Bloomberg: Governments Still Gambling on Derivatives

Check out this Bloomberg story on a Pennsylvania county getting into derivatives to help balance its budget.

The interest-rate swaps, which involve $42 million of fixed-rate debt, guarantees Dauphin County $816,000 the first year and then wagers taxpayers’ money that short-term interest rates beginning in September 2009 won’t exceed 7 percent. Those rates are 2.2 percent now.

“It’s a way for us to raise revenue for the county,” said Chad Saylor, chief of staff to the county commission. “The only source of revenue we have, much like the school districts here, is the property tax.”

The commission’s decision shows the appeal of derivatives, even as states, cities and counties reel from misplaced bets on them. It also illustrates the lure of easy money at a time when municipal finances are deteriorating and the market for interest-rate swaps is under a federal criminal investigation into whether Wall Street banks conspired to overcharge local governments on the contracts.

That’s telling it like it is. So is this:

“We’ve got to get municipalities out of managing their interest-rate risk based on their view of the world,” said Robert Brooks, the Wallace D. Malone Jr. endowed chair of financial management at the University of Alabama, Tuscaloosa. “If they can’t explain clearly to their constituencies what they’re doing, perhaps the transaction fails the explainability test and shouldn’t be done.”

In Alabama’s Jefferson County, home of Birmingham, rising interest costs on more than $3 billion in adjustable-rate sewer bonds combined with wrong-way bets on swaps is threatening to produce the biggest municipal bankruptcy since Orange County’s default in 1994. Governor Bob Riley is negotiating with JPMorgan Chase & Co. and the county’s bond insurers to restructure the debt and swaps.

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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.