UBS, BofA, and JPMorgan Pocketed $474 Million As Detroit Descended Into Financial Chaos By LIBOR Rigging


“Even in the worst of times someone turns a profit.” – Ferengi Rule of Acquisition #162

As the downtrodden African-Americans and whites who make up what’s left of the City of Detroit’s 700,000 resident are about to have their fundamental human rights taken away by the state of Michigan in the coming weeks, new information is coming out as to who and what is responsible for the Detroit’s financial problems.

As anyone with a brain can tell you, for nearly 40 years, Detroit residents have been getting the shaft in Detroit’s slide from thriving metropolis into a dystopian wasteland that once only existed in the imagination of some Hollywood Science Fiction screenwriter.  As the body count of victims is being assessed by finance experts and Michigan Governor Rick Snyder’s office, it is becoming clear there were actually some major winners in Detroit’s demise and no, former Mayor Kwame Kilpatrick hasn’t been mentioned yet.  Even if he is, it appears there were bigger winners than members of the Kilpatrick family.

It appears that UBS, Bank of America and JPMorgan Chase enabled about $3.7 Billion of bond issues to cover deficits, pension shortfalls since 2005 and with interest these liabilities rose to $15 billion including money owed to retires and the city employees pension fund.

These bond sales cost Detroit $474 million for underwriting expenses, bond insurance and the handling of interest rate swaps.  This total cost is equal to the Detroit’s budget for police and fire protection for that same period.

interest_rate_swap_with_bankWhat’s more shocking is the fact that nearly $350 million of this is owed for derivatives aka interest rate swaps meant to lower borrowing costs on variable-rate debt.  interest rate swaps are a bet on the direction of the interest rates and were illegal until the repeal of the Glass-Steagall Act in 2000.  The risk is that if the interest rate moves too quickly or unexpectedly it could cost the municipality huge amounts of money.  This interest on this debt was tied to the London Interbank Offered Rate or commonly known as the LIBOR index.  Going the least expensive way at the time is what is now coming back to hurt Detroit because it set them up for the liabilities of higher rates and fees.

Normally the parties in a transaction like this do not swap payments directly, but rather each sets up a separate swap with a financial intermediary such as a bank. In Detroit’s case it looks like UBS used one of it subsidiaries to handle the transactions which could be a conflict of interest.  In return for matching the two parties together, the intermediary gets a percentage from each swap payment.  On top of  it, it appears Detroit was a victim of LIBOR rigging committed by UBS.

Greedy Business Partners

In 2005, after Kwame Kilpatrick was re-elected, the city launched two of its most expensive bond issues, first paying $46.4 million in fees to UBS to borrow $1.4 billion for pension obligations. A year later, the city paid $61.8 million, including costs for insurance, for UBS to sell $948.5 million in bonds, replacing two-thirds of the debt sold the previous year.

The city’s financial managers at the time saw no red flags because the city usually makes periodic swap payments from revenue generated for the city from the city’s three casinos.

Detroit also entered into swaps contracts with UBS and a UBS affiliate SBS Financial Products Co., also know as Siebert Brandford Shank who served as a counter party on most of  swaps transactions for UBS clients. This is because of the long and intertwining relationship that UBS and SBS share with each other.

As rates fell, it left Detroit with a liability of $439 million on June 30, 2012, according to a city report. Bloomberg quoted Jack Martin, Detroit’s chief financial officer who claims, “that amount has since fallen to about $350 million as rates went back up.  (It) likely contributed to our current problems. It was the way people did business back then. We are where we are now and working hard to right the ship.”

In December 2012, UBS agreed to pay $1.505 billion to the US Department of Justice, the U.S. Commodity Futures Trading Commission, the UK Financial Services and the Swiss Financial Market Supervisory Authority for colluding with other banks and firms like SBS by making 2000 written requests for rate movements from January of 2005 to June of 2010.

According to Bloomberg,

“After the pension bonds, the city continued to issue general-obligation bonds and short-term debt totaling about $1.3 billion, according to data compiled by Bloomberg.

The city ran into “liquidity problems,” according to the 2012 financial statement. Because of low ratings and deficits, it was unable to borrow and turned to the Michigan Finance Authority, which arranged a $129.5 million bond issue underwritten by a Bank of America unit.

Costing $1.6 million in fees, part of the proceeds went to repay the unit for an earlier $80 million loan — and part of that loan had been used to service other debt, according to the financial statement.”

Wall Street did exactly to Detroit what they did to American homeowners.  They conned the city into borrowing money using complex loans that they’re finance people didn’t understand while they manipulated the market to set Detroit up to fail.   Then used complex derivatives to bet against Detroit.  Unfortunately Detroit’s financial people weren’t paying attention to what was going on with these types of bonds in other parts of the country and failed to act.  When Oakland, California discovered they were in this same scenario in 2010, they immediately forced Goldman Sachs to the table to renegotiate as did several other major cities.  The question is why didn’t Detroit?

Now Detroit’s bond rating is now lower than most countries in Africa.   In the past 12 months, Moody’s Investors Service has cut Detroit’s unlimited general-obligation bond ratings to B2, five levels into junk bond status and last November, Moody’s cut the rating again to Caa1 which is considered the seventh layer of hell of municipal credit ratings and is the third lowest score Moody’s offers.

The big hurdle for Detroit now is how to raise capital investment because no matter how you slice it or dice it, Detroit needs capital for a complete overhaul.

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