How the nation’s biggest banks are ripping off American cities with the
same predatory deals that brought down Greece
by Matt Taibbi
Rollingstone.com (Issue 1102, April 15 2010)
If you want to know what life in the Third World is like, just ask Lisa
Pack, an administrative assistant who works in the roads and
transportation department in Jefferson County, Alabama. Pack got rudely
introduced to life in post-crisis America last August, when word came
down that she and 1,000 of her fellow public employees would have to
take a little unpaid vacation for a while. The county, it turned out,
was more than $5 billion in debt – meaning that courthouses, jails and
sheriff’s precincts had to be closed so that Wall Street banks could be
paid.
As public services in and around Birmingham were stripped to the bone,
Pack struggled to support her family on a weekly unemployment check of
$260. Nearly a fourth of that went to pay for her health insurance,
which the county no longer covered. She also fielded calls from
laid-off co-workers who had it even tougher. “I’d be on the phone
sometimes until two in the morning”, she says. “I had to talk more than
one person out of suicide. For some of the men supporting families, it
was so hard – foreclosure, bankruptcy. I’d go to bed at night, and I’d
be in tears.”
Homes stood empty, businesses were boarded up, and parts of
already-blighted Birmingham began to take on the feel of a ghost town.
There were also a few bills that were unique to the area – like the $64
sewer bill that Pack and her family paid each month. “Yeah, it went up
about 400 percent just over the past few years”, she says.
The sewer bill, in fact, is what cost Pack and her co-workers their
jobs. In 1996, the average monthly sewer bill for a family of four in
Birmingham was only $14.71 – but that was before the county decided to
build an elaborate new sewer system with the help of out-of-state
financial wizards with names like Bear Stearns, Lehman Brothers,
Goldman Sachs and JP Morgan Chase. The result was a monstrous pile of
borrowed money that the county used to build, in essence, the world’s
grandest toilet – “the Taj Mahal of sewer-treatment plants” is how one
county worker put it. What happened here in Jefferson County would turn
out to be the perfect metaphor for the peculiar alchemy of modern
oligarchical capitalism: A mob of corrupt local officials and morally
absent financiers got together to build a giant device that converted
human shit into billions of dollars of profit for Wall Street – and
misery for people like Lisa Pack.
And once the giant shit machine was built and the note on all that
fancy construction started to come due, Wall Street came back to the
local politicians and doubled down on the scam. They showed up in
droves to help the poor, broke citizens of Jefferson County cut their
toilet finance charges using a blizzard of incomprehensible swaps and
refinance schemes – schemes that only served to postpone the repayment
date a year or two while sinking the county deeper into debt. In the
end, every time Jefferson County so much as breathed near one of the
banks, it got charged millions in fees. There was so much money to be
made bilking these dizzy Southerners that banks like JP Morgan spent
millions paying middlemen who bribed – yes, that’s right, bribed,
criminally bribed – the county commissioners and their buddies just to
keep their business. Hell, the money was so good, JP Morgan at one
point even paid Goldman Sachs $3 million just to back the fuck off, so
they could have the rubes of Jefferson County to fleece all for
themselves.
Birmingham became the poster child for a new kind of giant-scale
financial fraud, one that would threaten the financial stability not
only of cities and counties all across America, but even those of
entire countries like Greece. While for many Americans the financial
crisis remains an abstraction, a confusing mess of complex transactions
that took place on a cloud high above Manhattan sometime in the
mid-2000s, in Jefferson County you can actually see the rank
criminality of the crisis economy with your own eyes; the monster
sticks his head all the way out of the water. Here you can see a trail
that leads directly from a billion-dollar predatory swap deal cooked up
at the highest levels of America’s biggest banks, across a vast fruited
plain of bribes and felonies – “the price of doing business”, as one JP
Morgan banker says on tape – all the way down to Lisa Pack’s sewer bill
and the mass layoffs in Birmingham.
Once you follow that trail and understand what took place in Jefferson
County, there’s really no room left for illusions. We live in a
gangster state, and our days of laughing at other countries are over.
It’s our turn to get laughed at. In Birmingham, lots of people have
gone to jail for the crime: More than twenty local officials and
businessmen have been convicted of corruption in federal court. Last
October, right around the time that Lisa Pack went back to work at
reduced hours, Birmingham’s mayor was convicted of fraud and
money-laundering for taking bribes funneled to him by Wall Street
bankers – everything from Rolex watches to Ferragamo suits to cash. But
those who greenlighted the bribes and profited most from the scam
remain largely untouched. “It never gets back to JP Morgan”, says Pack.
