New York City and the Metropolitan Transportation Authority likely lost millions of dollars tied to derivatives in the interest rate–fixing scandal currently under investigation by state Attorney General Eric Schneiderman — money that the MTA says it will aggressively try to recover.
An MTA spokesman told the World last week that the Authority is communicating with Schneiderman’s office about the progress of the AG’s investigation into the suspected suppression of the interest rate known as LIBOR.
“Either through these proceedings, or through separate legal action in the event that should prove most beneficial to [the] agency, the MTA will pursue full recovery from the banks involved for any financial injuries suffered as a result of suppression of LIBOR rates,” the spokesman, Aaron Donovan, wrote in an email.
With the help of Peter Shapiro of Swap Financial Group, and Johan Rosenberg of Blue Rose Capital Advisors — two experts in the types of financial instruments hardest-hit by the interest rate manipulations — The New York World analyzed the LIBOR-related costs to the city, the Municipal Water Finance Authority, and the MTA, using information found in annual financial statements.
The World’s analysis suggests the MTA’s LIBOR-related losses on its derivatives are likely at least $5 million, and could amount to as much as $8 million. Donovan declined to comment on the World’s figures.
The MTA holds derivatives called interest-rate swaps on billions of dollars of its debt. These contracts are designed to hedge against changes in interest rates that affect the cost of repaying the authority’s debt, and many are tied to LIBOR.
In the specific type of swap vulnerable to the interest rate manipulation, the MTA first issues variable rate bonds, in which the interest due to the bonds’ purchasers fluctuates with the markets.
Then, the MTA pays a bank a fixed interest rate and receives payments based on a floating interest rate in return, which it uses to compensate the bond-holders.
The goal of the swap is to protect the MTA from spikes in interest rates. But because the floating payments the authority receives are tied to LIBOR, it was vulnerable to the manipulation: when LIBOR was lower, the banks were giving the MTA less money.
Experts say that banks kept LIBOR artificially low in the years during and after the financial crisis. The alleged goal of the banks was to make themselves look healthier, but a side effect of the suppression would be shortchanging the MTA, the city, and the water authority on their swaps.
UCLA economist Connan Snider, who wrote a paper questioning LIBOR rates in 2010 — before direct evidence surfaced of the manipulation — said his research suggests that banks held the interest rate down by several tenths of a percent between the summer of 2007 and the summer of 2011. He said a very conservative estimate would peg the suppression at one tenth of one percent, while the upper limit would be four tenths of a percent.
Using two tenths of a percent as an approximation, the New York World calculated the rough cost of four years of LIBOR suppression on swaps held by the city, the Municipal Water Finance Authority, and the MTA.
In addition to the MTA’s losses, the estimates suggest that banks underpaid the city and the water authority by about $2 million each.
While those numbers are very basic estimates, they appear to be “in the ballpark,” according to Rosenberg, one of the two financial experts who reviewed the World’s numbers.
Mike Loughran, a spokesman for the city comptroller John Liu, whose office manages the city’s portfolio of bonds and derivatives with the Mayor’s Office of Management and Budget, declined to answer specific questions about the potential impact of LIBOR’s suppression on the city’s derivatives portfolio.
“We’re closely monitoring developments and are keeping all our options on the table as the financial scope of the suspected manipulations is determined,” he said in an emailed statement.
The mayor’s office and water authority did not respond to a request for comment.
LIBOR’s use is not limited to interest-rate swaps, and because of its positive impact on other types of debt and investments, such as securities tied to mortgages, the losses by the city, water authority and MTA may have been offset in other areas.
Some municipalities and public entities, however — including the city of Baltimore — are suing banks over their LIBOR-related losses, in an effort to recover money they allege they were shortchanged on derivatives trades.
Schneiderman’s office has issued subpoenas to JPMorgan Chase, Barclays, Royal Bank of Scotland, Citigroup, Deutsche Bank, HSBC and UBS, according to reports in August.
Three of those banks—JPMorgan Chase, Citigroup, and UBS — are counterparties to the MTA swaps. Public records do not disclose the counterparties on the swaps held by the city or the water authority.
While another bank, Barclays, has already settled with U.S. and British regulators over manipulation of LIBOR, it could be difficult for Schneiderman to recover money lost by the MTA and the city, according to Roberta Karmel, a professor at Brooklyn Law School who specializes in securities regulation.
“Presumably other of these big banks could confess something…but how you translate that into damages for particular injured parties, that’s much more complicated,” she said. “How do you prove on which of these days there was this kind of price-fixing, what the price would have been without the price-fixing?”
The World did not perform calculations for state debt, but an official at the office of comptroller Tom DiNapoli, which oversees the state’s derivatives portfolio, said that swap-related losses amounted to no more than five figures.