On Jefferson County
My new article, “Looting Main Street,” is out on newsstands in Rolling Stone. It’s about Jefferson County, Alabama, and how a group of Wall Street banks (in particular JP Morgan Chase) ran the Birmingham area into the ground with predatory interest rate swap deals.
If you’ve heard of the financial scandal in Greece, JeffCo is sort of an earlier version of that, though slightly different. As Christopher “Kit” Taylor, the former chairman of the Municipal Securities Rulemaking Board, put it to me: “[The banks] basically took what they were doing in places like Jefferson County and exported it overseas.”
The broad story with municipal debt is that the incentives got out of whack for the banks, just like they had in the mortgage market, where commissions for doing safe, 30-year fixed loans fell to the point where they weren’t much of a moneymaker for brokers. And just as brokers reacted to the problem of low commissions by urging home-buyers into pricier variable-rate mortgages that inevitably had to be refinanced a few years down the line — bringing more fees to lenders, in a process called “churning’ — banks reacted to the low profit margins for normal, safe, long-term fixed municipal bonds by urging counties into riskier deals. They sold counties like Jefferson County on variable-rate and auction-rate bonds, and when the issuers’ debt service got too high, the banks pushed them into interest rate swaps to lower their variable-rate payments. This was just another form of “churning,” only on a much bigger scale: you hooked towns and cities and counties and school systems on risky bond issues, then got them to come back down the road and enter into interest rate swaps to refinance their ballooning debt structure.
The really sordid part of the Jefferson County story is how the banks funneled millions of dollars to buddies of the County Commissioner, who in turn bribed the local pols to sign off on the crappy swap deals. In the case of former Commissioner Larry Langford, a local greaseball named Bill Blount who had been paid millions in “consulting” fees by the banks was literally following Langford around with a charge card, picking up the tab for things like watches and Zegna suits. We get a rare look into this process in JeffCo, where the SEC published transcripts of taped conversations involving JP Morgan bankers talking about how much money it would take to grease guys like Blount. “Just tell us how much,” we hear former JP Morgan executive Charles LeCroy saying.
The financial transactions in Jefferson County are a little complicated, but once you fight through that you can see that this is basically an old-school organized crime story, with contractors buying off politicians to stick taxpayers with inflated bills for public “services.” The only difference is the scale of the ripoff and the complexity of the thing contracted for. Although there have been over 20 indictments in Jefferson County, the criminal prosecutions haven’t reached up to the banks yet, and part of that is because it’s so difficult to explain the crime to juries. The federal prosecutor who put Langford away for 15 years, George Martin, explained to me that even during that trial, he had to shy away from the details of the swap agreements in order to keep juries focused on the bribery. “I had to try to keep it simple as much as possible,” he said.
I got into this a little more on Don Imus’s show yesterday (I always feel bad delving into this highly unfunny stuff on his show). Of all the financial shenanigans I’ve had to write about in the last few years, this is the one that I wished was talked about more in public, because I think if more people knew what happened in places like Birmingham (and there are problems with swap agreements all over the country, from Pennsylvania to Detroit to Los Angeles to Chicago to Oakland and beyond), they’d completely lose their illusions about what modern Wall Street is all about. Anyway, more on this later on –
P.S. A friend of mine reminded me of this — over the summer, the Atlantic’s Randian blowhard Megan McArdle wrong a long criticism of my Goldman, Sachs piece. In making her case, McArdle in one part was trying to argue that I was naively painting all derivatives with the same brush, her point being that CDOs and CDS are nothing like, say, rate swaps. Which of course they aren’t, but that’s not the point; the similarity is in the fact that they’re not regulated at all. In any case, she writes:
To give you a flavor of what I mean, Taibbi rants about how we knew derivatives were bad bad BAD! because they’d gone so badly wrong before… But it’s not clear how much derivatives regulation would have helped any of these three companies. Gibson was defrauded by its bankers. P&G wasn’t; they spent a great deal of money unwinding their positions when the Treasurer realized they had a lot of exposure on a bad bet on falling interest rates. Orange County, too, was making a massive, levered bet on a steep yield curve (roughly, a large difference between short and long term interest rates) that came undone when the yield curve flattened and interest rates rose. Moderately complex derivatives allowed its idiot financial manager to take somewhat larger bets, but you can take massive, money losing bets without them. At any rate, none of these derivatives have much to do with CDOs or CDSs; you might as well conflate stocks and bonds because they’re both “securities”. No one, as far as I know, is now proposing that we need to curtail the use of interest rate swaps.
McArdle wrote this after Jefferson County had blown up. This is just FYI. It’s on par with Charlie Gasparino calling the notion that Hank Paulson and Lloyd Blankfein were regularly on the phone with each other brokering the AIG deal “the mother of all conspiracy theories.” The story about Blankfein and Paulson’s regular phone contacts during the AIG deal broke in the New York Times just days after Gasparino’s post.