At Bloomberg, columnist Joe Mysak has written a quite enlightening article detailing how Pennsylvania municipalities and school districts got themselves into big financial trouble getting played for suckers by bankers selling "synthetic fixed-interest rate" swaps.
It's a complex subject that Mysak explains well, and if you're interested in unraveling the mysteries of interest rate swaps, I'd recommend that you read his full column, instead of my attempting to summarize it into unintelligibility. But the basic gist is simple: The municipalities and school districts were trying to be too clever by half, hoping to save money through financial sleights of hand that ended up costing them far more than if they just issued traditional fixed-rate bonds.
Mysak's column is based on a 78-page report by Pennsylvania's Auditor General, Jack Wagner.
The Pennsylvania Auditor General, Jack Wagner, is no fan of swaps. His report concluded that they are "highly risky and impenetrably complex transactions that, quite simply, amount to gambling with public money." He asked the state to forbid their use, recommended municipalities avoid them "from this day forward," and advised those who did use them to terminate the things immediately.
Just so nobody would misunderstand, Wagner asked the General Assembly to prohibit the state’s municipalities from using swaps "or any of the specific devices and techniques encompassed therein currently in existence or yet to be invented in connection with the issuance of public debt."
Yet to be invented! Take that, financial innovation!
Best line from Mysak, in reference to the fact that the municipalities were ill prepared to deal with the consequences of their financial bets gone wrong:
As the Pennsylvania auditor general pointed out, municipalities rarely budget for financial-instrument catastrophe.
But who does?
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