With its subtropical climate and proximity to Disney World, Orlando, Florida has become one of America’s fastest growing cities — but it has a big problem: It is one of the largest mass transit deserts in the United States, gridlocking vast swaths of its population in some of the country’s worst traffic.
Worse, when the region’s highway authority had the opportunity to invest in its mass transit infrastructure, money that could have gone to buses and trains was instead siphoned to a handful of the world’s most powerful banks, thanks to a complex municipal loan deal signed in the leadup to the financial crisis more than a decade ago.
As that so-called interest-rate swap scheme continues to blow a hole in the highway authority’s budget, Orlando is now at the center of a landmark legal battle to unwind the transactions with UBS, JPMorgan, Citi, Morgan Stanley, and the Royal Bank of Canada. The suit is being brought by a retired county official and a former Democratic member of Congress. They say local officials were duped into an agreement by predatory Wall Street bankers who misled and entrapped them into signing away their communities’ economic future.
If the suit is successful, it could open up a spate of similar litigation in other communities ravaged by such deals.
“Complex financial swaps don’t benefit our region at all, not Main Street, or the working class,” said Naqiy Mcmullen, the co-chair of Central Floridians for Public Transit. “We have per-capita [transit] funding of just 71 dollars, lower than nearly every other major region. There’s a lack of dedicated funding that has been an issue for decades; so they can’t expand bus services.”
Finance industry players have said that municipal deals always come with risks, and that interest rate swaps were shrewd ways for states and cities to raise capital without having to jack up taxes.
“Issuing variable rate debt, together with a variable-to-fixed rate swap, is intended to provide a lower fixed cost of borrowing,” testified bond attorney Steven Turner at Securities and Exchange Commission hearing a decade ago. “Issuers enjoy the lower interest rates, and underwriters earn both the underwriting fee and continuing remarketing fees. In theory, these swaps are advantageous for both parties… In my experience, the nature of such risks was carefully explained to issuers, both orally and in writing, and, more importantly, were understood by them.”
But analysts aligned with labor and community groups point to debacles like Orlando to assert that interest-rate swaps are one of the most destructive legacies of Wall Street’s predatory behavior in the lead-up to the financial crisis.
Such swaps were “built and sold to public borrowers as a way to save money on debt,” said Saqib Bhatti, the co-executive director of the Action Center on Race and the Economy, who has spent much of the past 15 years working to address municipal financial crises caused by swaps. “They are loaded with lots and lots of risk — risks that materialized because of the 2008 financial crisis and has since drained billions of dollars from taxpayer coffers.”
A Wall Street Heist On Main Street
The Orlando case is the latest development in a two-decade-plus saga of interest-rate swaps, an exotic financial product peddled by Wall Street bankers who promised to give budget-strapped cities and states the equivalent of low-interest loans to help them pay for schools, roads, and other public sector initiatives.
Big banks pitched cities and states on schemes that seemed like a budget panacea: Instead of facing fixed interest rates at potentially higher levels, governments could borrow money at a variable rate that rose and fell with the market, but then periodically swap that debt for fixed rate loans — like a classic 30-year fixed-rate mortgage. Such complex swaps offered — in theory — the potential for the best of both worlds: lower interest rates and predictable payments.
But critics say the interest rate swaps have often operated exactly like predatory adjustable-rate mortgages, with repayment rates suddenly skyrocketing when the economy went south.
While variable-rate debt was marketed as being attractive for its initial low interest rates, it also carried inherent risks, because it is impossible to predict what future debt payments will be since the rates are tied to fluctuating global interest rates. If those interest rates are manipulated — like they were in the now-infamous rate-rigging scandal — it can financially destroy municipalities.
If the municipal borrower wants to get out of the swap early because payments end up being too high compared to interest rates on the open market, the swap deals require the borrower to pay huge termination fees.
The financial carnage from such deals has been widespread.
Detroit paid $85 million in termination fees during its bankruptcy in 2014 as it was cutting services across the city.
Illinois paid $618 million to large banks, with a total cost of more than $1.4 billion.
New Jersey spent $720 million to terminate their swap agreements.
In Denver, the local school district paid $215 million in termination fees to banks to unwind a deal negotiated by then-superintendent Michael Bennet, before he was appointed to the U.S. Senate.
Rampant misconduct in the negotiation of swaps forced JPMorgan to cancel the $647 million it said it was owed by Jefferson County, Alabama.
The big banks earned nearly $400 million in termination fees from swaps gone south in Puerto Rico.
Higher education has gotten caught up in such arrangements as well. Harvard spent $1.25 billion winding down its swaps. The City University of New York system spent nearly $200 million, and Michigan State spent more than $130 million.
Perhaps most egregious was Chicago, which spent $537 million in swap termination fees during the mayoral tenure of Ambassador to Japan Rahm Emanuel, a period that coincided with the closure of 48 public schools in Black and Brown neighborhoods in the city. The Chicago Teachers Union has frequently assailed the school district’s usage of swaps, organizing protests at the banks and financial firms that profited from the arrangements. In 2014, the Chicago Tribune caught then-Mayor Emanuel lying when he said that he had not negotiated any swap deals, when in fact he had negotiated four of them.
“Swaps are a perfect example of just one more way that the big banks rigged the system,” said Bhatti. “Just like they sold predatory loans to Black and Brown folks, they similarly sold predatory municipal products to cities, states, and school districts across the country.”
The interest-rate swaps, he said, “ended up having a terrible impact on some of the same folks who were impacted by predatory lending in the first place. It’s been a double whammy for communities subject to predatory lending at the individual household level, and then their cities, states, and school districts at the governmental level.”
