Sweet Hedge Alabama: A County Defends Rate-Swap Strategy
By KAREN RICHARDSON
Staff Reporter of THE WALL STREET JOURNAL June 8, 2005; Page C1
Jefferson County, Ala., is counting on a large portfolio of sophisticated interest-rate swaps to help save millions of dollars on pedestrian public-debt projects like a new sewer system.
Federal authorities are hoping the county’s finances don’t go down the drain instead. Critics point out that the swaps currently cost taxpayers money.
Welcome to the front of a growing debate over the use of swaps by municipal governments. In their most basic form, interest-rate swaps allow parties to trade exposure to fixed- and floating-rate debt. Swaps are often used by companies, and traders, including hedge funds, often take swap positions.
Wall Street banks, such as J.P. Morgan Chase and others, and boutique municipal underwriters like Rice Financial Products in New York have been pitching local governments on swaps that can help reduce debt — or greatly magnify it. Some of the terms of these swaps are complicated and reset frequently.
The proliferation of swaps among smaller municipalities in recent years “concerns me because these things are complicated,” says Martha Haines, chief of the Securities and Exchange Commission’s municipal-securities unit in Washington. “I’m concerned that little guys are getting in and don’t know what they’re doing.”
Towns of various sizes are turning to swaps. But Jefferson County — population 660,000, about one- third of whom live in Birmingham, and 2004 revenue of $534 million — has exposure that rivals some of the biggest hedge funds: 18 interest-rate swaps with a notional, or total underlying value, of $5.8 billion. By way of comparison, Houston — the Texas town of two million people with 2004 revenue of $2.6 billion and about 80% more debt than Jefferson County — has two swaps with a total notional value of $850 million.
Bankers and consultants say Jefferson County has the biggest swap exposure for a government of its size, and the portfolio is raising eyebrows.
“The fact that they’re doing all of these trades indicates they’re speculating,” says Robert Whaley, a business-school professor of finance at Duke University in Durham, N.C. “The question is whether they have any expertise.”