How the nation's biggest banks are ripping off American cities with the same predatory deals that brought down Greece
MATT TAIBBI
http://www.rollingstone.com/politics...n_street/print
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What happened here in Jefferson County would turn out to be the perfect metaphor for the peculiar alchemy of modern oligarchical capitalism: A mob of corrupt local officials and morally absent financiers got together to build a giant device that converted human #### into billions of dollars of profit for Wall Street and misery for people like Lisa Pack.
There was so much money to be made ... that banks like JP Morgan spent millions paying middlemen who bribed yes, that's right, bribed, criminally bribed the county commissioners and their buddies just to keep their business.
Birmingham became the poster child for a new kind of giant-scale financial fraud, one that would threaten the financial stability not only of cities and counties all across America, but even those of entire countries like Greece.
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Once you follow that trail and understand what took place in Jefferson County, there's really no room left for illusions. We live in a gangster state, and our days of laughing at other countries are over.
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The original cost estimates for the new [municipal] sewer system were as low as $250 million. But in a wondrous demonstration of the possibilities of small-town graft and contract-padding, the price tag quickly swelled to more than $3 billion. County commissioners were literally pocketing wads of cash from builders and engineers and other contractors eager to get in on the project, while the county was forced to borrow obscene sums to pay for the rapidly spiraling costs.
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Wall Street was happy to help. First, it employed the same trick it used to fuel the housing crisis: It switched the county from a fixed rate on the bonds it had issued to finance the sewer deal to an adjustable rate. The refinancing meant lower interest payments for a couple of years followed by the risk of even larger payments down the road. ...
...For an extra fee, the banks said, we'll allow you to keep paying a fixed rate on your debt to us. In return, we'll give you a variable amount each month that you can use to pay off all that variable-rate interest you owe to bondholders.
In financial terms, this is known as a synthetic rate swap the spidery creature you might have read about playing a role in bringing down places like Greece and Milan. On paper, it made sense: The county got the stability of a fixed rate, while paying Wall Street to assume the risk of the variable rates on its bonds. That's the synthetic part. The trouble lies in the rate swap. The deal only works if the two variable rates the one you get from the bank, and the one you owe to bondholders actually match.
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"It was right around the corner here, at the hotel," Martin says. "That's where they met that's where this all started."
They means Charles LeCroy and Bill Blount, the two principals in what would become the most important of all the corruption cases in Jefferson County. LeCroy was a banker for JP Morgan, serving as managing director of the bank's southeast regional office. Blount was an Alabama wheeler-dealer with close friends on the county commission. For years, when Wall Street banks wanted to do business with municipalities, whether for bond issues or rate swaps, it was standard practice to reach out to a local sleazeball like Blount and pay him a ####load of money to help seal the deal. "Banks would pay some local consultant, and the consultant would then funnel money to the politician making the decision," says Christopher Taylor, the former head of the board that regulates municipal borrowing.
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The scheme they operated went something like this: LeCroy paid Blount millions of dollars, and Blount turned around and used the money to buy lavish gifts for his close friend Larry Langford, the now-convicted Birmingham mayor who at the time had just been elected president of the county commission. ... Langford then signed off on one after another of the deadly swap deals being pushed by LeCroy. ... "The transactions were complex, but the scheme was simple," said Robert Khuzami, director of enforcement for the SEC. "Senior JP Morgan bankers made unlawful payments to win business and earn fees."
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Just tell us how much. That sums up the approach that JP Morgan took a few months later, when Langford announced that his good buddy Bill Blount would henceforth be involved with every financing transaction for Jefferson County. ... But the bank had one small problem: Goldman Sachs had already crawled up Blount's trouser leg, and the broker was advising Langford to pick them as Jefferson County's investment bank.
The solution they came up with was an extraordinary one: JP Morgan cut a separate deal with Goldman, paying the bank $3 million to back off, with Blount taking a $300,000 cut of the side deal. ...
That such a blatant violation of anti-trust laws took place and neither JP Morgan nor Goldman have been prosecuted for it is yet another mystery of the current financial crisis. "This is an open-and-shut case of anti-competitive behavior," says Taylor, the former regulator.
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All told, JP Morgan ended up paying Blount nearly $3 million for "performing no known services," in the words of the SEC. ...
The deals wound up being the largest swap agreements in JP Morgan's history. Making matters worse, the payoffs didn't even wind up costing the bank a dime. As the SEC explained in a statement on the scam, JP Morgan "passed on the cost of the unlawful payments by charging the county higher interest rates on the swap transactions." In other words, not only did the bank bribe local politicians to take the sucky deal, they got local taxpayers to pay for the bribes. ... According to an analysis of the swap deals commissioned by the county in 2007, taxpayers had been overcharged at least $93 million on the transactions.
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The crazy thing is that such arrangements where some local scoundrel gets a massive fee for doing nothing but greasing the wheels with elected officials have been taking place all over the country. In Illinois, during the Upper Volta-esque era of Rod Blagojevich, a Republican political consultant named Robert Kjellander got 10 percent of the entire fee Bear Stearns earned doing a bond sale for the state pension fund. At the start of Obama's term, Bill Richardson's Cabinet appointment was derailed for a similar scheme when he was governor of New Mexico. ...
... Imagine a mortgage that you have to keep on paying even after you sell your house. That's basically how a swap deal works. And Jefferson County had done 23 of them. At one point, they had more outstanding swaps than New York City.
Judgment Day was coming just like it was for the Delaware River Port Authority, the Pennsylvania school system, the cities of Detroit, Chicago, Oakland and Los Angeles, the states of Connecticut and Mississippi, the city of Milan and nearly 500 other municipalities in Italy, the country of Greece, and God knows who else. All of these places are now reeling under the weight of similarly elaborate and ill-advised swaps and if what happened in Jefferson County is any guide, hoo boy. Because when the #### hit the fan in Birmingham, it really hit the fan.
For Jefferson County, the deal blew up in early 2008, when a dizzying array of penalties and other fine-print poison worked into the swap contracts started to kick in. ...
It gets worse. Remember the swap deal that Jefferson County did with JP Morgan, how the variable rates it got from the bank were supposed to match those it owed its bondholders? Well, they didn't. Most of the payments the county was receiving from JP Morgan were based on one set of interest rates (the London Interbank Exchange Rate), while the payments it owed to its bondholders followed a different set of rates (a municipal-bond index). Jefferson County was suddenly getting far less from JP Morgan, and owing tons more to bondholders. ...
... Last year, when Jefferson County, staggered by the weight of its penalties, was unable to make its swap payments to JP Morgan, the bank canceled the deal. That triggered one-time "termination fees" of ... $647 million. That was money the county would owe no matter what happened with the rest of its debt, even if bondholders decided to forgive and forget every dime the county had borrowed. It was ... debt that does not go away, ever, for as long as you live. On a sewer project that was originally supposed to cost $250 million, the county now owed a total of $1.28 billion just in interest and fees on the debt. Imagine paying $250,000 a year on a car you purchased for $50,000, and that's roughly where Jefferson County stood at the end of last year.
... The destruction of Jefferson County reveals the basic battle plan of ... 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. "It's not high finance," says Taylor, the former bond regulator. "It's low finance." And even if the regulators manage to catch up with them billions of dollars later, the banks just pay a small fine and move on to the next scam. This isn't capitalism. It's nomadic thievery.
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