DMI Blog

Harry Moroz

The Other Financial Crisis

The worsening budget situation of state, city, and other local governments has obscured a related, but much less straightforward, danger: complex financial transactions brokered for states and municipalities by Wall Street firms eager to make big money at public expense. The New York Times looked into the impact on state governments last week and The Economist discussed a case from Italy last month in an article entitled “Cities in the casino.”

Matt Taibbi, who has made himself the intrepid if grandiloquent chronicler of Big Finance’s exploitation of ordinary Americans, explains these transactions in this month’s Rolling Stone. He describes a complicated financial mechanism – a synthetic rate swap – used by Jefferson County, Alabama to finance a new sewer system. Through deception and good old-fashioned bribes JP Morgan Chase bilked the county out of millions of dollars in fees and left it at the brink of bankruptcy. Taibbi writes:

A mob of corrupt local officials and morally absent financiers got together to build a giant device that converted human shit into billions of dollars of profit for Wall Street…

…The destruction of Jefferson County reveals the basic battle plan of these modern barbarians, the way that banks like JP Morgan and Goldman Sachs have systematically set out to pillage towns and cities from Pittsburgh to Athens. These guys aren’t number-crunching whizzes making smart investments; what they do is find suckers in some municipal-finance department, corner them in complex lose-lose deals and flay them alive. In a complete subversion of free-market principles, they take no risk, score deals based on political influence rather than competition, keep consumers in the dark – and walk away with big money.

Similarly, eyebrows were raised when the big banks managing the Build America Bonds program for states and cities, which subsidizes interest payments on bonds for infrastructure projects, extracted larger fees than normal for underwriting the bonds, though the Treasury Department says these fees have decreased over time. (Some are now looking to the municipal markets for the “next financial crisis”: Rick Bookstaber, formerly of the SEC, describes why and Paul Kedrosky concurs.)

These stories of municipal misfortune at the hands of big Wall Street banks demonstrate how interconnected the public and private sectors have become in recent years (or, put less charitably, how dependent the private sector has become on public funds in both good times and bad). They also demonstrate why a national infrastructure bank capitalized with federal funds is so important for the construction of big projects of national importance: it offers the potential for an institutionalized, and carefully overseen, process for financing big projects, hopefully eliminating the danger of local officials being duped by clever financiers and removing the opportunity for them to exploit their own political connections.

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Posted at 6:00 PM, Apr 05, 2010 in Cities
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