If you want to get all Glenn Beck about it, you could lay the blame for
this entire mess at the feet of weepy, tree-hugging environmentalists.
It all started with the Cahaba River, the longest free-flowing river in
the state of Alabama. The tributary, which winds its way through
Birmingham before turning diagonally to empty out near Selma, is home
to more types of fish per mile than any other river in America and
shelters 64 rare and imperiled species of plants and animals. It’s also
the source of one of the worst municipal financial disasters in
American history.
Back in the early 1990s, the county’s sewer system was so antiquated
that it was leaking raw sewage directly into the Cahaba, which also
supplies the area with its drinking water. Joined by well – intentioned
citizens from the Cahaba River Society, the EPA sued the county to
force it to comply with the Clean Water Act. In 1996, county
commissioners signed a now-infamous consent decree agreeing not just to
fix the leaky pipes but to eliminate all sewer overflows – a
near-impossible standard that required the county to build the most
elaborate, ecofriendly, expensive sewer system in the history of the
universe. It was like ordering a small town in Florida that gets a
snowstorm once every five years to build a billion-dollar fleet of
snowplows.
The original cost estimates for the new sewer system were as low as
$250 million. But in a wondrous demonstration of the possibilities of
small-town graft and contract-padding, the price tag quickly swelled to
more than $3 billion. County commissioners were literally pocketing
wads of cash from builders and engineers and other contractors eager to
get in on the project, while the county was forced to borrow obscene
sums to pay for the rapidly spiraling costs. Jefferson County, in
effect, became one giant, TV-stealing, unemployed drug addict who
borrowed a million dollars to buy the mother of all McMansions – and
just as it did during the housing bubble, Wall Street made a business
of keeping the crook in his house. As one county commissioner put it,
“We’re like a guy making $50,000 a year with a million-dollar mortgage”.
To reassure lenders that the county would pay its mortgage,
commissioners gave the finance director – an unelected official
appointed by the president of the commission – the power to
automatically raise sewer rates to meet payments on the debt. The move
brought in billions in financing, but it also painted commissioners
into a corner. If costs continued to rise – and with practically every
contractor in Alabama sticking his fingers on the scale, they were
rising fast – officials would be faced with automatic rate increases
that would piss off their voters. (By 2003, annual interest on the
sewer deal had reached $90 million.) So the commission reached out to
Wall Street, looking for creative financing tools that would allow it
to reduce the county’s staggering debt payments.
Wall Street was happy to help. First, it employed the same trick it
used to fuel the housing crisis: It switched the county from a fixed
rate on the bonds it had issued to finance the sewer deal to an
adjustable rate. The refinancing meant lower interest payments for a
couple of years – followed by the risk of even larger payments down the
road. The move enabled county commissioners to postpone the problem for
an election season or two, kicking it to a group of future
commissioners who would inevitably have to pay the real freight.
But then Wall Street got really creative. Having switched the county to
a variable interest rate, it offered commissioners a crazy deal: For an
extra fee, the banks said, we’ll allow you to keep paying a fixed rate
on your debt to us. In return, we’ll give you a variable amount each
month that you can use to pay off all that variable-rate interest you
owe to bondholders.
In financial terms, this is known as a synthetic rate swap – the
spidery creature you might have read about playing a role in bringing
down places like Greece and Milan. On paper, it made sense: The county
got the stability of a fixed rate, while paying Wall Street to assume
the risk of the variable rates on its bonds. That’s the synthetic part.
The trouble lies in the rate swap. The deal only works if the two
variable rates – the one you get from the bank, and the one you owe to
bondholders – actually match. It’s like gambling on the weather. If
your bondholders are expecting you to pay an interest rate based on the
average temperature in Alabama, you don’t do a rate swap with a bank
that gives you back a rate pegged to the temperature in Nome, Alaska.
Not unless you’re a fucking moron. Or your banker is JP Morgan.
In a small office in a federal building in downtown Birmingham, just
blocks from where civil rights demonstrators shut down the city in
1963, Assistant US Attorney George Martin points out the window. He’s
pointing in the direction of the Tutwiler Hotel, once home to one of
the grandest ballrooms in the South but now part of the Hampton Inn
chain.
“It was right around the corner here, at the hotel”, Martin says.
