Prodded by a nationwide union campaign, the Los Angeles City Council is trying to get out of an arrangement with two banks that was supposed to reduce the city's borrowing costs but instead has increased them by $19 million annually.
City Councilman Richard Alarcon said city officials should refuse to do business with any bank that won't rework the terms of the so-called "interest rate swaps," transactions that were embraced by Los Angeles and other cities over the last decade.
Alarcon said he did not believe that the banks involved in the transaction, Dexia Credit Local and Bank of New York Mellon, intentionally sought to harm the city when the swaps were created. Still, he compared the two banks to merchants in the San Fernando Valley who sold water for $20 per gallon in the days after the 1994 Northridge earthquake.
"To me, this is tantamount to gouging," said Alarcon, who represents the northeast Valley.
The City Council followed Alarcon's lead last week, voting unanimously to instruct its financial analysts to ask the two banks to rewrite or cancel the terms of its two interest swaps. Those deals, approved in 2006, cover $316.8 million in debt incurred by a wastewater program that pays for the repair and replacement of sewer lines and sewage treatment plants, according to city officials.
The two banks involved in the transactions did not respond to requests for comment. But the Service Employees International Union, which has been staging rallies to publicize the swaps, has begun prodding other government agencies in California to follow suit.
SEIU President Andy Stern said the higher payments being incurred by local governments are the byproduct of the Federal Reserve's decision to slash short-term interest rates to record lows in 2008 to rescue the financial system.
"We bailed [the banks] out for a reason, which was to get the economy stable . . . and they're turning around and telling state and local government, 'It's your problem,' " he said.
Union leaders have tried to tie the borrowing arrangements to the budget crises plaguing many cities, which have been forced to slash payroll and impose furloughs to reduce expenses.
But Natalie Brill, the chief of debt management for Los Angeles, said the higher cost of the swaps will not affect the budget because the wastewater program is maintained separately from the general fund, which pays basic services such as police and fire protection. The general fund is expected to face a $484-million budget shortfall starting July 1.
The council ordered Brill to meet with the banks and report back to the council in 30 days. She would not say how likely it was that the city would succeed in reworking the terms. The city would need to pay at least $26 million to cancel its interest rate swap agreements, which are scheduled to expire in 2028.
Many municipalities have used swap deals in recent years to protect themselves from rising interest rates on floating-rate bonds.
In a typical swap transaction, a local government pays a bank a fixed annual rate of interest to cover a specific amount of debt, and in exchange, the bank pays the city a variable interest rate. That formula, embraced by Los Angeles in 2006, was designed to free up $3.7 million annually for the city's wastewater program, according to a report on the agreement.
For the first two years of the swap, Los Angeles was paying 3.34% and receiving between 4% and 5% from the banks, according to city officials. After the economy collapsed, the city continued to pay 3.34% but only got 0.12%.
"If the interest rates go up, they pay us," Brill said. "If the interest rates go down, we pay them."
Alarcon's measure is part of a larger union-backed legislative package that, if approved by the council, would require banks that operate in Los Angeles to report on their local investing and comply with the council's effort to minimize the harm caused by foreclosures.
Business leaders voiced dismay over that proposal, telling Alarcon in a letter that the city has neither the money nor the employees to oversee new banking rules.
"This area is already heavily regulated by state and federal agencies," wrote Carol Schatz and Gary Toebben, who run the Central City Assn. and the Los Angeles Area Chamber of Commerce, respectively.