$this->bbcode_second_pass_quote('', 'D')etroit Mayor Dave Bing is struggling to save his city from fiscal calamity. Unemployment is at a record 28 percent and rising, while home prices have plunged 39 percent since 2007. The 66-year-old Bing, a former NBA all-star with the Detroit Pistons who took office 10 months ago, faces a $300 million budget deficit — and few ways to make up the difference.
Against that bleak backdrop, Wall Street is squeezing one of America's weakest cities for every penny it can. A few years ago, Detroit struck a derivatives deal with UBS and other banks that allowed it to save more than $2 million a year in interest on $800 million worth of bonds. But the fine print carried a potentially devastating condition. If the city's credit rating dropped, the banks could opt out of the deal and demand a sizable breakup fee. That's precisely what happened in January: After years of fiscal trouble, Detroit saw its credit rating slashed to junk. Suddenly the sputtering Motor City was on the hook for a $400 million tab.During late-night strategy sessions, Joseph L. Harris, Detroit's then-chief financial officer, scoured the budget for spare dollars, going so far as to cut expenditures on water and electricity. "I figured the [utility] wouldn't turn out our lights," says Harris. But there wasn't enough cash, and in June the city set up a payment plan with the banks.
Now Detroit must use the revenues from its three casinos — MGM Grand Detroit, Greektown Casino, and MotorCity Casino — to cover a $4.2 million monthly payment to the banks before a single cent can go to schools, transportation, and other critical services. "The economic crisis has forced us to move quickly and redefine what services a city can and should provide," says Bing. "While we face a tough road ahead, I believe we're on the right path." UBS declined to comment.
Detroit isn't suffering alone. Across the nation, local governments and related public entities, already reeling from the recession, face another fiscal crisis: billions of dollars in fees owed to UBS, Goldman Sachs and other financial giants on investment deals gone wrong.The seeds of this looming disaster were sown during the credit boom, when Wall Street targeted cities big and small with risky financial products that promised to save them money or boost returns.
Investment bankers sold exotic derivatives designed to help municipalities cut borrowing costs. Banks and insurance companies constructed complicated tax deals that allowed public utilities, transit authorities, and other nonprofit organizations to extract cash immediately from their long-term assets. Private equity firms, pointing to stellar historical gains, persuaded big public pension funds to plow billions of dollars into high-cost investments at the peak of the market.
Many of the transactions shared a striking similarity: provisions that protected the banks from big losses and left the customers on the hook for huge payouts.
Now, as many of those deals sour, Wall Street is ramping up its efforts to collect from Main Street."The banks stuffed customers with [questionable investments] and then extorted money from the customers to get rid of them," says Christopher Whalen, managing director at research firm Institutional Risk Analytics.
The New Jersey Transportation Trust Fund Authority, for instance, must pay nearly $1 million a month at least until December 2011 to Goldman Sachs on derivatives deals tied to municipal debt—even though the state retired the debt last year.
The Chicago Transit Authority, having entered into complex arrangements to lease its equipment to outside investors and then lease it back, could face termination fees of $30 million. The investors could collect penalties because American International Group, which backed the arrangement, has seen its credit rating tumble. "These [sorts of deals] are potentially huge liabilities," says Stanford Law School's Joseph Bankman. "Investors aren't going to be settling for chump change." Goldman Sachs declined to comment.
Of course, many of the municipal-finance investments blowing up now were fairly standard contracts that clearly spelled out the pitfalls. "Municipalities knew the risks," says James S. Normile, a New York partner at law firm Winston Strawn. "They just didn't think they were going to happen."
But some public entities, lacking the financial expertise, proved to be willing buyers for Wall Street's more dubious ideas.
Consider the plight of Hoosier Energy Rural Electric Cooperative. In 2002 a group of attorneys and investment bankers presented the tiny nonprofit utility, indirectly owned by its 800,000 mostly rural customers, with a quick way to earn some money. Hoosier Energy leased a power plant near the Wabash River in Sullivan County, Ind., to John Hancock Financial Services. Hancock then turned around and leased it back. As a result, the utility netted $20 million while Hancock planned to reap tax benefits on the facility. The bankers and lawyers, meanwhile, made $12 million.
The transaction was part of a broader trend: Over the past decade dozens of utilities, transportation agencies, and other public nonprofit entities struck so-called leaseback deals to collect cash on their assets.
Around the same time the Hoosier agreement was finalized, the IRS began cracking down on leaseback deals. The federal agency in a memorandum called them a "sham" that lacked any business purpose beyond tax evasion and amounted to a circular exchange of assets and cash.
Legally speaking, a transaction that merely reaps tax rewards and has no other economic purpose is often considered an abusive tax shelter. Although the IRS hasn't ruled on Hancock's tax breaks, U.S. District Court Judge David F. Hamilton concluded in an opinion last fall that they looked "abusive." Hancock says it believes it's entitled to the tax benefits.
Now Hancock is exploiting a technicality in the 3,000-page pact with Hoosier that could allow the financial firm to wiggle out of the contract and collect a fat fee. Even though Hoosier has continued to make all of its payments, it fell into technical default after Ambac Financial Group, which backed the transaction, suffered a credit-rating downgrade. Having not found a suitable replacement, Hoosier faces a $120 million penalty, a sum that could exhaust its cash and credit lines. "It's a huge challenge for us," says Donna L. Snyder, Hoosier's vice-president for finance. "We're a small not-for-profit."
Hoosier may have to pay up soon. In September the Seventh Circuit Court of Appeals ruled the utility had to find a new guarantor this year or pay Hancock the money. If the latter happens, residents could face higher electricity rates. Already, Hoosier has hiked rates 3 percent because of the uncertainty of the deal. In the meantime the utility is conserving cash by postponing environmental upgrades to its coal plants and putting off payments to other power companies in the co-op. Says Jonathan Chiel, John Hancock's general counsel: "We've acted reasonably, and we believe no party to the transaction should seek to gain an unfair advantage."
Public transportation systems around the nation could be vulnerable to leaseback blowups. Moody's Investors Service estimates that 25 big municipal transportation authorities entered into deals similar to Hoosier's.
http://www.msnbc.msn.com/id/34067419/ns/business-businessweekcom/page/3/Ok, let's connect the dots. The federal government gave all that money to AIG. AIG in turn gave a lot of it to UBS. Now, Detroit has to pay UBS $400 million in penalties on $800 million in bonds.
The amount of that penalty is an incredible number. It's hard to imagine how a slick financial package designed to save a paltry $2 million a year in interest can balloon into almost half a billion in penalties alone. But then, this is a "derivatives deal," one of those quantum mechanical algorithmic thingamajigs that nobody can explain.
It's really amazing, it's like Wall Street is shaking us down on every level -- from the consumer, to the federal government, the state governments, the cities, pension funds, and even non-profit utilities and transit authorities.
Not that anything will be done about this.. the White House is literally staffed by bankers from Goldman Sachs.
by ReverseEngineer » Thu 26 Feb 2009, 00:13:16 
