In July, the City of Philadelphia filed a lawsuit against Wall Street banks for illegally manipulating a major interest-rate index underpinning complex derivatives that have cost cities and schools billions of dollars. Now, the Philly School District may do the same. “The School District is currently in the process of analyzing whether or not the agency has a sufficient basis for pursuing claims against financial institutions which may have been involved in the manipulation of Libor,” a district spokesperson wrote in a statement issued to City Paper.
Other cities have filed similar lawsuits, contending that interest-rate swaps — billed as a protection against rising borrowing costs — were tilted in banks’ favor through the fraudulent rigging of the London Interbank Offered Rate, or Libor.
The school district took out swaps with Wachovia (purchased by Wells Fargo in 2008), Merrill Lynch, Goldman Sachs and Morgan Stanley. But a lawsuit could name more banks as defendants.
It is unclear when the District, run by the state-controlled School Reform Commission, will decide whether to file suit or what damages might be sought. The city could seek tens of millions of dollars, says Quinn Emanuel attorney Steig D. Olson, one of the lawyers representing the city. The precise damages at stake — a matter of figuring out how particular Libor manipulations affected particular swap deals — will be determined through discovery.
A successful lawsuit, however, could provide sorely needed revenue to Philadelphia schools, which are experiencing a severe fiscal crisis. Budget cuts orchestrated by Gov. Tom Corbett have exacerbated historic underfunding. The result is a “doomsday” budget gap of $304 million and the resulting layoff of thousands of teachers and staff. Only a small portion of that gap has been filled — and only tenuously. The District has also borrowed more and sunk further into debt. Philadelphia schools’ debt service is 10 times the national average.
Advocates have encouraged municipalities and school districts to take action against banks, which were saved by a taxpayer-funded bailout despite profiting from predatory financial transactions.
Philly schools lost $161 million from swaps, according to a 2012 report by the left-leaning Pennsylvania Budget and Policy Center.
Interest-rate swaps set borrowing costs for bond issuers (such as municipalities and districts) at a fixed rate. The banks then pay the bond issuer based on a floating interest rate, determined by an index such as Libor. Swaps were supposed to protect public entities from rising borrowing costs. But after the Fed drove interest rates down to combat the economic crisis, cities and districts were stuck paying banks at a high interest rate even while banks paid public entities at a low one. Bond issuers often paid heavy termination fees to exit the agreements. A 2012 report by the Refund Transit Coalition finds that 1,100 swaps with public entities, including SEPTA, cost taxpayers $2.5 billion a year.
Recently, the moral and political case against swaps has gained a sharp legal edge: It was revealed that banks were manipulating the Libor, an index tied to $300 trillion in financial instruments that is set by banks with no external oversight. Banks report how much they would pay to borrow from other firms on a given day — on the honor system. Britain’s Barclays and Royal Bank of Scotland and Swiss UBS have, according to Reuters, paid about $2.6 billion in penalties to U.S. and British regulators over Libor manipulation. One estimate puts losses related to Libor fraud at as much as $176 billion.
The city’s lawsuit, filed against banks that were all members of the British Bankers’ Association, says the deals “cost state and local governmental entities hundreds of millions or even billions of dollars, depleting treasuries, ruining budgets and hindering the delivery of public services.”
The district is currently negotiating a new contract with the Philadelphia Federation of Teachers (PFT), seeking $130 million in total labor givebacks. Randi Weingarten, president of PFT’s national organization, the American Federation of Teachers, said in a statement that those giveback demands come as “big banks continue to reap millions in profits off of risky and manipulated swaps deals.” AFT wants the district to go after the funds it lost to swaps — and soon. “While we welcome this action, we are surprised it has not yet been taken.”
Read the full story on our news blog Naked City.
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