Losses Mount in Birmingham
Alabama county refuses to pay lenders $200 million in margin calls.
Jefferson County, Alabama probably wishes it never heard of an interest rate swap.
The Wall Street Journal reports the county -- home to Birmingham -- has refused to post the $200 million its lenders asked for after losses on its portfolio of interest rate swaps. These derivative contracts enable investors to hedge exposure from interest rate spikes while reducing borrowing costs.
Turmoil in the fixed income markets has hammered the value of the contracts, and the county received what amounts to a margin call on its $5.4 billion swap portfolio. Moody's (MCO) notes Jefferson County has $3.2 billion in debt, and is the only county it's aware of with more interest rate swaps than outstanding bonds. Officials claim the county has no plans to declare bankruptcy, but rating agencies have already started downgrading its debt.
Jefferson County told lenders Bear Stearns (BSC), Bank of America (BAC), JP Morgan (JPM) and Lehman Brothers (LEH) it couldn't post the additional collateral without defaulting on its bond payment obligations. The downgrading of the county's bond insurer, Financial Guarantee Insurance Company, has also pushed its financing costs as high as 10%, up from previous levels of 3% to 4%.
One would think the credit crunch would push counties, states and pension funds to scale back risky investing to preserve capital and safeguard portfolios. But nothing could be further from the truth. South Carolina is looking to capitalize on mortgage market dislocation, the Pension Benefit Guaranty Corporation is doubling down on U.S. equities and Calpers is jumping on the commodities bandwagon.
If a loss on interest rate swaps for a non-financial firm rings a bell, it should. Back in December Professor Depew noted that CKE Restaurants (CKE) lost $1.8 million on similar swap contracts. "Many companies today," he wrote, "are essentially funds masquerading as businesses." It looks like masquerading isn't just for fast food chains.
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