Interest-Rate Swaps Cost Bethlehem Area School District Dearly
Ill-fated financing arrangements concocted back in 2002 by JPMorgan Chase and other Wall Street banks for a sewer project in Jefferson County, Alabama, are causing havoc once again - this time for school districts in Pennsylvania.
As reported Oct. 17 on Bloomberg.com, the Securities and Exchange Commission (SEC) is reviewing records from the Bethlehem Area School District in Pennsylvania over interest-rate swaps that the district entered into with JPMorgan and Morgan Stanley.
As in the case of Jefferson County, Alabama - which continues to teeter on the brink of bankruptcy as a result of the flawed financing deals put together by JP Morgan and others - the SEC inquiry in Pennsylvania is part of a larger investigation concerning at least $8 million in fees that Bethlehem and other school districts paid to various Wall Street banks that sold the interest-rate swaps.
Interest-rate swaps are tied to variable interest rates. The swap itself is much like a bet between the purchaser and a bank: If interest rates remain favorable, the purchaser is the winner. If market conditions create an unfavorable interest rate environment, the bank that sold the swap receives higher payments from the purchaser.
In the case of the Bethlehem Area School District, the bank is now winning. In September, the district’s weekly debt costs increased by $250,000 - nearly $1 million a month.
Just like in Jefferson Country, Alabama, Bethlehem school board members say they failed to fully understand the ramifications of interest-rate swaps at the time they approved the deal with JP Morgan and others. Only now do they realize their mistake, they say, and just how risky and speculative the derivatives market can be.
Unfortunately, hindsight is 20/20. Now, it’s left to taxpayers to pick up the pieces and pay for the error in judgment by school board members of the Bethlehem Area School District. Students, too, are going to be affected by those bad decisions. As debt costs continue to mount for the district, tough choices will need to be made, including cutbacks to educational programs and reduced services in schools.
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