Oakland has taken the lead in what we hope will become a national movement to level the playing field between bailed out banks and struggling cities.
Oakland Action: On July 3, 2012, the Oakland City Council unanimously passed my motion to instruct the Oakland City Administrator to terminate a toxic financial derivative called an “interest rate swap” between Oakland and Goldman Sachs within 60 days and without termination fees or penalties. If Goldman Sachs refuses, then Oakland will stop doing business with Goldman Sachs for future transactions.
The San Francisco Chronicle published an Opinion Editorial that I wrote on July 17th describing Oakland’s action.
High Stakes: This is the first time any city or other public agency has taken this kind of action and the stakes are very high. When the Oakland Coalition to Stop Goldman Sachs asked me to introduce this legislation, I was delighted to do it. One of the reasons I’m running for City Attorney is to be able to implement exactly this type of action. Without it, Oakland will be paying $4 million a year up to a total of $15.57 million to Goldman Sachs with no corresponding benefit. These funds could be used for additional police, city services, or after school programs.
Multiply that by the thousands of cities and other public agencies involved in this type of transaction and it’s enough money to make it worthwhile for us all to learn how an interest rate swap works.
Interest Rate Swaps: Here’s how. Government agencies fund major projects by issuing bonds with either fixed or variable interest rates. Variable interest rate bonds (like a variable interest rate home mortgage) have lower interest rates initially, but they carry the risk of much higher rates later on. Banks invented the interest rate swap to limit the risk of soaring interest rates. Government agencies pay a fixed rate to the banks and the banks pay the variable rate back to the agencies. When the variable rate is above the fixed rate, then the agency benefits. When the fixed rate is higher, then the bank benefits.
That would all be fine, except that, as part of the banking industry bailout, the federal government has aggressively driven interest rates down to near zero, and they are expected to stay near zero. To make matters worse, a dozen banks are under investigation for artificially lowering the LIBOR rate that determines the variable interest rate on many of these deals, including Oakland’s. This means that Goldman Sachs is making little or no payment back to Oakland and Oakland has to pay Goldman Sachs 5.6775% a year on over $100 million in bonds through to 2021.
Huge Market: According to Dollars and Sense, U.S. banks have an outstanding $202 trillion in interest rate derivative contracts and five banks dominate this market: JPMorgan Chase, Citibank, Bank of America, Goldman Sachs, and HSBC. “Together they control $150 trillion of the $154 trillion of interest rate swaps sold by U.S. banks. A large chunk of this business is made up of ‘over the counter’ swap contracts with local governments.”
Justice for Cities: The banks sold these interest rate swaps to cities as a way to save money in the market conditions that had prevailed for decades. That all changed with the recent recession. The Troubled Asset Relief Program (TARP) and other federal actions pumped hundreds of billions of dollars into the banks to, among other things, help them off load troubled assets.
In addition, the federal government slashed interest rates to help bail out the banks, so that banks would make lower cost loans. However, instead of passing these savings on, Goldman Sachs and the other banks are profiting from continuing to charge artificially high interest payments on these interest rates swaps. The result is that billions of dollars are being illegitimately taken from cash starved cities to inflate bank profits and bankers’ bonuses.
The federal bailout should have incorporated mechanisms to make sure the banks passed on the assistance they received. Instead, the banks got bailed out, but the cities were left holding the bag. It is past time to correct this injustice. Main Street deserves the same kind of assistance that the Wall Street received. It’s time for cities to take their own action to make sure they get what they deserve.
Oakland has taken a first step. We hope this will become a national movement.