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Working In These Times

Monday, Mar 8, 2010, 7:18 am

L.A. Sparks Revolt Against Banks and Wall Street Shakedowns, Abuses

BY Art Levine

What do the titans of Wall Street do for an encore after they created the country's worst recession since the 1930s and then conned the U.S. taxpayers out of $14 trillion in loans and guarantees?

On top of all that, big banks and Wall Street firms still hold billions in so-called toxic assets that are now backed by the U.S. government, even as they foreclose on millions of home loans, lobby hard against any financial reforms and refuse to lend to small and mid-size businesses. In fact, bank lending dropped by the biggest amount since 1942, according to a new FDIC report.

What else can they do to destroy the economy and help keep joblessness at near-record levels while raking in billions in bonuses?

How about shaking down cities with costly, toxic "swap deals" supposedly designed to hedge risk for revenue-starved municipalities—and then force them each to pay tens of millions in excess interest payments after the economy tanked. Then the banks further squeeze them to slash services and lay off thousands of cops and other front-line workers.

As one SEIU officials told In These Times, "It's like the International Monetary Fund going after third-world countries." On Friday, the Los Angeles City Council took a stance against such banking practices in a resolution backed by SEIU and other labor groups, and led by city councilman Richard Alercon, who proposed the "Responsible Banking Initiative."

As SEIU declared after the unanimous vote:

With Los Angeles facing a nearly $500 million budget gap next year and proposing to slash services at parks, libraries and public safety, the Los Angeles City Council unanimously passed historic legislation today to put an end to the banking practices that created the city's budget crisis. The move will save the city $19 million immediately.

The legislation passed today sets new community standards for banks the city does business with and ends swap deals. These new standards will ensure taxpayer money is only invested in banks actively working to help families keep their homes, expand lending to small businesses to create jobs, end toxic swap deals that put public services at stake and relieve the city's enormous budget gap. Los Angeles joins the state of Pennsylvania in targeting swap deals that are costing taxpayers billions of dollars in excessive fees and interest nationwide.

"Today Los Angeles sent a clear message to Wall Street--if you continue to ravage our city, you will not get a dime of taxpayer money," said SEIU Secretary-Treasurer Anna Burger. "It's time for Wall Street banks to stop focusing on their profits and start doing their part to help our cities and families recover.

The convoluted interest swap deals that have lured cities into paying exorbitant interest rates combine the worst elements of subprime mortgages and so-called "credit default swaps" and other reckless investment bets into one toxic mess spelling fiscal disaster for American cities. Already, cities have paid over $30 billion in excess interest and extortionist termination fees while having to drastically cut services and payrolls. Unless they can extricate themselves from this still-legal scam, they'll have practically no chance to revive their economies and lower unemployment, unions and city officials say.

"The banks crashed the economy, taxpayers saved them with drastic steps [of the bailouts], and now local governments are locked into high interest rates and banks are taking advantage of them," says SEIU researcher Bahar Tolu in Los Angeles. "We're saying they need to get out of these deals."

As local SEIU leaders pointed out in a letter in February to bank executives, "The cause of the public budget crisis in Los Angeles as well as cities across this country is not hard to understand. The banks crashed the economy which created massive shortfalls in essential property tax and income revenue for critical public services. The City of Los Angeles is facing a $200 million budget hole in current fiscal year and a deficit of $400 million next year."

But there may be another reason that the interest rates muncipalities are paying are so devastantingly high—alleged rate-rigging by the banks. According to one SEIU backgrounder:

Finally, there is also mounting evidence that it is no accident that these deals have gone so badly, so quickly for state and local governments. Ongoing investigations by the U.S. Department of Justice and the California, Florida, and Connecticut attorneys general implicate nearly every major bank in a nationwide conspiracy to rig bids and drive up the fixed rates state and local governments pay on their derivative contracts.

If the allegations are proven true, the banks’ illegal practices have directly contributed the outsized costs and risks now faced by state and local governments.