“That’s where they met – that’s where this all started”.
They means Charles LeCroy and Bill Blount, the two principals in what
would become the most important of all the corruption cases in
Jefferson County. LeCroy was a banker for JP Morgan, serving as
managing director of the bank’s southeast regional office. Blount was
an Alabama wheeler-dealer with close friends on the county commission.
For years, when Wall Street banks wanted to do business with
municipalities, whether for bond issues or rate swaps, it was standard
practice to reach out to a local sleazeball like Blount and pay him a
shitload of money to help seal the deal. “Banks would pay some local
consultant, and the consultant would then funnel money to the
politician making the decision”, says Christopher Taylor, the former
head of the board that regulates municipal borrowing. Back in the
1990s, Taylor pushed through a ban on such backdoor bribery. He also
passed a ban on bankers contributing directly to politicians they do
business with – a move that sparked a lawsuit by one aggrieved
sleazeball, who argued that halting such legalized graft violated his
First Amendment rights. The name of that pissed-off banker? “It was the
one and only Bill Blount”, Taylor says with a laugh.
Blount is a stocky, stubby-fingered Southerner with glasses and a pale,
pinched face – if Norman Rockwell had ever done a painting titled
“Small-Town Accountant Taking Enormous Dump”, it would look just like
Blount. LeCroy, his sugar daddy at JP Morgan, is a tall, bloodless,
crisply dressed corporate operator with a shiny bald head and silver
side patches – a cross between Skeletor and Michael Stipe.
The scheme they operated went something like this: LeCroy paid Blount
millions of dollars, and Blount turned around and used the money to buy
lavish gifts for his close friend Larry Langford, the now-convicted
Birmingham mayor who at the time had just been elected president of the
county commission. (At one point Blount took Langford on a shopping
spree in New York, putting $3,290 worth of clothes from Zegna on his
credit card.) Langford then signed off on one after another of the
deadly swap deals being pushed by LeCroy. Every time the county
refinanced its sewer debt, JP Morgan made millions of dollars in fees.
Even more lucrative, each of the swap contracts contained clauses that
mandated all sorts of penalties and payments in the event that
something went wrong with the deal. In the mortgage business, this
process is known as churning: You keep coming back over and over to
refinance, and they keep “churning” you for more and more fees. “The
transactions were complex, but the scheme was simple”, said Robert
Khuzami, director of enforcement for the SEC. “Senior JP Morgan bankers
made unlawful payments to win business and earn fees”.
Given the shitload of money to be made on the refinancing deals, JP
Morgan was prepared to pay whatever it took to buy off officials in
Jefferson County. In 2002, during a conversation recorded in Nixonian
fashion by JP Morgan itself, LeCroy bragged that he had agreed to
funnel payoff money to a pair of local companies to secure the votes of
two county commissioners. “Look”, the commissioners told him, “if we
support the synthetic refunding, you guys have to take care of our two
firms”. LeCroy didn’t blink. “Whatever you want”, he told them. “If
that’s what you need, that’s what you get. Just tell us how much.”
Just tell us how much. That sums up the approach that JP Morgan took a
few months later, when Langford announced that his good buddy Bill
Blount would henceforth be involved with every financing transaction
for Jefferson County. From JP Morgan’s point of view, the decision to
pay off Blount was a no-brainer. But the bank had one small problem:
Goldman Sachs had already crawled up Blount’s trouser leg, and the
broker was advising Langford to pick them as Jefferson County’s
investment bank.
The solution they came up with was an extraordinary one: JP Morgan cut
a separate deal with Goldman, paying the bank $3 million to fuck off,
with Blount taking a $300,000 cut of the side deal. Suddenly Goldman
was out and JP Morgan was sitting in Langford’s lap. In another
conversation caught on tape, LeCroy joked that the deal was his
“philanthropic work”, since the payoff amounted to a “charitable
donation to Goldman Sachs” in return for “taking no risk”.
That such a blatant violation of anti-trust laws took place and neither
JP Morgan nor Goldman have been prosecuted for it is yet another
mystery of the current financial crisis. “This is an open-and-shut case
of anti-competitive behavior”, says Taylor, the former regulator.
