Those of you who enjoy a good interest rate swap debacle (Traders, Guns and Money-style) are in for a treat.
And Goldman Sachs conspiracy theorists especially.
From Bloomberg:
Oct. 23 (Bloomberg) — New Jersey taxpayers are sending almost $1 million a month to a partnership run by Goldman Sachs Group Inc. for protection against rising interest costs on bonds that the state redeemed more than a year ago.
The most-densely populated U.S. state is making the payments under an agreement made during the administration of former Governor James E. McGreevey in 2003, when New Jersey’s Transportation Trust Fund Authority sold $345 million in auction-rate bonds whose yields fluctuated with short-term interest costs. The agency finances road and rail projects.
“This vividly shows the risk of entering into interest- rate swap agreements,” said Christopher Taylor, former executive director of the Municipal Securities Rulemaking Board in Alexandria, Virginia. “The world’s got to see what stupidity even the sophisticated investors like the transportation fund can get into.”
While New Jersey replaced the debt with fixed-rate securities in 2008 after the $330 billion auction-rate bond market froze, the swap, in which two parties typically exchange fixed payments for ones based on floating interest rates, isn’t scheduled to expire until 2019.
The state paid $940,000 under the agreement last month and a total of $11.4 million since the auction-rate bonds were redeemed. The expenditures come as the fund reaches its borrowing limit and Governor Jon Corzine, Goldman’s former chairman who was a U.S. senator when the contract was signed, seeks $400 million in budget reductions as tax receipts fall.
Of course, this is just the latest incidence of an institution or municipality losing millions on interest rate swaps arranged by major investment banks, with a blow-up in Harvard and Jefferson County, Alabama.
What’s likely to get Goldman conspirators going here though, in light of Corzine’s employment history, is the question as to why this particular interest rate swap has not been cancelled. Just to play devil’s advocate — we’d note that on top of the inevitable exit costs, there may also be a timing issue. Harvard for instance, paid $500m to various banks to extricate itself from its own interest rate swap, at what was perhaps the worst possible time.
Here, in any case, is New Jersey’s explanation:
New Jersey couldn’t reach acceptable terms when it tried to issue variable-rate bonds last year to replace the failed auction-rate securities hedged by the Goldman swap, the Office of Public Finance said in a three-page response to questions about the transaction. It is unfair to judge the ultimate performance of the 16-year agreement until it concludes in 2019, the agency said in the statement.
Nevertheless, in the meantime:
New Jersey saved $9.9 million from 2003 to 2008 by issuing the auction-rate bonds instead of fixed-cost debt, the Office of Public Finance said in a report last year.
The trust fund paid $4.5 million in penalty interest payments when the auction-rate market collapsed and some borrowers’ costs soared. After it failed to put together a sale of a different type of variable-rate bonds, New Jersey then reissued 11-year notes yielding 4.18 percent in August 2008, according to the Office of Public Finance.
Refinancing the bonds cost $2.1 million, reducing the authority’s savings on the transaction to $3.3 million, state records show.
Since then, the fund has paid almost four times that amount on a contract that hedges nothing.
Related links:
Harvard’s big swap unwind – Sober Look
Harvard’s bet on interest rate rise cost $500m to exit – Bloomberg
Who were the winners on interest rate swaps? – Seeking Alpha