Around the country, cash-strapped cities are facing a harsh reality: They lack the money to pay their employees, keep their schools open, and maintain public services for their citizens. Making matters worse for dozens of metropolitan hubs are obscure, toxic deals with the world's biggest banks called "interest rate swaps," a peculiar kind of financial contract that provided city governments with easy cash before the crisis but has now turned sour and cost taxpayers more than $1.25 billion a year, according to a new report (PDF) from labor union Service Employees International Union. Cities like Detroit, Chicago, and Denver will in 2010 pay big banks—Citigroup, Goldman Sachs, and JPMorgan Chase, among them—tens of millions of dollars in swaps payments, SEIU found; meanwhile, those same cities have previously cut tens and even hundreds of millions of dollars from their budgets to stay afloat. "These deals amount to the biggest taxpayer bailout of Wall Street you've never heard of," says SEIU Secretary-Treasurer Anna Burger.
What's an interest rate swap, you ask? Well, they're contracts that allow, say, Baltimore to enter into a deal with Bank of America to pay for public infrastructure projects. In that deal, Baltimore and BofA will "swap" interest rates with each other: the city will pay the bank a fixed rate—3 to 5 percent, say—to borrow money, and the bank will in return pay the city cash based on a floating, variable interest rate. (This is determined by some underlying source, like the LIBOR rate for short-term lending.) The point of a swap deal is that, when the economy was booming, cities could borrow from banks on the cheap, because their fixed payment rate was on par with or better than the bank's floating rate. But after the economy tanked, and the LIBOR rate dropped with it, banks emerged as the winners: Their variable payment rates to cities are now basement-low because overall interest rates are low. Cities, however, are still stuck with those higher fixed rates. Essentially they're getting fleeced.
And banks want to keep it that way. To do so, they've imposed steep termination fees to get out of an interest rate swap. To wit: Detroit, which has annual swaps payments of $103 million and faces a crippling budget shortfall, would have to pay $303 million to exit its swap deals. The same applies to most swaps deals throughout the country, which means most cities are saddled with onerous payments with no reprieve until the contract ends some years down the road. (That said, there have been a few instances where cities and banks renegotiated; Los Angeles' City Council voted earlier this month to terminate their swaps deals altogether, a decision that's catching on throughout the country.)
Of course, a swaps deal is a contract. Cities willingly entered into these deals with the likes of Goldman and JPMorgan. There's no doubt they're getting screwed now, paying banks way more than they're getting in return, but they agreed to the swaps back when everyone was binging on credit and living beyond their means. However, their citizens are the same people who bailed out the world's biggest banks, so perhaps everyone would be better off agreeing to kill the swaps deals and go their separate ways.
In a brisk, no-frills 20-minute session, Sen. Chris Dodd's version of a sprawling financial reform bill was passed by the Senate banking committee—13 Democrats to 10 Republicans—and moves on to what will surely be a legislative war on the Senate floor. Today's mark-up session by the banking committee was meant to be a debate among committee members over nearly 400 amendments to Dodd's original bill (PDF), released last week. But lawmakers instead approved a manager's amendment to the bill, which makes a number of technical and rhetorical tweaks to Dodd's bill, then voted on the bill entirely, knowing that a Democratic majority would pass it and set up the real debate in the Senate.
There was an anticlimactic feeling surrounding the event, and a few senators, including several Republicans, didn't even show up to the mark-up and voted by proxy. Sen. Bob Corker (R-Tenn.), a top GOP negotiator on the Dodd bill before talks broke down, had hinted earlier today that a low-key vote would happen, and predicted that the Senate would take up the bill after Easter. "It's probably true that we have a better opportunity with a different cast of characters, the full Senate, to do something that is sound policy-wise," Corker told CNBC today.
The quick vote today is undoubtedly an indication that senators handling financial reform didn't want a health care-like battle in committee. For months, health care talks were bogged down in the Senate finance committee, between Sen. Max Baucus (D-Mont.) and Chuck Grassley (R-Iowa), but by skipping over contentious amendments today, Dodd and his colleagues bypassed a several weeks' worth of infighting. The mark-up today marked a shift in GOP tactics more than anything. At several points in the meeting, Dodd, the banking committee's chair, asked GOP counterparts whether they wanted to make any statements or comment on the bill, but those in attendance all declined but for brief remarks by Shelby, the ranking member. Bypassing the committee negotiations was clearly a decision made by Senate Republicans to fight it out on the Senate floor, where the Dems enjoy a slim majority but Republicans have gained momentum. The Senate floor is also a more visible, high profile venue—center court, if you will—to lay out their hundreds of amendments.
Those amendments range from watering down an independent consumer agency to declawing a council of regulators that would guard against systemic, AIG-like risk. So while today's brief affair might've brought the negotiations to prime time sooner, all those amendments will still see the light of day in a few weeks. The battle over Wall Street is still coming.
Sen. Bob Corker (R-Tenn.), a top GOPer in the Senate's financial reform talks, told CNBC today that the committee charged with drafting a comprehensive Wall Street overhaul could ditch the negotiations and amendments process and vote on the bill as early as today. Nearly 400 amendments to the Dodd bill had been offered by Democrats and Republicans on the Senate banking committee over the weekend, but those all appear to be forgotten now. The move to vote now in committee, where there's a partisan split on the financial bill drafted by committee chair Sen. Chris Dodd (D-Conn.), sets the stage for a negotiations to take place in the full Senate, which won't take up financial reform until next month. "You'll have Easter recess, and that's when, I guess, over the course of the next several weeks when the real negotiations will be taking place," Corker said. "It's probably true that we have a better opportunity with a different cast of characters, the full Senate, to do something that is sound policy-wise."
