I think the Times does a pretty good job explaining how the arcane financial product works for readers without making them want to run away—no easy feat. That said, I don’t understand this part:
But as the nationwide credit market collapsed, most of the bond insurers’ credit ratings were downgraded, including the Ambac Financial Group, the primary insurer of Tennessee bonds. That allowed the investors to accelerate the retirement of the debt, usually from 20 years to 7, leading to a steep increase in the interest rate.
Did the change in the time needed to pay back the debt result in higher interest rates? Seems like that would send the principal payments soaring, but interest rate increases would be triggered by something else.
The Times also is good showing how Morgan Keenan played down the risks of its scheme—if it acknowledged them at all (with bonus Greenspan tweak):
In a 177-page book used in 2003 and reviewed by several bond experts for The Times, there was far more about rewards than risks. On a page titled “Interest Rate Swap Risks” for example, there is no mention of the consequences of a downgrade in the bond insurer’s rating. Ms. Evans said the daylong seminars, held in Memphis, Nashville and Knoxville, amounted to “nothing more than an infomercial.”
The first page of a manual used at a 2007 seminar quotes the former Fed chairman Alan Greenspan extolling the virtues of derivatives in 1999.
Need more convincing?
Peter Shapiro, the managing director of Swap Financial Group of South Orange, N.J., said the material “certainly doesn’t have what we would consider the requisite amount of detail going through the risks, how they materialize and how you might attempt to mitigate them.”
Sounds like these folks have themselves a lawsuit.
The piece has more on information asymmetry:
Sheila Luckett, the city recorder in Mount Juliet, attended the swap school twice. “It was way over my head,” she said. “I’m not a bonds person. People with Morgan Keegan told me, ‘Don’t worry if you don’t understand it.’ ”
And more nails for the coffin:
In many corners of Tennessee, the first anyone heard of interest-rate swaps was from C. L. Overman, a vice president of Morgan Keegan who assured officials that the deals carried little risk, city and county officials said.
“He told us it would be a good thing and there wasn’t much downside,” said Mayor Duncan of Claiborne County. He then laughed, adding, “When everything went belly up, of course, they told us it wasn’t their fault.”
The paper makes clear that regulators are to blame, as well, largely because they just didn’t regulate.
Good job by the Times.