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Chicago Teachers Union says ‘swaps’ payments sap schools

Updated: July 3, 2011 1:02PM

Four investment banks are costing the Chicago Public Schools $35.9 million in annual interest payments tied to so-called swaps contracts that have turned “toxic” for taxpayers, the Chicago Teachers Union charged Wednesday.

The union said the banks should renegotiate the swaps or let the school system out of them entirely. Doing that would be only fair, as some of the banks received taxpayer bailouts and all benefited from federal policies that steadied the system after the financial crisis hit in 2008, the CTU said.

But the full picture may be more complex. Swaps are side deals over exposure to changes in interest rates. One party, the schools in this case, pays interest at a fixed rate each month while the banks pay the schools interest at a variable rate.

Governments usually sign the deals to hedge against risk elsewhere from debt that carries floating interest rates.

When rates rise, government borrowing costs also grow but swaps could reduce that payment. With interest rates at historic lows, governments pay more for swaps protection but also pay less to borrow money.

The idea is that the costs are supposed to even out and give governments predictability in their financing expenses.

The banks that hold swaps for Chicago schools are Bank of America Corp., Goldman Sachs Group Inc., Royal Bank of Canada and Loop Capital LLC.

Schools spokesman Franklin Shuftan said the agency is satisfied with its swaps agreements, in part because “CPS actively monitors all credit risk and market conditions with its swaps.”

Shuftan also said the contracts are a hedge and not used for speculation.

Records show that for one swaps deal with Loop Capital, CPS pays a fixed 3.66 percent while the bank pays back a floating rate close to 0.05 percent. The difference is caused by historic lows in interest rates.

The teachers union said the swaps have produced a $120.7 million net loss for the schools since 2003. One such agreement extends until March 2036.

Banking industry leaders have said many customers benefit from swaps protection. They also insist that swaps payments aren’t profit; they are often sent to other investors because the banks hedge their own interest-rate risk.

Swaps have drawn fire in Los Angeles, where city officials have asked two banks to renegotiate contracts. A union in Los Angeles said the contracts cost the city $19 million annually.

Several other cities also are looking at the issue, or considering a ban on on municipal business with banks that do not rewrite their swap deals.

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