Will Jackson meet Jefferson County's current fate: a local government slowly dragged into bankruptcy after it bet its municipal bonds on complex derivatives?

The Jackson City Council approved a motion to enter into an interest rate swap for its 2002 and 2004 bonds with Deustche Bank and Rice Financial Products. Unfortunately for the rest of us, the gang of four who voted for this deal along with swap-promoter and Finance Director Rick Hill probably had no real idea of what they were doing, as many officials in other cities have discovered to their dismay.

The media and citizens of Jackson should hold city councilors Melton, Hill, Crisler, Bluntson, McLemore, and Tillman accountable for trying to push this on us. There was no competitive bidding. Jackson is exposed to an adjustable rate agreement similar to those that have devastated other local governments. The fees were not even mentioned or made available to the public yet we are expected to fork over millions of dollars of our money to bankers and "advisers.”

Councilman Jeff Weill of Ward 1 voted against the bill and sent this statement to Jackson Jambalaya explaining his vote:

"I had no comfort level with the swap initially proposed last November. Since that time the mayor of Birmingham's been indicted and attorneys general across the U.S. have convened grand juries looking into these schemes. They are purely fee driven. Even the 'independent' financial advisers who advised the council had an interest in the transaction, not to mention the players and the bond lawyers.

“Most of those proposing this deal worked hard to obscure the costs of issuance. As a lawyer and former prosecutor that was a giant red flag to me."

While every other municipality is running away from these instruments of financial self-destruction as fast as they can, our leaders instead choose to chain us to a ticking time bomb with these variable rates. If these variable rates go south, Jackson will pay dearly for that ten million pieces of silver. We should hold the council's feet to the fire and demand a thorough hearing on this matter as well as opening this entire process to competitive bids. Thanks to these guys, Jackson is going to be just like Birmingham in more ways than one.

Bloomberg reported how Birmingham’s Jefferson County thought it could use these swaps to its advantage as it fell for some sweet talk from Wall Street:

"The county relied on advice from a bank, JP Morgan Chase and Co., to arrange its funding, rather than use competitive bidding.

‘Like homeowners who took out mortgages they couldn't afford and didn't understand, Jefferson County officials rejected fixed-rate debt and borrowed instead at rates that varied with the market.

‘The county paid banks $120 million in fees -- six times the prevailing rate -- for $5.8 billion in interest-rate swaps. That was supposed to protect the county from rising rates for their bonds. Lending rates went the wrong way, putting the county $277 million deeper into debt..."

"Officials there (in Birmingham) relied on the advice of JP Morgan in 2002 and 2003 while refinancing almost all the $3.2 billion of fixed-rate debt that built sewers into variable-rate bonds coupled with interest-rate swaps.

Costs Spiral: When the insurers guaranteeing the bonds lost their top credit ratings and the auction-rate market seized up in February, the yield on the bonds jumped as high as 10 percent, from about three percent in January. At the same time, the swaps tied to the debt, instead of protecting against higher rates, backfired. That pushed the sewer system's annual debt costs to $460 million, more than twice the $190 million it collects in revenue..."

When Birmingham tried to escape the death spiral it faced, the bankers from New York turned into Bruno and Vito from Jersey when it failed to post $184 million collateral and was in technical default. JP Morgan and other counterparties wanted Jefferson County to raise taxes to cover the debt. Jefferson County in turn wanted Wall Street to renegotiate the swaps. One County Commissioner told the Birmingham News, "We are dealing with a virtual immovable force on Wall Street." Consequently, several commissioners are pushing the county to declare bankruptcy while the mayor of Birmingham faces criminal prosecution for receiving bribes and favors for these no-bid contracts. Such a bankruptcy will be the largest municipal bankruptcy in American history.

Birmingham is not the only city suffering from the interest rate swap time bomb. The New York Times reported the rate adjustments on these swaps harmed many small towns in Tennessee. Lewisburg, a town of only 11,000, saw its "annual interest payments on the bond had quadrupled to $1 million this year." Some municipalities tried to withdraw from these bond market traps:

In Claiborne County, north of Knoxville, officials said they were recently told by Morgan Keegan bankers that extracting themselves from a municipal bond derivative would cost $3 million, a sum the poor county cannot afford...."

In Mount Juliet, a suburb east of Nashville, city leaders were surprised to discover that the payments on its bonds had increased by 500 percent to $478,000..." New York Times story.

Officials are now negotiating the terms of the agreement with Deutsche Bank and Rice Financial Products, the two banks that will actually conduct the rate swap. The city has brought on Sterne Agee and Leach Inc., a national investment firm with an office in Jackson, to serve as its financial advisor, as well as two local law firms - Baker Donelson Bearman Caldwell and Berkowitz, and Anthony Simon - to serve as legal counsel for the transaction.

One must ask what kind of dope Mr. Hill thinks we are smoking if he expects us to buy this malarkey. Investors will be more than happy to buy variable rate debt as long as they think they can squeeze us for every cent of it. The reporter failed to ask Mr. Hill what would happen if the rates adjusted. No serious person expects the interest rates to remain near zero as they are now. As interest rates increase (not to mention the effect Obama's deficit spending will have on the bond markets) over the next few years, any deal using these variable rates will cost Jackson much more money. Something ignored by Mr. Hill while he pimped this deal for the loan sharks.

It is also troubling that the city did not advertise for bids on the refinancing. Since the fees for these refinances will cost us up to more than $4 million, Mr. Hill should have sought competitive bids. What was his criteria for choosing these banks? What are the fees going to be and why are we awarding contracts worth millions in fees without any bidding whatsoever? In fact, the story says the terms are being negotiated. The city council approved these swaps without even knowing the final terms of the agreement. As Mac would say, you CAN'T be serious.

James Hendrix is a Northsider.