With Goldman out of the way, JP Morgan won the right to do a $1.1
billion bond offering – switching Jefferson County out of fixed-rate
debt into variable-rate debt – and also did a corresponding $1.1
billion deal for a synthetic rate swap. The very same day the
transaction was concluded, in May 2003, LeCroy had dinner with Langford
and struck a deal to do yet another bond-and-swap transaction of
roughly the same size. This time, the terms of the payoff were spelled
out more explicitly. In a hilarious phone call between LeCroy and
Douglas MacFaddin, another JP Morgan official, the two bankers groaned
aloud about how much it was going to cost to satisfy Blount:
LeCroy: I said, “Commissioner Langford, I’ll do that because that’s
your suggestion, but you gotta help us keep him under control. Because
when you give that guy a hand, he takes your arm.” You know?
MacFaddin: [Laughing] Yeah, you end up in the wood-chipper.
All told, JP Morgan ended up paying Blount nearly $3 million for
“performing no known services”, in the words of the SEC. In at least
one of the deals, Blount made upward of fifteen percent of JP Morgan’s
entire fee. When I ask Taylor what a legitimate consultant might earn
in such a circumstance, he laughs. “What’s a ‘legitimate consultant’ in
a case like this? He made this money for doing jack shit”.
As the tapes of LeCroy’s calls show, even officials at JP Morgan were
incredulous at the money being funneled to Blount. “How does he get
fifteen percent?” one associate at the bank asks LeCroy. “For doing
what? For not messing with us?”
“Not messing with us”, LeCroy agrees. “It’s a lot of money, but in the
end, it’s worth it on a billion-dollar deal”.
That’s putting it mildly: The deals wound up being the largest swap
agreements in JP Morgan’s history. Making matters worse, the payoffs
didn’t even wind up costing the bank a dime. As the SEC explained in a
statement on the scam, JP Morgan “passed on the cost of the unlawful
payments by charging the county higher interest rates on the swap
transactions”. In other words, not only did the bank bribe local
politicians to take the sucky deal, they got local taxpayers to pay for
the bribes. And because Jefferson County had no idea what kind of deal
it was getting on the swaps, JP Morgan could basically charge whatever
it wanted. According to an analysis of the swap deals commissioned by
the county in 2007, taxpayers had been overcharged at least $93 million
on the transactions.
JP Morgan was far from alone in the scam: Virtually everyone doing
business in Jefferson County was on the take. Four of the nation’s top
investment banks, the very cream of American finance, were involved in
one way or another with payoffs to Blount in their scramble to do
business with the county. In addition to JP Morgan and Goldman Sachs,
Bear Stearns paid Langford’s bagman $2.4 million, while Lehman Brothers
got off cheap with a $35,000 “arranger’s fee”. At least a dozen of the
county’s contractors were also cashing in, along with many of the
county commissioners. “If you go into the county courthouse”, says
Michael Morrison, a planner who works for the county, “there’s a
gallery of past commissioners on the wall. On the top row, every single
one of ‘em but two has been investigated, indicted or convicted. It’s a
joke.”
The crazy thing is that such arrangements – where some local scoundrel
gets a massive fee for doing nothing but greasing the wheels with
elected officials – have been taking place all over the country. In
Illinois, during the Upper Volta-esque era of Rod Blagojevich, a
Republican political consultant named Robert Kjellander got ten percent
of the entire fee Bear Stearns earned doing a bond sale for the state
pension fund. At the start of Obama’s term, Bill Richardson’s Cabinet
appointment was derailed for a similar scheme when he was governor of
New Mexico. Indeed, one reason that officials in Jefferson County
didn’t know that the swaps they were signing off on were shitty was
because their adviser on the deals was a firm called CDR Financial
Products, which is now accused of conspiring to overcharge dozens of
cities in swap transactions. According to a federal antitrust lawsuit,
CDR is basically a big-league version of Bill Blount – banks tossed
money at the firm, which in turn advised local politicians that they
were getting a good deal. “It was basically, you pay CDR, and CDR helps
push the deal through”, says Taylor.
In the end, though, all this bribery and graft was just the
table-setter for the real disaster. In taking all those bribes and
signing on to all those swaps, the commissioners in Jefferson County
had basically started the clock on a financial time bomb that, sooner
or later, had to explode. By continually refinancing to keep the county
in its giant McMansion, the commission had managed to push into the
future that inevitable day when the real bill would arrive in the mail.
But that’s where the mortgage analogy ends – because in one key area, a
swap deal differs from a home mortgage. Imagine a mortgage that you
have to keep on paying even after you sell your house. That’s basically
how a swap deal works. And Jefferson County had done 23 of them. At one
point, they had more outstanding swaps than New York City.
