The city finds it is no easy task to fight what is arguably the world’s most powerful financial corporation
A finance committee meeting of the Oakland City Council today grappled with the interest rate swap that has drained tens of millions of tax dollars over the last five years. A update from the city’s administrator about efforts to terminate the deal contained a harsh message most observers saw coming: Goldman Sachs, the city’s counterparty, absolutely refuses to terminate the swap at zero cost to the city, in spite of Oakland’s threat to cut the bank off from future business.
The swap in question was agreed to in 1997 as part of a larger bond deal in which Goldman Sachs underwrote $187 million in variable rate debt to keep the under-funded Police and Fire Retirement System pension fund solvent. The swap was intended to convert the variable rate on the bonds into a synthetic fixed rate of 5.67%.
But the swap with Goldman Sachs had an ulterior purpose also, one that virtually all the city’s elected officials have refused to own up to, and which has gone totally unreported in the press, except for this single article. This ulterior purpose was to free up $15 million to pay down debt on the Raiders Coliseum which had exploded in the city’s face after a disastrous business plan designed to lure the team back from Los Angeles. Later in 2003 the City Council again used the swap to create ‘free’ money to patch a budget hole. Council members amended the swap’s terms, switching the benchmark rate used to calculate Oakland’s payments to Goldman Sachs from SIFMA to LIBOR, a change that re-valued the swap $5.97 million in the bank’s favor. That revaluation was designed to produce an payment of the same sum from Goldman to the city. Oakland used the money to subsidize the Forest City Uptown real estate deal.
Using the swap to free up dollars to subsidize private business ventures like sports teams and real estate developers was a clear violation of the city’s swap and debt policies which it adopted in later years. Even so, the swap was mostly working as it was supposed to with respect to the variable rate bonds it hedged, and these half-too-clever schemes weren’t responsible for what happened next. In 2008 the financial crisis caused the federal government to drop central bank rates to virtually zero. LIBOR, which was already being manipulated downward by the banks that set that rate, followed fast by dropping below 1%. Oakland’s swap turned into a toxic asset overnight, draining millions of tax dollars during what has been arguably the city’s worst budget crisis in history.
The payment schedule for Oakland’s interest rate swap with Goldman Sachs: Assuming LIBOR stays below 1%, Goldman’s obligation to pay Oakland 65% of the 1-month LIBOR rate of a given notional amount in each year until 2021 means that the bank is obligated to pay Oakland virtually nothing. Meanwhile, the city pays 5.6775% of the same notional amount. The operative rate is the net rate produced by subtracting the lower rate from the higher rate. So if LIBOR doesn’t move over the next 9 years, Oakland will be stuck paying upwards of 5% on the decreasing notional amount as determined in the swap contract and summarized in the above table. (Source: “Comprehensive Annual Financial Report,” City of Oakland, FY July 1, 2010 – June 30, 2011, p. 75)
In the Summer of 2012 Oakland’s City Council was spurred to action by the Coalition to Stop Goldman Sachs, a grassroots collection of activists who pointed out the injustice of Goldman’s federal bailout while the bank continued to collect money from the city on a swap deal turned sour by political decisions, and also by the illegal conspiracy of banks that set LIBOR.
Oakland’s elected officials, aware that their constituents were demanding strong action, drew a line in the sand and demanded that the bank terminate the swap at zero cost to the city (it has been valued around $14-16 million in current dollars). If the bank refused, a resolution passed by the full council states that the city will debar the bank from future business, an option already vetted by the City Attorney Barbara Parker.
Goldman Sachs now appears to be calling what the bank thinks is a bluff by city officials. Goldman, which supposedly assigned senior level staff to negotiate with the city, has offered to terminate the swap, but is demanding that Oakland pay fair market value. Oakland’s assistant city administrator for finance, Scott Johnson, delivered a report to City Council members today offering three options:
1. The city can stick with the swap till 2021, making the contractual payments which are pegged at 5.6775% minus 65% of LIBOR, which currently amounts a net rate of 5.54% of $68.9 million. That’s about $3.8 million dollars this year, and similarly calculated, but smaller amounts in future years.
