Alabama, Hawaii, Pennsylvania
by BOB WILLIAMS | May 18, 2010
In addition to general fiscal irresponsibility, legislators are consistently enacting budgets that lead expenditures to exceed revenues. The management of debt itself is causing big problems for public finance in America. The financial health of states and municipalities is strained as debt piles up, and is further undermined by what they are doing with that debt.
A way that many local governments try to alleviate debt is through credit swaps. Credit swaps allow issuers and conduit borrowers to swap variable demand obligations (VRDO) so they may pay a fixed interest but receive a variable rate in return.
According to a statement by SEC Chair Mark Schapiro on May 7th:
-Last year nearly $4 trillion of municipal bonds were traded.
-Investors hold approximately $2.8 trillion of municipal debt.
-More than a quarter of the municipal bond offerings today are unregistered corporate bonds that finance private activities and yet they still bear a tax-exempt interest rate.
-Issuers of 70% or more of variable rate demand obligations (VRDO) entered into swaps in order to pay a fixed interest rate and receive a variable rate, in the belief that they were guaranteeing their cost of financing. The drop in the short term interest rates, led to a decline in the market value of the swaps, while the cost of canceling them rose. To refinance VRDOs, issuers and conduit borrowers who had entered into the swaps to hedge their risk found that the swaps had
magnified, rather than decreased their costs.
Pennsylvania Auditor General, Jack Wagner is concerned enough about the problem to ask for increased
oversight over interest-rate swaps. Wagner wants the Pennsylvania Department of Community and Economic Development to require all local governments, municipal authorities, and agencies of state government to file their swap agreement upon execution and to update the status and financial results of those swaps every three months.
Meanwhile, Hawaii has seen its credit swaps lose at least $250 million and Jefferson County, Alabama defaulted on $3.8 billion of sewer bonds. Including Jefferson County there were 136 defaults on municipal
securities in 2008 amounting to $7.5 billion.