Wednesday, April 08, 2009

Cities Got Suckered by Predatory Banks, Too

The common counterargument from conservatives I get when I advocate regulating lending in the wake of predators who prey on the unknowing is some version of caveat emptor: that buyers should know what they're getting themselves into in these deals.

Well, one small Tennessee town demonstrates that its not just individuals that can be easily suckered by pushy and unforthcoming lending institutions. The Lewisburg Mayor tells the NY Times flat out that labyrinthine guidelines and stipulations to the financial world make municipal navigation impossible without some private financial advisor who usually has a stake in the recommendations. Allow me to insist that the maze is set up to conceal corporate intentions and confuse consumers, including cities themselves.

But the State of Tennessee and the Governor's Office shares much of the blame in this case, because of the lack of regulation and late response in the wake of the newspaper's investigation:
Lewisburg is one of hundreds of small cities and counties across America reeling from their reliance in recent years on risky municipal bond derivatives that went bad. Municipalities that bought the derivatives were like homeowners with fixed-rate mortgages who refinanced by taking out lower-interest, variable-rate mortgages. But some local officials say they were not told, or did not understand, that interest rates could go much higher if economic conditions worsened — which, of course, they did.

The municipal bond marketplace was so lightly regulated that in Tennessee Morgan Keegan was able to dominate almost every phase of the business. The firm, which is based in Memphis, sold $2 billion worth of municipal bond derivatives to 38 cities and counties since 2001, according to data compiled by the state comptroller’s office.

After The New York Times made inquiries, the Tennessee comptroller, Justin P. Wilson, ordered a statewide freeze on bond derivatives and a review of the seminar taught by Morgan Keegan and others.
The article goes on to describe how Mount Juliet got snookered by Morgan Keegan as well.


  1. don't agree entirely with the idea that Morgan Keegan was "snookering" or "hoodwinking" or "okeydoking" anyone. there is general agreement that the catastrophe that happened in 2008 was a perfect storm, the likelihood of which was somewhere around 0.0000001%.

    the real problem was that once the systemic failure started, it was hard to stop it. CDS, MBS, CDOs, etc., were all so complicated that people didn't react to the overleveraging quickly enough. there was also a belief (proven wrong now) that if you spurred growth (which Lewisburg and Mount Juliet did), you were basically "fireproof" and could make money even in a down market. as it turned out, this was a huge gamble. lewisburg and mt juliet leaders knew it. they knew that they were making a bet. they thought they could win the bet. they lost.

    welcome to the post-Friedman world.

    Arthur Laffer, by the way, is a total idiot.

  2. there is general agreement that the catastrophe that happened in 2008 was a perfect storm

    Which leaves you to explain how Regions-Morgan Keegan investment funds lost over 60% of their par value in 2007.

    And I quote:

    "Investors in six Regions Morgan Keegan (“RMK”) bond funds lost $2 billion in 2007. This paper explains how extraordinary and undisclosed risks
    allowed these funds to generate higher returns than their competitors for many years but ultimately caused the funds’ collapse in 2007.

    The investors’ losses were not the result of a “flight to quality” or a “mortgage meltdown.” Diversified portfolios of high yield bonds and mortgage-backed securities did not suffer significant losses as the RMK funds suffered massive losses. The RMK funds collapsed because they held concentrated holdings of low-priority tranches in structured finance deals backed by risky assets."

    RTWT. It's instructive.

    And keep in mind that a lot of Bass Berry & Sims alumni hold powerful positions in state government. Bob Cooper, the state attorney general, is a former BB&S partner, e.g.

  3. This is not a "perfect storm." This is a storm of our making through a combination of lax enforcement, indifferent regulators, ineffective and out-of-date-law.