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Interest Rate Swaps: Increased Risk, or Revenue?

http://2cccd5dfe1965e26adf6-26c50ce30a6867b5a67335a93e186605.r53.cf1.rackcdn.com/Swap Wrap_Mary Wilson_SOC.mp3

State lawmakers are considering changes to a Pennsylvania law aimed at curbing risky financing among municipalities and school districts.

A state law created in 2003 allows local governments to use interest rate agreements, also known as swaps.  An interest rate swap is a complicated bet that can provide up-front revenue, hence the attraction for municipalities and school districts. But since the law was passed, there have been some famous cases of cities and school districts being burned by swap agreements.

Dave Davare, with Pennsylvania School Boards Association says there’ is no way for the state to play a policing role in swaps, but there is a way for the school district or city to better protect their finances.

"Develop a contract or an agreement with their independent financial advisor that would be enforceable if it were discovered that their financial advisor was making money on the swap and that standalone contract would be enforceable," Davare said.

State Senator John Blake (D-Lackawanna) said the state law allowing municipalities and schools to use swaps needs to be revised to institute more controlls. 

"I'’m not sure that the local government officials who are making the decisions and who have an obligation to assess risk to some extent to the tax payers, are as financially literate as the professionals who are making the assessment," Blake said.

Bond lawyer and swap expert, Steven Goldfield disagrees.  He said it’'s not the state law that needs to be changed regarding the financial instrument because they can be used effectively, provided the public officials entering into the swaps understand the risk involved, and they'’re getting sound advice from a trusted financial consultant.

"I don’t want to make a blanket statement that no municipalities can handle this but this is like a loaded gun," Goldfield said.  "It can protect you, but you’'ve got to be really careful, and really trustworthy, and it could go off,  and when it does, it could be really expensive."