Wall Street bankers for decades sold municipalities like Indianapolis on debt instruments called swaps as a safe way to reduce borrowing costs and hedge against rising interest rates.In reality, the swap arrangements were complicated bets that relied on a few seemingly reasonable assumptions: Interest rates would either stagnate or rise, and financial partners on the deals would remain strong. Both proved wrong, and taxpayers paid a big price.
Municipal units of the city of Indianapolis in 2009 paid more than $93 million in penalties to unwind spoiled swap arrangements. And city agencies including the Indianapolis Local Public Improvement Bond Bank and the Indianapolis Airport Authority still are saddled with swaps that sport a negative value of more than $65 million, an IBJ review of dozens of bond records found.
Meantime, Los Angeles-based CDR Financial Products Inc.—the city’s adviser on most of the swap deals—is facing federal fraud and corruption charges stemming from its dealings with cities, school districts and not-for-profits coast to coast.
CDR, which earned at least $378,000 advising the Indianapolis Bond Bank on swap deals in 2005 and 2006, is accused of rigging bids on so-called guaranteed investment contracts, or GICs. Government agencies deposit proceeds from bond sales into the interest-earning vehicles until they need to spend the money. It’s not clear whether any of the allegations involve Indianapolis.
Although there is no evidence of "pay for play" there is a great deal of evidence that un-elected representatives were talked into deals they has limited understanding off:
The bank, created in 1985, issues and holds bonds to raise money for municipal agencies including CIB, the Marion County Health and Hospital Corp., Indianapolis Airport Authority and the Indianapolis-Marion County Public Library. The bank holds loans and cash valued at $4.5 billion.
Bond bank board members (all appointed by the mayor) who signed off on the instruments may have thought they were buying insurance to protect against rising rates, Skarbeck said, “but that turned out not to be the case as the swaps generated substantial losses when interest rates instead declined.”
“What strikes me is the complexity in these deals,” Skarbeck said. “I don’t understand them, I’m certain the bond bank people didn’t understand them, and the world now knows that the investment bankers who concocted and sold these things did not understand them.”
A key question is whether the investment banks and advisers selling municipalities on the swaps made the public officials aware of all the risks, said Craig T. Jones, a partner in the Atlanta-based law firm Page Perry LLC, which specializes in investment fraud cases against brokers and financial advisers.
I would suggest you read the whole article as it contains a detailed snapshot of how these deals work on local level. For now start with this simple yet effective chart:
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