Too Big to Prosecute? Not For A
California Jury -
By Ellen brown
– Web of Debt
Friday, 25
April 2014
Sixteen of the world’s largest banks
have been caught colluding to rig global interest rates. Why are we doing
business with a corrupt global banking cartel?
United States Attorney General Eric
Holder has declared that the too-big-to-fail Wall Street banks are too big to prosecute. But an outraged
California jury might have different ideas. As noted in the California legal newspaper The Daily Journal:
California
juries are not bashful – they have been known to render massive punitive
damages awards that dwarf the award of compensatory (actual) damages. For
example, in one securities fraud case jurors awarded $5.7 million in
compensatory damages and $165 million in punitive damages. . . . And in a
tobacco case with $5.5 million in compensatory damages, the jury awarded
$3 billion in punitive damages . . . .
The question, then, is how to get
Wall Street banks before a California jury. How about charging them with common
law fraud and breach of contract? That’s what the FDIC just did in its
massive 24-count civil suit for damages for LIBOR
manipulation, filed in March 2014 against sixteen of the world’s largest banks,
including the three largest US banks – JP Morgan Chase, Bank of America and
Citigroup.
LIBOR (the London Interbank Offering
Rate) is the benchmark rate at which banks themselves can borrow. It is a
crucial rate involved in over $400 trillion in derivatives called interest-rate
swaps, and it is set by the sixteen private megabanks behind closed doors.
The biggest victims of interest-rate
swaps have been local governments, universities, pension funds, and other
public entities. The banks have made renegotiating these deals prohibitively
expensive, and renegotiation itself is an inadequate remedy. It is the equivalent
of the grocer giving you an extra potato when you catch him cheating on the
scales. A legal action for fraud is a more fitting and effective remedy. Fraud
is grounds both for rescission (calling off the deal) as well as restitution
(damages), and in appropriate cases punitive damages.
Trapped in a Fraud
Nationally, municipalities and other
large non-profits are thought to have as much as $300 billion in outstanding
swap contracts based on LIBOR, deals in which they are trapped due to
prohibitive termination fees. According to a 2010 report by the SEIU(Service Employees
International Union):
The
overall effect is staggering. Banks are estimated to have collected as much as
$28 billion in termination fees alone from state and local governments over the
past two years. This does not even begin to account for the outsized net
payments that state and local governments are now making to the banks. . . .
While the
press have reported numerous stories of cities like Detroit, caught with high
termination payments, the reality is there are hundreds (maybe even thousands)
more cities, counties, utility districts, school districts and state
governments with swap agreements [that] are causing cash strapped local and
city governments to pay millions of dollars in unneeded fees directly to Wall
Street.
All of these entities could have
damage claims for fraud, breach of contract and rescission; and that is true
whether or not they negotiated directly with one of the LIBOR-rigging banks.
To understand why, it is necessary
to understand how swaps work. As explained in my last article here, interest-rate swaps are sold to parties who
have taken out loans at variable interest rates, as insurance against rising
rates. The most common swap is one where counterparty A (a university,
municipal government, etc.) pays a fixed rate to counterparty B (the bank),
while receiving from B a floating rate indexed to a reference rate such as
LIBOR. If interest rates go up, the municipality gets paid more on the swap
contract, offsetting its rising borrowing costs. If interest rates go down, the
municipality owes money to the bank on the swap, but that extra charge is
offset by the falling interest rate on its variable rate loan. The result is to
fix borrowing costs at the lower variable rate.
At least, that is how they are
supposed to work. The catch is that the swap is a separate financial agreement
– essentially an ongoing bet on interest rates. The borrower owes both the
interest onits variable rate loan and what it must pay on its
separate swap deal. And the benchmarks for the two rates don’t necessarily
track each other. The rate owed on the debt is based on something called the
SIFMA municipal bond index. The rate owed by the bank is based on the
privately-fixed LIBOR rate.
As noted by Stephen Gandel on CNNMoney, when the
rate-setting banks started manipulating LIBOR, the two rates decoupled,
sometimes radically. Public entities wound up paying substantially more than
the fixed rate they had bargained for – a failure of consideration constituting
breach of contract. Breach of contract is grounds for rescission and damages.
Pain and Suffering in
California
The SEIU report noted that no one
has yet completely categorized all the outstanding swap deals entered into by
local and state governments. But in a sampling of swaps within
California, involving ten cities and counties (San Francisco, Corcoran, Los
Angeles, Menlo Park, Oakland, Oxnard, Pittsburgh, Richmond, Riverside, and
Sacramento), one community college district, one utility district, one
transportation authority, and the state itself, the collective tab was $365
million in swap payments annually, with total termination fees exceeding $1
billion.
