Overspending or Overempowered? Part II – The Transfer of Income from Taxpayers to Banks

By Amanda Page-Hoongrajok

Part II of of a two part series. Here’s Part I.

The implication of banks’ power over state and local budget management is that money is effectively being transferred from residents of the locality to big banks.  Public schools are being shut down, social services to the economically most vulnerable are cut while banks take in millions of dollars in fees and interest payments.

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As discussed in Part I in the Detroit case, cities have responded to budget shortfalls by cutting their expenses, but budget deficits can persist from depressed revenues and ballooning financial expenses. For example, a third of the City of Oakland’s expenditures in 2012 were financial.  When such sizable portions of revenue flows to the financial sector, municipalities must cut vital social services, especially public school resources and jobs but not limited to libraries, community centers, and public transportation.  For example, Wisconsin Gov. Scott Walker proposed cutting $300 million dollars from UW system, $127 cuts to public k-12, in order to spend $400 million between swaps and cancellation fees.

Solutions?

Are state and local governments helplessly trapped in toxic deals with the big banks? The ReFund America Project and other research organizations say no.  In a series of case studies, they outline several short-term and long-term solutions to budget shortfalls due to financial deals.

First, the deals between municipalities and big banks which were discussed above may have been predatory in nature. The Municipal Securities Rulemaking Board (MSRB) Rule G-17 states that banks must engage in “fair dealing” with municipalities, prohibiting them from “misrepresenting or omitting facts, risk, potential benefits, or other material information.” Since banks benefit disproportionately from these deals, the fair dealing rule may have been broken.  Bhatti and Sloan document the potential cases in which fraudulent dealings may have occurred[1], entitling municipalities to renegotiations, if not complete refunds, for the losses state and local governments incurred. Municipalities should investigate their specific financial contracts with the big banks and approach the SEC for disgorgement – meaning a refund of all of the payments municipalities made on the deals. Banks can also illegally manipulate key interest rates, looking to profit from their positions.  The ReFund and ReBuild Oakland Coalition has estimated a loss of $15 million due to banks illegally depressing the LIBOR. Even if the dealings were completely within the law, there is precedent for renegotiation. JP Morgan restructured the San Francisco Asian Art Museum’s debt with a mixture of forgiveness, changing the museum’s portion of outstanding bonds from variable to fixed rate, and canceling the swap agreement.

A longer-term solution is to create state/municipal bargaining space by cooperating with other cities/states.  Bhatti and Sloan demonstrate the amount of economic power the cities can wield.  New York City, Los Angeles, and Chicago, and Cleveland hold over a half trillion dollars worth of financial leverage.  These cities and other localities could coordinate and threaten to collectively take their business out of the major banks unless they negotiate deals.  Some municipalities and organizations have already retracted or threatened to retract their business from big banks.  Oakland has threatened to not do business with Goldman Sachs and the SEIU has highlighted Minnesota school districts do not have to work with Wells Fargo.  Chicago Teachers Union recently closed their Bank of America account.

Pooling accounts together to form a significant chunk of the major banks business is one way to develop bargaining power.  Another way is to figure out who to turn to when big banks do not offer fair, transparent deals. The banks have power over municipalities because municipalities cannot finance projects without the services of investment banks. Thus creating viable alternatives to investment banks can create bargaining space for state and local budget officials. Bhatti and Sloan recommend that the City of Chicago create a public bank.  The only public bank in the US, the Bank of North Dakota has operated for over a hundred years and sustained in the face of the crisis.  The Bank of North Dakota can be looked at as a model for other cities to build alternatives to big banks that leverage their power over municipalities to extract resources from them.

Why should we still care about deals made before the financial crisis? The variable rate bonds are long-term, lasting 20 or even 30 years, meaning this transfer of income from public budgets will continue unless state and local governments can restructure their contracts with the big banks. State and local governments need to break free from these deals through legal channels, creating pressure, and coordinating with other municipalities – therefore reclaiming revenue from the big banks back to public services like schools and transportation.

 

[1] This includes but not limited to failing to explain risks, encouraging long durations, disclose the bank’s relationship with interest rate indices
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References

Bhatti, S. & Sloan, C. (2016). Turned Around: How the Swaps that Were Supposed to Save Illinois Millions Became Toxic. Roosevelt Institute.

Bhatti, S. & Sloan, C. (2015). Our Kind of Town: A Financial Plan that Puts Chicago Communities First. Roosevelt Institute.

Sloan, C. & Bhatti, S. (2015). Wisconsin’s Dirty Deals. Roosevelt Institute.

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