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That's what happened to Orange County a couple of decades ago and caused them to declare bankruptcy. Just like states/localities are barred from running budget deficits, they should also be barred from trading derivatives (complex financial instruments). It's very hard to maintain oversight of governments that take these off-balance-sheet risks (i.e., risks that don't show up as liabilities on a balance sheet).

The financial products that got transit agencies in trouble are called interest rate swaps — deals that were supposed to protect transit agencies against increases in borrowing costs

The financial products did (do) in fact protect transit agencies against increases in borrowing costs. The transit agencies essentially purchased insurance against a future event that would have been bad for them. Just because that potential future event didn't happen, doesn't mean you get your money back. It's like asking for your premiums back from an insurance company because your house didn't end up catching on fire.

“Banks sold these deals as insurance policies that would let taxpayers lock in lower interest rates without having to worry about rates shooting up in the future,” the organization says in the report. “However, these deals were actually more of a gamble than an insurance policy.”

Every insurance policy is a gamble. You're gambling that the payout of the policy will be greater than the premiums you pay for the insurance.

by Falls Church on Jun 11, 2012 10:52 am • link • report