The seedy underbelly of the derivatives market:
The charges filed Thursday are related to a wide-ranging government investigation of the U.S. municipal bond market. In December 2010, four federal agencies and 20 states announced a sweeping $137 million settlement with Bank of America for its role in a scam authorities said defrauded state agencies, cities and nonprofits that sought to invest with banks the millions they borrowed through bond offerings for hospitals, apartment complexes and other projects.
I know I've harped on this before, and I'm going to keep on harping until the cash cow comes home: As long as banks and other financial institutions continue to favor derivatives and other "exotic products" over sound (direct) investment in business, our economy will continue to struggle.
That settlement, which included $3.4 million for North Carolina, resulted from a 2007 leniency agreement the bank reached with the Justice Department, sparing it from criminal prosecution. Bank of America, which officials then said was the first and only company to self-report its activities in the case, paid restitution but no fines after it approached the Justice Department, prompting the investigation.
For those (like me) who aren't well-versed in bankster behavior, these transactions are 2nd- and 3rd-tier in nature. Investments that are "derived" from other investments, as it were. Meaning, while we have current businesses struggling to stay afloat due to a lack of operating capital, and prospective businesses stuck in the planning stages, banks are playing this shell game with billions that could fuel a recovery.
The settlement agreement (rotund pdf) provides some helpful info, if you're so inclined:
While the proceeds from the issuance of Municipal Bonds are usually earmarked for specific purposes, the monies often are not required to be spent immediately. For instance, if the bond was issued to fund the construction of a stadium, the Issuer may only have an immediate need for a portion of the proceeds raised through the bond offering. The remainder typically is placed in an account that can be drawn upon as construction~related expenses are incurred. In such cases, the Issuer may seek a safe interest-bearing investment vehicle in order to earn interest on the funds until they are ready to use.
Investment agreements used to invest the proceeds from a Municipal Bond issue include forward purchase, supply or delivery agreements, repurchase agreements, certificate of deposits on escrows and secured ("collateralized") and unsecured Guaranteed Investment Contracts (collectively, "Municipal InvestmentProducts").
Apart from Municipal Investment Products, Issuers also utilize various hedging instruments and strategies designed to manage or transfer the interest rate risk associated with the issuance of bonds, such as swaps, options, "swaptions," collars, caps, and floors (collectively, "Municipal Risk Management Products").
Municipal Risk Management Products are risk management tools used by many Issuers of long-term debt to hedge, offset, or reduce the cost of borrowing by managing the short and long-teon risks associated with fluctuating interest rates. A Municipal Risk Management Product is usually a contract under which each party agrees to make periodic payments to the other for an agreed period of time based upon a notional amount of principal. In one such type of product, an interest rate swap, one party agrees to make payments to the other based on a fixed rate in exchange for payments from the other party based on a floating rate.
Much like the skewed formula that drove the housing meltdown, officers and brokers are driven (hard) to finalize these transactions. It is only then that commissions are made, promotions are secured, etc. As such, the same problems of misrepresentation of value and risk are present, which will eventually lead to a loss of wealth, and a continuation of our current recession.
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