Derivatives Set To Blow In European Town

Saint-Etienne Swaps Explode as Financial Weapons Ambush Europe

Excerpts follow:
April 15 (Bloomberg) -- The worst global financial crisis in 70 years arrived in Saint-Etienne this month, as embedded financial obligations began to blow up.

A bill came due for 1.18 million euros ($1.61 million) owed to Deutsche Bank AG under a contract that initially saved the French city money. The 800-year-old town refused to pay, dodging for now one of 10 derivatives so speculative no bank will buy them back, said Cedric Grail, the municipal finance director. They would cost about 100 million euros to cancel today, he said.

“It’s a joke that we’re in markets like this,” said Grail, 38, from the 19th-century city hall fronted by an arched facade and the words Liberte, Egalite, Fraternite. “We’re playing the dollar against the Swiss franc until 2042.”

Saint-Etienne is one of thousands of public authorities across Europe that tried to shave borrowing expenses by accepting derivatives deals whose risks they couldn’t measure. They may be liable for billions of euros, according to the Bank of Italy and consulting and law firms in France and Germany. As global economies climb out of recession, the crisis is hitting Saint-Etienne in central France, Pforzheim in western Germany and Apulia, an Italian regional government on the Adriatic. They may pay for their bets into the next generation.

Alabama’s Jefferson County

From the Mediterranean Sea to the Pacific coast of the U.S., governments, public agencies and nonprofit institutions have lost billions of dollars because of transactions officials didn’t grasp. Harvard University in Cambridge, Massachusetts, agreed last year to pay more than $900 million to terminate swaps that assumed interest rates would rise.

For Jefferson County, Alabama, the day of reckoning came earlier than in Saint-Etienne, but the common denominator was the use of complex, unregulated financial instruments known as derivatives that are typically linked to changes in market interest rates, currencies, stocks or bonds. Billionaire investor Warren Buffett, chairman of Berkshire Hathaway Inc., in 2003 called derivatives “financial weapons of mass destruction.”

They pushed Jefferson County close to bankruptcy two years ago. It had refinanced $3 billion of debt with variable-rate bonds and purchased interest-rate swaps to guard against borrowing costs rising. Its interest rates soared when insurers guaranteeing the bonds lost their top credit grades, and the rate the county received under the swap deals fell.

Under the interest-rate swap deals popular with European municipalities, a bank would agree to cover a locality’s fixed debt payment and the government or agency would pay a variable rate gambling its costs would be lower -- and taking on the risk that they could be many times higher.

‘Hopes of Gain’

The deals were often based on differences between short- and long-term rates or currency movements.

“This is speculating in the hopes of gain,” said Peter Shapiro, managing director at Swap Financial Group LLC, in South Orange, New Jersey, an adviser to companies and governments. “The investor is taking a chance in hopes of a high return. It has nothing to do with hedging.”

Use of swaps in Europe soared in the late 1990s and early 2000s because banks pitched them as the easiest way to reduce costs on fixed-rate loans, according to Patrice Chatard, general manager of Finance Active, which helps more than 1,000 localities across Western Europe manage their debt.

The town followed the advice of Deutsche Bank in taking out bets on interest rates in 2004 and 2005, according to Susanne Weishaar, Pforzheim’s budget director until March.

‘Painted Hand Grenade’

The bank gave her a 10-year chart showing long-term rates were consistently higher than short-term, she said. During an initial phase of guaranteed rates, the town paid 1.5 percent to the bank on 60 million euros of debt while receiving 3 percent to 3.75 percent.

In 2005 and 2006, the difference between long- and short- term rates collapsed. As potential losses soared in 2006, Weishaar bought more swaps from JPMorgan Chase & Co. in a vain attempt to protect the town budget. Today Pforzheim owes 55 million euros to New York-based JPMorgan, she said. That’s 11 percent of this year’s spending.

The Deutsche Bank swaps have a positive value for the city of about 9 million euros, Weishaar said, offset by the negative value of JPMorgan swaps set up to protect the city.

“It’s like Easter eggs,” said Weishaar, 45, who holds a degree in math and economics from the University of Ulm. “You want to buy one and somebody sells you a painted hand grenade instead.”

If the grenades explode -- or when local officials decide to cut their losses and get out of long-term contracts when the market is against them -- taxpayers foot the bill.


As we have mentioned in the past, the crisis is not over.

First - Cities and towns will go bankrupt.
Then - States and provinces will default.
Finally - Entire countries will become insolvent and default.

In our opinion, some of the few hedges against the developing crisis are physical gold & silver, and tangible assets that are owned free & clear.

In our drive to create a "fair & just" society in Western Democracies, we have empowered the State to borrow without restraint or consideration of long term consequences.

The debt monster continues to grow and the full consequences are yet to be experienced.

"For wind they sow, and a hurricane they reap" Hosea 8:7a (Young's Literal Translation)


  1. Socialists "playing" with other people's money. What's new???? Maybe next time they'll look up the definition of "speculative".


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