2. The city can issue two promissory notes (essentially obligations to pay a fixed debt) due over the next two years, totaling about $14.7 million dollars to Goldman Sachs. The $14.7 million is the current market value of the swap, about the same amount the yearly payments described above in option 1 would total out to by 2021 (discounted of course to current dollars). Goldman may or may not have offered to take a few hundred thousand off the termination payments through a promissory note, either by not charging interest on the notes, and/or knocking some value off the swap’s termination price, but the city’s administrator was only able to report vague offers made by the bank’s employees to consider doing this. Goldman has offered no firm promise to reduce the termination price.
3. Under the third option presented by the city administrator, the city can continue to negotiate with Goldman Sachs, exploring other means of ending the swap, but it was made clear that Goldman Sachs considers the deal sacred, and the bank will not agree to a termination without some kind of lucrative gain.
Assistant city administrator Scott Johnson also reported that Oakland might have already incurred as much as $100,000 in expenses paid to outside counsel, most likely the BLX Group, a company hired to advise the city about how to terminate the swap.
Members of the finance committee were not pleased with the report. Council member Patricia Kernighan made it clear that the report lacked any details or hard numbers to inform any decisions.
Council member Desley Brooks was visibly annoyed by the staff recommendations, noting that the report, and three options presented by the city administrator, contradicted what the council had directed staff to do back in July when they passed the original resolution calling for the swap’s termination. That resolution called on Goldman to cancel the swap at no cost to the city, and if the bank refused the city would move ahead with debarment. “We need to stop doing business with Goldman Sachs. We have a debarment process,” said Brooks.
Council member Ignacio De La Fuente went the furthest, saying he felt the city should try to find a way to simply stop making the swap payments, in addition to ceasing other business with the bank. “We have to call them on this,” said De La Fuente. “I think we should stop paying.”
Brooks focused the discussion back on the council’s original position saying “the only thing to discuss is how to move forward with some campaign to build pressure against them to terminate the swap. We need to initiate the debarment process.”
Kernighan, who wasn’t initially very interested in the swap issue, made her irritation with the bank known, adding, “Goldman Sachs clearly is not taking this very seriously. If that’s the way they’re going to be, well then fine, we just wont do business with them anymore.” She also expressed concern that negotiations with the bank over the swap were already becoming too costly for the city.
Members of the Coalition to Stop Goldman Sachs told the council members during the public comment period that they supported taking a firm stand against the bank. Beth Kean, a member of ACCE and the Coalition summed up what the council members themselves seemed to be thinking: “Goldman Sachs is basically telling us to go stick it.”
Maurice Peaslee, another member of the Coalition, surmised that Goldman’s offer to cancel the swap in two years time through the use of promissory notes could just be another attempt to outmaneuver Oakland. “If interest rates go up in the future, then the value of the swap goes down. Goldman Sachs is probably betting that interest rates are going to go up in the future.”
“If we agree to a payment of say $12 million now,” Peaslee explained, “but LIBOR goes up, the value of the swap should only be $8 million.” In other words, Goldman’s offer could just be yet another effort to squeeze extra dollars from the city. A promissory note would create an obligation for Oakland to make a set of $7 million payments within two years, whereas sticking with the swap has the possibility that the total cost to the city could actually drop as LIBOR rises.
“Apparently we are not sending a strong enough message,” said Joe Keffer, an organizer with SEIU 1021, and also a member of the Coalition. “We’ve got to make it clear their days are numbered.”
When it comes to business with Oakland, members of the finance committee seemed to agree. The finance committee directed staff to move head with the process for debarring the bank from future business, something that must go through the council’s rules committee and then be voted on by the whole council. It’s likely this won’t happen until early next year when several new council members take office.