The NYTimes and the 0.14% that Swallowed Your Town, pt3 (final)

Posted by Peter Orr on May 31, 2010

In the 2nd post on the topic, Dan Cooreman of the Sunday Business section indicated that the problems Gretchen Morgenson spoke to in her article,The Swaps That Swallowed Your Town, were in fact related to the variable rate instruments.  He seemed to agree with exactly my point but ultimately, my final words (below) to the Times editors on the topic have gone unanswered.


Thank you for the response, Mr. Cooreman, and the quote from the NYS Division of Budget.  You have hit on, and seemingly agreed with, exactly my point - if what Mrs. Morgenson was talking about was how "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" why wasn't the headline, "Auction Rate Securities and Bad Variable Rate Bonds Gobble a Gotham Near You"?  Did someone bury the lead?  If it's the auctions and variable rate securities that are swallowing your nearest town, where is the "ensnared in the derivatives mess" coming from in the article?  Why is it all about how interest rate swaps have caused a problem???  The fact is, in the vast majority of cases, they didn't. 

The critical background Ms. Morgenson seems to misunderstand is that interest rateswaps are only really useful for hedging interest rate risk.  They are not designed to hedge the fragility of the auction rate market, the melting down of MBIA, Dexia's balance sheet exposure, or "credit concerns for a number of liquidity providers."  Blaming the swaps for these problems (the headline is about swaps after all) is akin to having a fearsome headache after a late night and blaming the hat you're wearing in the morning for the pain.  Here's the equivalent headline, "Knit Cap Causes Enormous Hangover."  The cap is there to keep your head warm, not fix your headache, and it certainly didn't create your hangover in the first place.   

The reporter has conflated every possible economic and financial event that could impact an issuer's specific auction or variable bond rate, and then blamed interest rate swaps for not hedging them all.  This is again, dead wrong.  These interest rate swaps were never designed to remove all the risks inherent in an auction or variable rate borrowing program, and to imply otherwise is again, fundamentally incorrect.  And anyone in public finance who's worked on these structures knows it.

The story in its entirety is misleading at best but this sentence in particular, "The contracts, however, assumed that economic and financial circumstances would be relatively stable and that interest rates used in the deals would stay in a narrow range." is patently untrue, and there's no way to avoid it.  New York Times readers deserve a clarification.  And the talented public finance officials who structured these transactions on behalf of taxpayers, prudently and with the best information available at the time, are owed even more. If the New York Times is going to Monday morning quarterback the credit crisis, at least get the facts right.

On this Memorial Day, my dad the Navy officer and Korean War vet may not have fully approved of my sneaking in some work-related activity.  That said I'm pretty sure my dad the writer and English Lit major wouldn't get too bent.  Thinking of you...