NYT and the 0.14% that Swallowed Your Town, pt 2

Posted by Peter Orr on May 18, 2010

Last week I embarked down a path of trying to get the NYT to correct their errors in an article ostensibly on municipal swaps. This is the second round exchange (of three) with the NYT editors justifying their mistakes in the article, The Swaps That Swallowed Your Town.  My response was simple, though I was forced to use a three number example.
Dear Editor(s),

I'll try and keep this brief.  

Given Ms. Morgenson's response, it is clear she is sorely confused about what has caused financial strain for states/municipalities.  I'll prove this simply, although I will use a few numbers - 3 to be exact.  Let's take the last year to represent our time period of market stress (though you could pick any reasonable representative period, the answer will be substantively identical).  The first number is 0.20%, which is the average of 67% of 1M LIBOR over the last year.  I use 67% because it is the most common rate municipalities have used in swaps to hedge variable rate bonds.  The second number is 0.34%.  This is the average of the SIFMA index, the index against which all tax-exempt variable rate bonds are priced.  The difference between these two numbers is the spread that Ms. Morgenson shockingly claims is outside the "narrow range."  It is this crushing differential that she, and worse, the NYTimes has told its entire readership is going to imminently "swallow" all the swap-exposed towns near you in a madly corrupt, swap induced, financial maelstrom.  And how big is this staggering, non-narrow differential???  0.14%.   Please look carefully at where the decimal point is on that number; it is no mistake. 

This would be funny if it weren't exposing such flagrant misinformation and flat out bad reporting.  And if 0.14% isn't in the "narrow range," I would ask Ms. Morgenson what is, exactly?  As a point of reference, the 2 year average differential is 0.32% so this wild differential has only gotten narrower over the last year.  The simple undeniable fact as it relates to this "narrow range" issue is that the current period actually shows one of the narrowest spreads we've seen historically, because the actual level of interest rates is so close to zero.  Again, this is simple, unalterable, basic fact that anyone can check.  I urge you to run this by your "municipal experts" in the story, or anyone else who knows something about public finance - I assure you they will agree with me.  Your readers deserve better and this egregious mistake should be corrected.  

Again, the actual reasons states and municipalities are under stress from their debt programs are exactly those that I described in my first letter: failed auction rate securities and variable rate bond programs which have lost the support of the banks. Whether those programs were hedged with interest rate swaps is an entirely separate issue, though admittedly can cause additional stress if the state/municipality chooses to terminate the swap.   

I'm sure Ms. Morgenson is a good writer; as an NYT reader I have enjoyed some of her articles in the past.  Unfortunately in this case, she is in over her head, knows only enough about the subject matter to be factually wrong, and has embarrassed the New York Times.  I believe an editor's job is in part to acknowledge and correct when the paper doesn't have its facts straight.  The premise of this entire article is clearly mistaken (I hope in good faith and not just to sell papers), and your readers deserve to know it.  There's enough falsehood in our public discourse without news organizations throwing their own rubbish onto the heap.

Happy to discuss this or the real challenges municipalities face with whomever cares about accurate reporting.  At minimum I look forward to a correction of this error.  
I was a bit edgy that day so the tone wasn't quite as constructive as I would've liked.  Nonetheless, here was the response from Dan Cooreman of the NYT Sunday biz section:
Mr. Orr:

Thank you for the additional information in your email message of last evening. But it seems that you and Gretchen Morgenson are discussing two different things.

Here is a summary of her explanation:

The spread that was referred to in the column did not refer to the difference between 67% of LIBOR and the average of the SIFMA index. When the column said the contracts assumed that the rates in the deals would stay in a narrow range, it was referring to the problems associated with spikes in interest rates on variable rate debt. When the spread between this rate and that received by the issuer from the swap counterparty blew out, it created significant problems for tax-exempt debt issuers. A crucial reason for this, as you and the column both pointed out, was the seizing up of the auction rate securities market.

As outlined in the Annual Performance Report from the New York State Division of the Budget: "In 2008-09, the crisis in the credit markets negatively affected the performance of the swap portfolio. The global credit crisis has highlighted that the use of these financial instruments can expose municipal debt issuers to large unanticipated costs. In particular, the increased costs associated with credit risk, basis risk and early termination payment risk have had a significant impact on the performance of synthetic fixed rate swaps. During the past year, the collapse of the auction rate and bond insurance market, in conjunction with rising credit concerns for a number of liquidity providers (commercial banks) caused the interest rates on certain variable rate bonds to increase to unprecedented levels. For example, interest rates on auction rate bonds in the Tobacco bond program rose to 14.2 percent from 4 percent over a one month period. The dislocation in the credit markets negatively affected more than half of the state's variable rate portfolio ($5.2 billion)."

This is the aspect of the deals that the column was referring to, not the difference between 67% of LIBOR and the SIFMA index.

Dan Cooreman
Sunday Business section
Ahh. So the article was referring "to the problems associated with spikes in interest rates on variable rate debt"? Wait, what was the title of her article again?  Somehow I don't remember seeing anything about interest rates on variable rate debt. Read the third and final chapter.