STUMP » Articles » Chicago Watch: Throwing Rahm Under a Bus, Plus Swaps » 17 March 2016, 20:43

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Chicago Watch: Throwing Rahm Under a Bus, Plus Swaps  


17 March 2016, 20:43

This won’t be a dataviz of mine, but there’s quite a few graphs to be had.

Let’s see what has been going on in Chicago this past week, shall we?


Bernie Sanders Blasts Rahm Emanuel, Backs Chicago Union Before Ill. Primary:

Ahead of the Illinois Democratic primary on Tuesday, Democratic candidate Sen. Bernie Sanders has made it clear who he likes in Chicago, and who he doesn’t.

This past weekend, the Vermont senator blasted Chicago Mayor Rahm Emanuel for, among other things, closing public schools in the city, according to the New York Times. Sanders also blasted Emanuel for hurting the Windy City’s teachers by “luring the school system” into an exotic debt-finance scheme.

“Hillary Clinton proudly lists Mayor Rahm Emanuel as one of her leading mayoral endorsers,” Sanders told the paper. “Well let me be as clear as I can be: based on his disastrous record as mayor of the city of Chicago, I do not want Mayor Emanuel’s endorsement if I win the Democratic nomination.”

The debt-finance approach mentioned by Sanders refers to the decision by Chicago schools, during former U.S. Secretary of Education Arne Duncan’s tenure as the district’s CEO, to raise $1 billion by floating securities based on interest-rate swaps, instead of more traditional bonds. (What’s an interest-rate swap? The Khan Academy can help answer that.)

So first, let’s take a look at the interest rate swap explanation:

Interest Rate Swaps, Part 1:

Interest Rate Swaps, Part 2:

And what did that get Bernie? A loss.

Heck, Bernie’s margin was worse in Cook County (where Chicago is) than the state as a whole, with him losing 46% to Hillary’s 54% in the county. That said, the pledged delegate split was about 50-50. Given Hillary is from Illinois, perhaps it did help Bernie.


Here’s some recent commentary regarding the swaps:

Chicago Settling $390 Million Tab When City Can Least Afford It

Council approves bonds to cover fees to end water swap pact
Termination payments have piled up since cut to junk in May

Chicago taxpayers, already reeling from a financially strapped school system and mounting pension costs, are looking at a final tab of about $390 million to end ill-timed bets on interest rates.

The city council on Wednesday authorized issuing as much as $200 million of bonds to help pay termination fees, estimated at $100 million, to unwind derivative contracts linked to its water debt, the last of the city’s interest-rate swaps. Chicago has already paid about $290 million to exit other swaps, according to city documents. In May, Moody’s Investors Service lowered its rating to speculative grade, increasing pressure on the city to restructure the debt.

The deals were agreements to trade interest payments based on variable-rate debt and intended to reduce losses for municipalities when interest rates rose. Instead, the Fed kept rates near historic lows, and governments had to pay the market value to break the contracts. To compound the pain, interest rates have declined this year even after the central bank boosted its target rate in December for the first time in almost a decade.

In April [2015], Mayor Rahm Emanuel announced a plan to end the city’s interest-rate swaps and convert its variable-rate debt to fixed rate. Less than a month later, Moody’s dropped Chicago’s rating to Ba1, one step below junk, accelerating the strain on the city by giving banks the right to require it to repay debt early or pay fees to break swap contracts.

The city has exited all of its interest-rate swaps tied to general-obligation, sales and waste-water debt. Chicago is using the approved borrowing to get out of the water derivatives. There was no public discussion during Wednesday’s meeting before aldermen approved issuing the bonds.
Exiting the swaps is necessary to ensure long-term stability of the water system, said Dennis Derby, an analyst and portfolio manager at Wells Fargo Asset Management, which holds Chicago general obligations and water debt among its $39 billion in assets. The city’s water system’s security is “fairly strong,” he said.

Just a note: interest rate swaps are not necessarily bad if you’re hedging an exposure directly tied to what you’re dealing with. Insurance companies use swaps to help match crediting rates for their liabilities, for example.

The problem is when one isn’t really hedging an explicit asset/liability, but speculating on the direction of the market.

From a January article:

When rates keep moving in one direction… yeah, there’s going to be a strain.


What is below is not unique to Chicago, but perhaps they invite it more than most places:

In Financially Distressed Chicago, Public And Private Lines Are Blurred

May 15, 2015, was an important day in the world of Chicago’s city finances. On that day the city reached a deal with Barclays to take over a $100 million soured bet on an interest rate swap. Inked mostly in the early 2000s, these specialty financial products backfired after the 2008 financial crisis, saddling Chicago taxpayers with hundreds of millions of dollars in fees.

But the Barclays swap deal wasn’t the only piece of financial news for Chicago that day. The city also announced that a new chief financial officer, Carole Brown, would soon take charge of the city’s budgets.

At the time, Brown was still with her previous employer: Barclays Capital.

Now, multiple city representatives have told International Business Times that Brown not only had knowledge of the agreement that transferred the lucrative interest rate swap from Swiss bank UBS to Barclays, but that Brown had personally lobbied her superiors on behalf of the deal while she was a managing director at Barclays.

Chicago is currently yoked to more than $1 billion in bonds tied to interest rate swaps, which, as of last September, would cost some $216 million to terminate. Chicago Public Schools also hold about $1 billion in bonds covered by swaps. Combined payments on those deals have amounted to more than $100 million a year since the financial crisis, according to estimates from Saqib Bhatti, a research fellow at the progressive Roosevelt Institute.

The agreement reached in May transferred Chicago’s water bond swap from UBS to Barclays, which paid $26 million for the derivative. According to city spokeswoman Molly Poppe, the move was precipitated by UBS’s desire to exit the field. “UBS was getting out of the municipal swap business, thus the city was required to find another institution to hold the swap,” Poppe told IBT. In lieu of paying the termination fee, Chicago approached Barclays for a transfer.

The deal left the contracts largely intact in all but two respects. First, the city secured a lower bond rating threshold. Swap deals generally specify a lower bound for the credit rating of underlying bonds, below which the swap is terminated and the issuer must repay the swap in full at a cost derived from what the swap would be worth at current interest rates. The lower threshold gives cash-strapped Chicago more breathing room.

Poppe told IBT that the city paid no fees for moving the swap from UBS to Barclays. But in general, evaluating the city’s complex swap-related deals often poses challenges. “There’s a real lack of transparency there, which is a big problem,” Hagerty, the Northwestern professor, said. “It’s really hard to tell how good a job they did.”

As the city moves forward in addressing its debt woes, however, swaps are just one part of a much larger picture, Hagerty said. “They owe a boatload of money. They can’t financial-engineer their way out of this.”

In general, it may be better for cities to stay away from high finance, especially the opaque sort.

Compilation of Chicago posts.

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