFMA, was operated by a Wall Street
trade association. Neither was an independent monitor for the public
interest.
When the two sets of cash flows are calculated, the side that generates
the larger payments receives the difference between the sums. In many
cases, continuing to this day, the municipality ended up receiving a
fraction of one percent, while contractually bound to pay Wall Street
firms as much as 3 to 6 percent in a fixed rate for twenty years or
longer. If the local or state governments or school boards wanted out
of the deal, a multi-million dollar penalty fee could be charged based
on the rate structure and notional (face amount) of the swap.
We learned late last month that the Libor rate the municipalities were
receiving was manipulated downward from at least 2007 to 2010 by a
global banking cartel. The U.S. dollar Libor panel included U.S. banks
JPMorgan Chase, Citibank (whose parent is the former ward of the
taxpayer, Citigroup), and Bank of America. Canadian prosecutors have
implicated JPMorgan and Citibank in a criminal probe, as well as other
banks. A whistleblower has provided the names of traders that are
alleged to have taken part in the scheme and turned over emails,
according to affidavits filed with the Ontario Superior Court.
At least 12 global banks are being investigated by U.S., British and
European authorities. Barclays admitted in June that its employees
rigged Libor rates. It paid $453 million in fines to U.S. and British
authorities and turned over emails showing its traders and those at
other, as yet unnamed, banks gave instructions on how the rates were to
be rigged on specific dates.
No one has accused SIFMA, the other interest rate benchmark used to set
variable rates of interest on municipal bonds, of overseeing a rigged
index but it is certainly not a comfort to understand just what SIFMA
is. On its web site, SIFMA defines itself as follows: “The Securities
Industry and Financial Markets Association (SIFMA) represents the
industry which powers the global economy. Born of the merger between
the Securities Industry Association and the Bond Market Association,
SIFMA is the single powerful voice for strengthening markets and
supporting investors -- the world over.”
Notice that the words “Wall Street” do not appear in this description
and yet, that is precisely what SIFMA is: a Wall Street trade
association that viciously lobbies for Wall Street. (As for “supporting
investors,” it should be sued for false advertising.) In February of
this year, it even
sued the top regulator of derivatives,
the Commodity Futures Trading Commission in Federal Court to stop it
from setting limits on the maximum size of derivative bets that can be
taken in the market.
From 2000 through 2011, SIFMA spent $96.4 million lobbying Congress on
behalf of Wall Street. In the 2008 election cycle, according to the
Center for Responsive Politics, SIFMA spent $865,000 in political
donations, giving to both Republicans and Democrats.
In March 2010, the Service Employees International Union (SEIU) issued a
report indicating that from 2006 through early 2008 banks are estimated
to have collected as much as $28 billion in termination fees from state
and local governments who were desperate to exit the abusive interest
rate swaps. That amount does not include the ongoing outsized interest
payments that were and are being paid. Experts believe that billions of
abusive swaps may be as yet unacknowledged by embarrassed
municipalities.
In 2009, the Auditor General of Pennsylvania, Jack Wagner, found that
626 swaps were done in Pennsylvania between October 2003 and June 2009,
covering $14.9 billion in municipal bonds. That encompassed 107 of
Pennsylvania’s 500 school districts and 86 other local governments. The
swaps were sold to the municipalities by Citibank, Goldman Sachs,
JPMorgan and Morgan Stanley.
In one case cited by Wagner, the Bethlehem Area School entered into 13
different swaps, covering $272.9 million in debt for school construction
projects. Two swaps which had concluded at the time of Wagner’s
investigation cost taxpayers $10.2 million more than if the district had
issued a standard fixed-rate bond or note and $15.5 million more than
if the district had simply paid the interest on the variable-rate note
without any swaps at all.
