Bloomberg Covers Yet Another Swap Flop

A Bloomberg story this morning points (me, anyway,) to a simple conclusion: state and local governments need to stay away from Wall Street.

New Jersey is paying the Bank of Montreal $627,000 a month for interest-rate swaps to protect itself on bonds it never got around to issuing. Huh? That will total $23.5 million—enough, as Bloomberg is good to point out, to pay 113 teachers for three years.

Bloomberg could have better explained why and how the bank sold Jerz the swaps on bonds that didn’t yet exist. Why would you agree to pay somebody for something in the future you haven’t bought yet, without a backout condition? This is all we get:

The so-called forward-starting agreement was one of 15 such contracts the state set up to help finance construction.

The issue was deferred to 2009 because the school program wasn’t borrowing fast enough to use swaps coming due in 2007, according to treasury spokesman Tom Bell.

That should have been explored further.

But this is good:

The payments, which work out to $21,892 a day for three years, show how elected and appointed officials failed taxpayers by agreeing to financial strategies they didn’t fully understand. New Jersey spent $21.3 million in 2008 to exit three contracts signed when James Florio and James McGreevey were governors. The state’s transportation trust fund is giving almost $1 million a month to a Goldman Sachs Group Inc. partnership in an agreement linked to bonds that were redeemed.

As is this broader context:

New Jersey isn’t alone. Borrowers from Massachusetts to California are struggling with billions of dollars in swap penalties and losses at the same time that budget deficits expand to an estimated $350 billion in 2010 and 2011, according to the Washington, D.C.-based Center on Budget and Policy Priorities.

The derivatives, mostly interest-rate swaps used to exchange fixed payments for variable rates, have grown to as much as $300 billion annually, the Alexandria, Virginia-based Municipal Securities Rulemaking Board said in an April report, citing information from market participants.

Which leads to an obvious: Why get into such complicated transactions at all? You’re not as smart as Wall Street. You never will be (see BusinessWeek a couple of weeks ago) Maybe that’s why someone was able to sell you variable-interest rate risk on municipal bonds, for crying out loud.

Has America ever needed a media watchdog more than now? Help us by joining CJR today.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.