“They Were Played For Chumps”
In Orlando, the Central Florida Expressway Authority, the regional highway operator, paid $177 million to the banks last year to terminate rate swaps from 2005, on top of $117 million paid to the banks in 2013 to terminate swaps from 2003. The $177 million payment to banks was larger than the total 2021 operating expenses for Lynx, the regional bus agency.
But now Rick Fitzgerald, a former Goldman Sachs executive and retired county official, is suing to demand accountability from Wall Street — and to get back the money that he says the banks used wrongful means to obtain from the authority. He is partnering with prominent Wall Street critic and trial attorney Brad Miller, a former five-term Democratic congressman from North Carolina who sat on the financial services committee.
According to the lawsuit, the banks failed to fully disclose the risks the rate swaps to the highway authority.
“The information that [the banks] provided the [highway] Authority were sales pitches intended to induce the Authority to enter the synthetic fixed-rate financings, not to inform the Authority of the magnitude of the risks of the transactions,” the complaint says.
Miller told The Daily Poster that the scheme followed a key statutory change by Florida lawmakers.
“Until 2002, Florida required that the bond issues be done by a state agency,” said Miller. Prior to the 2003 swaps, the authority “had always had plain vanilla financings. The legislature changed the law, likely because of lobbying from the banks, and [the authority] suddenly jumped right in the deep end into two half-billion dollar financings that were as complicated as it gets.” The swaps were “completely unfamiliar to this board. Nobody on the board had any expertise in municipal finance,” he said.
The suit is based on Florida’s False Claims Act, which states that anyone can bring what is called a “qui tam” case alleging defrauding of the government. While the rate swaps in question were started in 2003 and 2005, the plaintiffs argue that their claim is still covered within the False Claims Act’s six-year statute of limitations because the termination payments to the banks were made as late as 2021.
Violations of Florida’s False Claims Act are subject to triple damages, meaning that if successful, the authority could reap a windfall of more than $800 million. But more than that, says Miller, the lawsuit could also bring much-needed accountability to Wall Street, which he argues should have faced consequences for such behaviors years ago.
“It should have been like the asbestos settlement, or the tobacco settlement, because (financial swaps) were so far ranging,” Miller said. “[The banks] were able to keep a lid on it because nobody wanted to say they were played for chumps. The fact was they were played for chumps.”
As of press time, UBS, JPMorgan, RBC, Citi, and Morgan Stanley did not respond to requests for comment.
“The banks didn’t fully explain the risk to the municipal issuers,” said Joe Fichera, a Wall Street veteran who has been a vocal critic of the arrangements. “Nobody disclosed the full cost to cancel the swaps, [such as] the termination payments. Municipal issuers didn’t understand what they were getting into. There wasn’t sophistication on the side of the issuer.”
A Federal Solution
If the Orlando lawsuit is successful, other cities and states could follow with their own similar lawsuits.
“There is a possibility of more litigation like this,” said Miller. “There certainly are a lot of allegations of bad conduct.”
Many other states, notably Illinois, have false claims statutes similar to Florida’s. In Illinois there is also a six-year statute of limitations, but the state made swap termination payments as late as August 2018, leaving the door open for litigation there.
While Fitzgerald and Miller’s lawsuit could lead to reforms, another potential solution to Wall Street’s predation in municipal debt markets is to eliminate the behavior altogether.
If the Federal Reserve began to lend directly to municipal governments at a zero-percent interest rate — a process that would be entirely legal — state and local governments would not only save $160 billion in interest payments every year, but they would also avoid the trap of interest-rate swaps and other complex forms of Wall Street financing like capital appreciation bonds.
“[We’re] calling on the Fed to make direct loans to states and municipalities,” said Bhatti. “The reason why you have swaps, LIBOR [London Interbank Offered Rate] manipulation, auction rate securities, and variable rate debt obligations is because we go to private markets. If the Fed would just provide the financing for free, we wouldn’t have to deal with predatory interest rate swaps.”
While the Fed did launch an initiative to purchase municipal bonds in the aftermath of the Coronavirus Aid, Relief, and Economic Security (CARES) Act economic stimulus bill passed in March 2020, the central bank ended up offering money to communities at far higher rates than it provided to Wall Street banks and corporations.
“The Fed is using public money to purchase a bond from Chevron at a rate of 0.9% over more than 4.5 years,” said then-Bailout Oversight Commission member Bharat Ramamurti, who’s now deputy director of President Joe Biden’s National Economic Council. “A state like Wisconsin, with the exact same rating as Chevron has to pay 1.28 percent over 3 years.”
Until there’s a federal solution, cities and states are left to fend for themselves. In fact, changes in Donald Trump’s 2017 tax law related to refinancing municipal bonds have been a selling point for financial firms seeking to peddle additional swap deals.
In Arizona, for example, an authority with close ties to Republican Gov. Doug Ducey is now embracing swaps, changing its regulations so it can enter into new deals that closely resemble the Orlando highway authority agreements.
Elsewhere, local reform efforts have struggled to gain traction. In Pennsylvania, legislation was introduced by a Republican state representative in 2019 that would have restricted local governments from entering into additional swap agreements. Despite the state’s acute history of misconduct in the space, the bill failed to make headway.
Back in Florida, Orange County Mayor Jerry Demings, husband of Democratic Rep. Val Demings, has proposed increasing the county sales tax from 6.5 to 7.5 percent to improve the region’s mass transit systems. The tax hike would disproportionately impact lower-income Central Floridians, but it would bring in $600 million annually.
While the tax increase is likely necessary, the money paid to the big banks over the swaps could have also helped address the problem.
“The money they spent on the interest rate swaps could double bus service alone,” said McMullen, the transit activist. “The rising cost of transit has really caused displacement. Mass transit benefits everyone — it reduces congestion, reduces carbon emissions, and saves lots of money for our vulnerable working class.”
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