Essentially, before the economy crashed, cities issued bonds to lenders to pay for major projects, as in a wastewater plant in L.A., but to avoid paying back even higher interest rates over the long run, they hedged their bets by accepting deals for a fixed rate of about 3 percent from banks, as in L.A., or between 4 to 6 percent elsewhere -- all based on the assumption that interest rates would remain in the three to six percent range. Nobody predicted that they would in fact plunge to near-zero following an economic collapse, but cities still have to pay the pre-recession rate to banks. Moreover, all this cheap money given to banks by the Fed as part of the various bailouts allows the banks to make money on the spread between dirt-cheap rates they pay the Fed, and the exorbitant rates they can now now charge municipalities.

As Mike Elk of Campaign for America's Future points out about the municipal deals:

Big Banks have created an exotic financial instrument that is the equivalent of a payday loan for cash-strapped state and local governments, innocently labeled an "interest rate swap."

In the United States, states and local governments cannot run deficits. This year states face a $357 billion budget shortfall and local governments are facing an additional $82 billion budget shortfall. States have begun cutting basic services like snow removal, reduced garbage pickup, and in Colorado Springs they went to the pawn shop – selling police helicopters on the Internet.

In a desperate effort to meet budget needs, states and local governments over the last decade have gone to the big banks to ask for exotic instruments known as interest rate swaps. These desperate state and local governments were taken advantage of in the same way that Greece was by Goldman Sachs. Likewise, these swaps are threatening the economic health of local cities and states.

These interest rate swaps have cost American taxpayers $28 billion alone in fees and excessive interest. The money which could have been used for badly needed basic services instead goes to help the big banks develop more sophisticated practices to steal money off of regular Americans. Big banks led by Goldman Sachs used deceptive marketing to get states and local governments to buy these swaps.

Indeed, the swaps are just part of a pattern of shady investment deals that investment firms peddled to revenue-starved cities before the crash, and have now worsened since tax and real estate revenues have plunged.

Business Week recently reported on the scope of the municipal squeeze in an article headlined, "Wall Street Plays Hardball." The sub-head was even more ominous, "Taxpayers are taking another hit as strapped local governments fork over billions in fees on investments gone bad."

Among the disturbing news for localities as Congress dithers on aiding state and local governments in crisis:

Now Detroit must use the revenues from its three casinos—MGM Grand Detroit (MGM), Greektown Casino, and MotorCity Casino—to cover a $4.2 million monthly payment to the banks before a single cent can go to schools, transportation, and other critical services. "The economic crisis has forced us to move quickly and redefine what services a city can and should provide," says Bing. "While we face a tough road ahead, I believe we're on the right path." UBS declined to comment.

Detroit isn't suffering alone. Across the nation, local governments and related public entities, already reeling from the recession, face another fiscal crisis: billions of dollars in fees owed to UBS, Goldman Sachs (GS), and other financial giants on investment deals gone wrong...

The seeds of this looming disaster were sown during the credit boom, when Wall Street targeted cities big and small with risky financial products that promised to save them money or boost returns...

A start at getting out of this financial mess began with the L.A. council's action on Friday, also an opening shot at forcing reforms in banking practices -- or the city, and other municipalities and states, around the country, could start to move their funds to more potentially responsive community banks. A key element of the legislation is essentially a social responsibility audit of the banks to determine how well they are meeting community needs.

As SEIU declared:

The legislation sets key benchmarks forcing banks to:

* Save the city $19 million each year by renegotiating or canceling toxic interest rate swap deals to protect services from being cut. Los Angeles would be the largest city to act against these deals that have already cost American taxpayers billion in fees and excessive interest;

* Stop home foreclosures and meet a minimum number of permanent mortgage modifications; and

* Restore small business lending to jumpstart job creation.

Art Levine, a contributing editor of The Washington Monthly, has written for Mother Jones, The American Prospect, The New Republic, The Atlantic, Slate.com, Salon.com and numerous other publications.

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