L.A. weighs plan to press banks to renegotiate rate swaps

Los Angeles could become the nation's biggest city seeking to jettison financial deals crafted on the eve of the Great Recession that union and community activists contend are draining funds from city services.

The City Council will vote Wednesday on a proposal to pressure two banks to redo borrowing agreements entered into before the 2007-09 financial crash. Supporters of the proposal argue banks benefited unfairly when interest rates fell to historic lows during the recession.


The local push to renegotiate the so-called interest rate swaps is part of a national campaign that public employee labor groups and other advocates say seeks to correct a lingering and harmful effect of the financial crisis: local governments paying millions in above-market interest on debt. City budget analysts defend the deals, saying they made economic sense at the time they were made, saved money in the past and will continue to do so.

But Councilman Paul Koretz, who introduced the motion seeking to roll back the deals, said renegotiating them is in the "moral, ethical and operational interest of our city."

"Los Angeles and other cities were ripped off," Koretz said. "This was supposed to be something that saved us money, and clearly it didn't."

In 2006, the city entered into interest rate swaps with Bank of New York Mellon and Dexia Credit Local intended to reduce borrowing costs for $316.8 million in wastewater bonds issued in 1988.

To take advantage of what were then historically low interest rates, the city locked into a fixed interest rate of 3.34%. If interest rates rose, the banks would end up paying the city money; if interest rates fell, the city would end up paying the banks money. City budget analysts thought the deal would protect the city against an expected rise in rates.

But when the recession worsened in 2008, interest rates went even lower as officials sought to stimulate the economy, noted Lisa Cody, research policy analyst with Fix LA, a coalition of labor and community groups that in March released a report criticizing the city's Wall Street spending . By Cody's calculations, the city has paid more than $104 million in debt service tied to rate swap deals since 2006, and could lose in excess of $65 million more between now and 2028.

Getting out of the deals would cost $24.7 million in termination fees, according to city budget officials. The measure before the council Wednesday calls on the city to pressure the banks to renegotiate or terminate the deals at no cost. The proposal also would instruct city staff to explore terminating all current and future business with the banks if they refuse to renegotiate the deals at no cost.

City budget officials are recommending the deals remain in place and the city not risk having to pay termination fees. Natalie Brill, the city's chief of debt management, said the deals have saved the city money, just not as much as expected.

Brill said the city knew of the risks when it entered into the deals, and paying the termination fees "doesn't make financial sense."

A city report prepared by its budget analysts compared the payments made on these swaps to payments that would have been made with a 4.3% fixed interest rate — the prevailing rate in 2006 — and found that the city has saved $21.7 million to date and will save an additional $22.9 million by 2028.

Cody said her group wants the banks to drop the termination fees. In June, city officials said they had begun talks with the banks and that the banks were willing to discuss renegotiating but were not open to terminating the deals at no cost.

Glenn Byers, assistant treasurer and tax collector for Los Angeles County, said there is little incentive for banks to let borrowers off the hook once they've taken a rate swap deal. County government has avoided such agreements since a deal in the 1990s almost led to losses, he said.

"The fact is, they're dangerous," Byers said.

Supporters of the measure before the City Council argue that Wall Street banks caused the financial crash, and the Federal Reserve used taxpayer money to keep interest rates artificially low. Now, those interest rates are letting banks reap a profit from cities through these swap deals, Cody said.

"They're still ahead," Cody said, "so we're losing no matter what."

Bank of New York Mellon declined to comment. Dexia could not be reached for comment.

Large cities such as New York and Chicago also have been criticized for rate swap deals, but so far only smaller cities have taken action to undo the agreements. The Northern California city of Richmond successfully renegotiated an interest rate swap deal with the Royal Bank of Canada at no cost. The city of San Francisco renegotiated a no-cost deal to reduce debt payments on its Asian Art Museum. Other cities have gone to court seeking payment relief, an option the L.A. council measure would instruct staff to explore.

Jono Shaffer, deputy director of the Service Employees International Union, said he is hoping for approval of the L.A. measure, saying it will add momentum to the national campaign to help cities get relief from the rate swap agreement costs.

"The banks aren't going to roll over on it," he said, "but I do think that having Los Angeles weigh in is going to make a huge difference in the long run."