And therein lies the rub. Municipalities never needed these nonsensical
weapons of mass deception. Muni bond issuers could have simply done
what muni investors have done for a century – laddered their bonds. To
hedge risk, an issuer simply has bonds maturing along a short,
intermediate and long-term yield curve. If rates rise, they are hedged
with the intermediate and long term bonds. If rates fall, the short
munis will mature and can be rolled over into the lower interest rate
environment. Municipal issuers are further protected by being able to
establish call dates of typically 5 years, 7 years, or 10 years when
they issue long terms bonds. They pay moms and pops and seniors across
America, who buy these muni bonds, a small premium of usually $10 to
$20 per thousand face amount and call in the bonds if the interest rate
environment becomes more attractive for issuance of new bonds.
According to the June 30, 2011 auditor’s report for the City of
Oakland, California, the city entered into a swap with Goldman Sachs
Mitsui Marine Derivatives Products in connection with $187.5 million of
muni bonds for Oakland Joint Powers Financing Authority. Under the swap
terms, the city would pay Goldman a fixed rate of 5.6775 percent
through 2021 and receive a variable rate based on the Bond Market
Association index (that was the predecessor name to the SIFMA index). In
2003, the variable rate was changed from being indexed to the Bond
Market Association index to being indexed at 65 percent of the one-month
Libor rate.
The city is still paying the high fixed rate but it’s receiving a
miniscule rate of less than one percent. According to local officials,
the city has paid Goldman roughly $32 million more than it has received
and could be out another $20 million if it has to hold the swap until
2021. A group called the
Oakland Coalition to Stop Goldman Sachs succeeded
in getting the City Council to vote on July 3 of this year to stop
doing business with Goldman Sachs if it doesn’t allow Oakland to
terminate the swap without penalty. It called the vote “a huge victory
for both the city of Oakland and for the people throughout the world
living under the boot of interest rate swaps.”
The Mayor of Baltimore, the Baltimore City Council, the City of New
Britain Firefighters’ and Police Benefit Fund of Connecticut have filed a
class action lawsuit in Federal Court in New York over the rigging of
Libor. The plaintiffs state that the City of Baltimore purchased
hundreds of millions of dollars of derivatives tied to Libor while the
New Britain Firefighters and Police Benefit Fund purchased tens of
millions. They are suing the banks involved in submitting the Libor
rates.
Wall Street’s boot on interest rate swaps dates back at least 17
years. In February 1995, Smith Barney (now co-owned by Citigroup and
Morgan Stanley) fired Michael Lissack as a managing director in the
firm's public finance department after he publicly accused the firm of
cheating Dade County, Florida out of millions on an interest rate
swap. Lissack went on to become the scourge of Wall Street by expertly
detailing how counties and states were being ripped off by Wall
Street. He even set up this
amusing web site to do battle with
the firm. The case became known as the “yield burning case,” an
esoteric term that the public could hardly fathom, much like the Libor
scandal today.
In 2000, the Securities and Exchange Commission settled the yield
burning matter with 21 firms and imposed fines of $172 million, a minor
slap on the wrist given the profits of the firms. Arthur Levitt was
Chairman of the SEC at the time and came from the ranks of Wall Street.
Which brings us full circle. If you’ve ever wondered where all of
those revolving doors between Wall Street and Washington would
eventually lead us, we’ve just found out. It leads to the regulators
becoming just as jaded and compromised as Wall Street. While Wall
Street banks and their global counterparts were grabbing the loot, their
regulator was watching carefully behind the wheel of the getaway car
for at least four years.
This past Friday, the Federal Reserve Bank of New York turned over
emails and documents showing that Timothy Geithner, the sitting U.S.
Treasury Secretary of the United States, knew at least as early as 2008
that Libor was being rigged. At the time, Geithner was the President
and CEO of the Federal Reserve Bank of New York – the top regulator of
Wall Street’s largest banks. As far as we know currently, Geithner did
nothing more to stop the practice than send an email with
recommendations to Mervyn King, Governor of the Bank of England. Libor
rigging continued through at least 2010.
As the U.S. grapples with intractable wealth disparity and the related
ills of unemployment and recession, we need to understand that this was
not merely a few rascals rigging some esoteric index in London. This
was an institutionalized wealth transfer system on an almost
unimaginable scale.
Pam Martens worked on Wall Street for 21 years. She is the editor of
Wall Street On Parade.
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