Judgment Day was coming – just like it was for the Delaware River Port
Authority, the Pennsylvania school system, the cities of Detroit,
Chicago, Oakland and Los Angeles, the states of Connecticut and
Mississippi, the city of Milan and nearly 500 other municipalities in
Italy, the country of Greece, and God knows who else. All of these
places are now reeling under the weight of similarly elaborate and
ill-advised swaps – and if what happened in Jefferson County is any
guide, hoo boy. Because when the shit hit the fan in Birmingham, it
really hit the fan.
For Jefferson County, the deal blew up in early 2008, when a dizzying
array of penalties and other fine-print poison worked into the swap
contracts started to kick in. The trouble began with the housing crash,
which took down the insurance companies that had underwritten the
county’s bonds. That rendered the county’s insurance worthless,
triggering clauses in its swap contracts that required it to pay off
more than $800 million of its debt in only four years, rather than
forty. That, in turn, scared off private lenders, who were no longer
interested in bidding on the county’s bonds. The banks were forced to
make up the difference – a service for which they charged enormous
penalties. It was as if the county had missed a payment on its credit
card and woke up the next morning to find its annual percentage rate
jacked up to a million percent. Between 2008 and 2009, the annual
payment on Jefferson County’s debt jumped from $53 million to a
whopping $636 million.
It gets worse. Remember the swap deal that Jefferson County did with JP
Morgan, how the variable rates it got from the bank were supposed to
match those it owed its bondholders? Well, they didn’t. Most of the
payments the county was receiving from JP Morgan were based on one set
of interest rates (the London Interbank Exchange Rate), while the
payments it owed to its bondholders followed a different set of rates
(a municipal-bond index). Jefferson County was suddenly getting far
less from JP Morgan, and owing tons more to bondholders. In other
words, the bank and Bill Blount made tens of millions of dollars
selling deals to local politicians that were not only completely
defective, but blew the entire county to smithereens.
And here’s the kicker. Last year, when Jefferson County, staggered by
the weight of its penalties, was unable to make its swap payments to JP
Morgan, the bank canceled the deal. That triggered one-time
“termination fees” of – yes, you read this right – $647 million. That
was money the county would owe no matter what happened with the rest of
its debt, even if bondholders decided to forgive and forget every dime
the county had borrowed. It was like the herpes simplex of loans – debt
that does not go away, ever, for as long as you live. On a sewer
project that was originally supposed to cost $250 million, the county
now owed a total of $1.28 billion just in interest and fees on the
debt. Imagine paying $250,000 a year on a car you purchased for
$50,000, and that’s roughly where Jefferson County stood at the end of
last year.
Last November, the SEC charged JP Morgan with fraud and canceled the
$647 million in termination fees. The bank agreed to pay a $25 million
fine and fork over $50 million to assist displaced workers in Jefferson
County. So far, the county has managed to avoid bankruptcy, but the
sewer fiasco had downgraded its credit rating, triggering payments on
other outstanding loans and pushing Birmingham toward the status of an
African debtor state. For the next generation, the county will be in a
constant fight to collect enough taxes just to pay off its debt, which
now totals $4,800 per resident.
The city of Birmingham was founded in 1871, at the dawn of the Southern
industrial boom, for the express purpose of attracting Northern capital
- it was even named after a famous British steel town to burnish its
entrepreneurial cred. There’s a gruesome irony in it now lying sacked
and looted by financial vandals from the North. The destruction of
Jefferson County reveals the basic battle plan of these modern
barbarians, the way that banks like JP Morgan and Goldman Sachs have
systematically set out to pillage towns and cities from Pittsburgh to
Athens. These guys aren’t number-crunching whizzes making smart
investments; what they do is find suckers in some municipal-finance
department, corner them in complex lose-lose deals and flay them alive.
In a complete subversion of free-market principles, they take no risk,
score deals based on political influence rather than competition, keep
consumers in the dark – and walk away with big money. “It’s not high
finance”, says Taylor, the former bond regulator. “It’s low finance”.
And even if the regulators manage to catch up with them billions of
dollars later, the banks just pay a small fine and move on to the next
scam. This isn’t capitalism. It’s nomadic thievery.
More by Matt Taibbi:
http://www.rollingstone.com/politics/taibbiblog/;kw=[blog,58584]
http://www.rollingstone.com/politics/story/32906678/looting_main_street