Because Detroit’s New Lawyers Represent The Major Banks That Financially Raped Detroit

 

Kevyn OrrDetroit’s Emergency Financial Manager Kevyn Orr released his first 45 day report about the City of Detroit’s financial situation.  As you can imagine, the report doesn’t paint a very pretty picture for the city.   Although, disappointing, it really wasn’t a surprise to anyone who lives in the region or has been following Detroit area politics for the past year and it said something everyone on the street has known for months, Detroit is heading toward Chaper 9 bankruptcy.

One thing that does surprise me is that no one is talking about using Union Bank of Switzerland’s admitted role in manipulating the LIBOR Index (the rate used in the bonds Detroit issued) and possible litigation as a negotiating to tool to shave $4-5 Billion off Detroit’s long term $15 Billion debt created by UBS, Bank of America and JPMorgan Chase.

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.

Just these bond sales alone 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 the past decade.

interest_rate_swap_with_bank
An example of a typical interest rate swap similar to the one the City of Detroit was in

What’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.  UBS’s admitted role in LIBOR manipulation will cost Detroit nearly $5 Billion in interest alone in as part of it’s long term debt.

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.

Detroit also entered into swaps contracts with UBS and a UBS affiliate SBS Financial Products Co., also known 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 that made manipulation of the LIBOR Index easy to do.

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.

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.

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.”

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 their own finance people didn’t understand while they manipulated the market to set Detroit up to fail.

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.

Under normal situations, the City of Detroit could easily use the threat of litigation to negotiate this $15 Billion debt down to $9 or $10 Billion, like other cities did at the beginning of the financial crisis.  After all, as a bank do you want be known internationally that you ripped off a city that once saved Europe from being enslaved by the Nazis?

There is legal precedence for a city to sue a financial institution on a case like this.  When Oakland, California discovered they were in this same scenario in 2010, they immediately forced Goldman Sachs to the table to renegotiate using the threat of litigation.

Unfortunately, these are not ordinary times.   Three days before Kevyn Orr was appointed Emergency Financial Manager by the Michigan Department of Treasury, the City of Detroit under pressure from Rick Snyder hired Orr’s former employer, Jones Day  to represent them in it’s restructuring.  Jones Day also represents JPMorgan Chase, Bank of America and UBS.  The three banks involved in structuring at least nearly a dozen bond sales for the City of Detroit since 2005.  This means if the city wants to sue these banks for fraud and other issues revolving around the rigging of the LIBOR Index, they will have to hire another law firm to represent them.

Unfortunately, now that Detroit is under the leadership of Kevyn Orr, filing a suit against the banks to reduce that $15 billion debt probably isn’t going to happen due to the fact that when the curtain closes on this blue collar Shakespearean financial drama, Snyder, Dillon and Orr will be heading back to the world of high high finance and will and need to do business with these same banks that essentially financially raped a vulnerable Detroit.

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