Banks Dumping Debt on Taxpayers

The worlds largest banks are feeding on the worlds public sector more than ever. Bloomberg is reporting that Citigroup and UBS are exiting the auction rate securities market.

Taxpayers from Massachusetts to California are paying Wall Street banks to end derivative contracts gone bad as they exit the collapsing auction-rate bond market, with penalties in some cases topping $10 million and compounding the pain of rising borrowing costs.

Confused? Typically municipalities issue auction-rate bonds (securities) using banks to underwrite the offering.

Auction-rate securities (ARS) are long-term variable-rate instruments with their interest rates reset at periodic and frequent auctions. The underwriters in this case pay that variable-auction rate to the city in return for the fixed rate.

Things usually go something like this-

Suppose the city sells a bond for a a fixed 3% rate. At the auction the following month the city may receive a 4% payment from the bank. Fine for the city. But suppose during the following month the creditworthiness of insurer becomes damaged (usually the underwriting bank). Then the city may get only a 1% payment from the bank at the next auction, remember their rate is fixed. Now where do you think the 2% difference is going to be made up. Well Joe's six pack just got more expensive and were not talking about the one on his stomach.

For example

Sacramento County did a swap with Morgan Stanley in conjunction with a sale of $79.5 million in auction-rate securities for its airport in May 2006. The contract was to last until the bonds, which were insured by New York-based XL Capital Assurance Inc., matured in 2024.

The county agreed to pay the bank a fixed rate of 3.785 percent in return for a variable payment that was supposed to cover the cost of the bonds. The rate it received from Morgan Stanley was capped at 65 percent of the one-month Libor, which averaged 5.08 percent that month.

Again someone is going to have to make up the difference, who, and will they even know? All Joe six knows is that his pack just got heavier, but does he know why?

Then there is the monster subprime loser UBS who exited the auction rate bond market on the sly.

The move, part of a massacre slashing 5,500 jobs, was framed in other terms when it was announced on May 6. The bank was going to sell the municipal department. UBS was getting out of the business ``on the institutional side,'' as Jerker Johansson, chief executive officer of the investment-banking unit, put it in a conference call. UBS would move some traders over to the wealth-management division.

Listen to them lie.

The real reason that UBS and more firms will depart the municipal market isn't because the underwriting spread on the bonds is lousy, but because the business has been broken and they don't want to stick around and wait while it is fixed. Short-term thinking isn't new in the securities business.

We have seen the auction-rate securities market go bust and now we are seeing the banks who profited highly during the heyday cut and run in the credit crunch. These banks shared none of their profits made in the good times, but they will eagerly spread the losses around. Most insidious of all most taxpayers only can only see bleeding, but never even knew they were cut.