By GRETCHEN MORGENSON
Published: August 6, 2011
AMID all the talk of debt and default in Washington last week, tiny Central Falls, R.I., went bankrupt.
Joe Songer/The Birmingham News, via Associated Press
A protest of potential sewer rate increases in Jefferson County, Ala. One sign took aim at JPMorgan Chase, an adviser to the county on a bond deal.
Like many states and cities in these hard economic times, Central Falls — population: 19,000 — was caught short by hefty pension obligations and weak tax revenue. It may not be the last municipality to file for bankruptcy. Jefferson County, Ala., is now on the brink of it, thanks to a sewer bond issue gone wildly bad.
But while pensions and the economy are behind many of municipalities’ troubles, Wall Street has played a role, too. Hidden expenses associated with how local governments finance themselves are compounding financial problems down at city hall.
Wall Street banks have peddled to municipalities all sorts of financial products, some of which have turned out to be costly mistakes. Testifying on July 29 at a public hearing on municipal securities sponsored by the Securities and Exchange Commission, Andrew Kalotay, an expert in financial derivatives who runs a debt management advisory firm in New York, asserted that poorly structured financial transactions involving bonds and derivatives known as interest rate swaps represented “Wall Street’s multibillion-dollar hidden tax on Main Street.”
Mr. Kalotay is talking about a type of complex financing that big banks have pushed onstate and local authorities in recent years. The arrangements are typically made when borrowers want to exchange variable-rate debt for fixed-rate obligations.
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