Omitted from the sample was the
University of California system, which alone is reported to have lost tens of
millions of dollars on interest-rate swaps. According to an article in the
Orange County Register on February 24, 2014, the swaps now cost the university
system an estimated $6 million a year. University accountants estimate that the
10-campus system will lose as much as $136 million over the next 34 years if it
remains locked into the deals, losses that would be reduced only if interest
rates started to rise. According to the article:
Already
officials have been forced to unwind a contract at UC Davis, requiring the
university to pay $9 million in termination fees and other costs to several
banks. That sum would have covered the tuition and fees of 682 undergraduates
for a year.
The
university is facing the losses at a time when it is under tremendous financial
stress. Administrators have tripled the cost of tuition and fees in the past 10
years, but still can’t cover escalating expenses. Class sizes have increased.
Families have been angered by the rising price of attending the university,
which has left students in deeper debt.
Peter Taylor, the university’s Chief
Financial Officer, defended the swaps, saying he was confident that interest
rates would rise in coming years, reversing what the deals have lost. But for
that to be true, rates would have to rise by multiples that would drive
interest on the soaring federal debt to prohibitive levels, something the
Federal Reserve is not likely to allow.
The Revolving Door
The UC’s dilemma is explored in a
report titled “Swapping Our Future: How Students and Taxpayers Are Funding
Risky UC Borrowing and Wall Street Profits.” The authors, a group
called Public Sociologists of Berkeley, say that two factors were responsible
for the precipitous decline in interest rates that drove up UC’s relative
borrowing costs. One was the move by the Federal Reserve to push interest rates
to record lows in order to stabilize the largest banks. The other was the
illegal effort by major banks to manipulate LIBOR, which indexes interest rates
on most bonds issued by UC.
Why, asked the authors, has UC’s
management not tried to renegotiate the deals? They pointed to the revolving
door between management and Wall Street. Unlike in earlier years, current and
former business and finance executives now play a prominent role on the UC
Board of Regents.
They include Chief Financial Officer
Taylor, who walked through the revolving door from Lehman Brothers, where he
was a top banker in Lehman’s municipal finance business in 2007. That was when
the bank sold the university a swap related to debt at UCLA that has now become
the source of its biggest swap losses. The university hired Taylor for his
$400,000-a-year position in 2009, and he has continued to sign contracts for
swaps on its behalf since.
Investigative reporter Peter Byrne
notes that the UC regent’s investment committee controls $53
billion in Wall Street investments, and that historically
it has been plagued by self-dealing. Byrne writes:
Several
very wealthy, politically powerful men are fixtures on the regent’s investment
committee, including Richard C. Blum (Wall Streeter, war contractor, and
husband of U.S. Senator Dianne Feinstein), and Paul Wachter (Gov. Arnold
Schwarzenegger’s long-time business partner and financial advisor). The probability
of conflicts of interest inside this committee—as it moves billions of dollars
between public and private companies and investment banks—is enormous.
Blum’s firm Blum Capital is also an
adviser to CalPERS, the California Public Employees’ Retirement System, which
also got caught in the LIBOR-rigging scandal. “Once again,” said CalPERS Chief Investment Officer Joseph Dear of
the LIBOR-rigging, “the financial services industry demonstrated that it cannot
be trusted to make decisions in the long-term interests of investors.” If the
financial services industry cannot be trusted, it needs to be replaced with
something that can be.
Remedies
The Public Sociologists of Berkeley
recommend renegotiation of the onerous interest rate swaps, which could save up
to $200 million for the UC system; and evaluation of the university’s legal
options concerning the manipulation of LIBOR. As demonstrated in the new FDIC
suit, those options include not just renegotiating on better terms but
rescission and damages for fraud and breach of contract. These are remedies
that could be sought by local governments and public entities across the state
and the nation.
The larger question is why our state
and local governments continue to do business with a corrupt global banking
cartel. There is an alternative. They could set up their own publicly-owned
banks, on the model of the state-owned Bank of North Dakota. Fraud could be
avoided, profits could be recaptured, and interest could become a much-needed
source of public revenue. Credit could become a public utility, dispensed as
needed to benefit local residents and local economies.
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Ellen Brown is an attorney, founder of the Public
Banking Institute, and a candidate for
California State Treasurer running on a state bank platform.
She is the author of twelve books, including the best-selling Web of Debt and
her latest book, The Public Bank Solution, which explores
successful public banking models historically and globally.
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