The move to bypass committee-level negotiations and go straight into the full Senate, provided the bill gets out of the banking committee, will open financial reform up to a divided Senate already bogged down with its legislative agenda. Many of the amendments offered within the banking committee over the weekend—by turns to weaken and strengthen a new consumer protection bureau, kill a council that would tackle too-big-to-fail issues, and bulk up shareholder input on executive compensation—will likely emerge in the full Senate's debate, where Democrats will try to beef up Dodd's bill, introduced last week, and GOPers will fight an independent consumer agency and other expansions of government authority in the bill. At least one senator on the banking committee held out hope the bill could garner bipartisan support. "There is no choice other than a bipartisan compromise solution," Sen. Evan Bayh (D-Ind.) told CNBC.
When Sen. Chris Dodd (D-Conn.) unveiled his financial reform bill last Monday, among the numerous reforms included—an independent Consumer Financial Protection Bureau, greater say on executive compensation, a risk council created to prevent too-big-to-fail situations—was a version of what's called the "Volcker Rule." Named for the former Federal Reserve chairman Paul Volcker, the rule in Dodd's bill would ban insured banks from engaging in risky proprietary trading (i.e., trading for their own gain, as opposed to trading for their customers—a practice rife with conflicts of interest) and sponsoring casino-like entities like hedge funds and private equity funds. But there was a rub: Instead of mandating the "Volcker Rule," Dodd's bill requires a six-month study by the newly created financial risk council, after which the council will recommend whether or not to implement it. That study, as some observers see it, would more likely kneecap or kill the Volcker Rule than anything else.
A look at the nearly 400 amendments offered by senators on the banking committee, which begins marking up the bill this evening, shows the Death-By-Study strategy could become a tool to blunt financial reform. Sen. Richard Shelby (R-Ala.), the top GOPer on the banking committee, is the king of the study so far, judging by nine study-related amendments he's offered. Among others, he's requested studies to replace: the SEC's rulemaking power on arbitration, mandatory pre-dispute arbitration, and the Volcker Rule. Sen. Kay Bailey Hutchison (R-Tex.), in addition to requesting an exemption for banks with $150 million or less in assets from the Sarbanes-Oxley Act, which tightened accounting and disclosure standards for public companies, wants a study to see whether banks with $700 million or less shouldn't be exempted, too. An amendment offered by Sen. Bob Corker (R-Tenn.) would move an existing bankruptcy study in the bill from the tough, independent Government Accountability Office to the financial risk council, which is headed by top financial regulators.
That's not to say all proposed studies are intended to blunt the bill. One of Dodd's amendments would require the GAO to study the "Repo 105" accounting gimmick, a trick used by Lehman Brothers to cook its books and make it look healthier than it really was. Another study, by Corker, would require the GAO to study the government's role in propping up the troubled housing twins, Fannie Mae and Freddie Mac, a backstopping effort costing the government $125 billion.
But on the whole, as the banking committee begins tweaking and changing Dodd's financial reform bill (which we'll be covering here), keep an eye on any suggestions to replace mandatory rules or authority with "studies." Those studies could be just another way for the bill's opponents to punch holes in what's currently a relatively tough piece of legislation. And if they succeed, the bill could emerge from committee looking more like a piece of Swiss cheese than a Wall Street overhaul.
Bloomberg News reports today that, according to the bond market, you're safer investing in Warren Buffett than in what used to be the safest of all bets—the US government. The yield on bonds offered by Buffett's storied Berkshire Hathaway last month had a yield that was 3.5 basis points, or 0.035 percent, lower than the US government's Treasury bonds—essentially American debt. Joining Buffett in the safer-than-US-debt category as well were bonds for household names like Proctor and Gamble, Johnson and Johnson, and Lowe's, the home improvement store. "It's a slap upside the head of the government," one financial officer told Bloomberg.
So what's it mean? For one, that the US is selling massive amounts of Treasury bonds—$2.59 trillion since the start of 2009—to borrow money to finance its projects like the stimulus package, bailout, wars in Iraq and Afghanistan, and Obama's other projects. So much money, in fact, that the US will pay 7 percent of revenues to service its debt this year, according to Moody's rating service. According to the Congressional Budget Office, the federal budget proposed by Obama will create record deficits of more than $1 trillion this year and next, and the total deficit between 2011 and 2020 would reach $9.8 trillion, or 5.2 percent of GDP. The US' looming debt crisis is getting so bad and threatening to swallow so much money that Moody's said earlier this month that the US was "substantially" closer to losing its AAA debt rating, the gold standard of bond rating.
From a strictly financial standpoint, the Buffett-Obama comparison highlights just how grim the US' fiscal situation is. It's one thing to borrow deeply to try to create jobs, backstop an ailing housing market, and restart the American economy. But on the morning after the passage of a historic health care bill, the Bloomberg story nonetheless offers a rude awakening as to how deep in debt this country really is.