“How does it feel to work for a division that ultimately rips off the government and non-profits?” When I accepted an offer to work in investment banking I knew what I was getting into. People hate the banks, hate what they stand for, and hate what they did to the country. This comment was not simply out of the blue, though having been egged by occupiers three times while walking out of work this summer; I have become accustomed to these types of sneak attacks. It came in response to an article written in the New York Times, citing Oakland as the latest California city to be crippled with debt, and on the verge of bankruptcy.
Anyone following state politics knows that many municipalities around the country are completely collapsing under the face of financial obligations. To this point however, it has been small entities, such as San Bernardino County and the City of Stockton. But if Oakland collapses, that will surely grab national headlines. Oakland’s issues stem from their abundance of derivatives, a financial product that boils down to the trading of interest rates between a bank (in this case, Goldman Sachs) and the client (in this case, Oakland). These “bets” on the interest rate have completely gone against the city of Oakland, in the tune of $4 million per year. The city has asked Goldman to cancel the derivate, and Goldman Sachs has said “absolutely, just pay the termination agreement of $9 million and we’ll call it even.”
The best way to describe a derivative is to take you back to the lunch room when you were in elementary school. Imagine you looked at the fat kid across the table’s lunch every day and said, his lunch is really good some days, but other days, poor. His mom works so it just depends on the day. When it’s good though, it’s good… Pudding, fruit snacks, the best foods. Your lunch, on the other hand, is the same thing every single day, peanut butter sandwich and fruit. It is hardly exciting, but consistent. The fat kid across the table decides he wants some security, and you want to take a little risk, so the two of you decide you will trade lunches every day for a year, regardless of what is inside, it’s just a straight swap, every day.
At first the trade is great. His mom packs ring-dings and Twinkies every day. You have completely dominated this trade. But all of a sudden fatty’s mom picks up more hours at work. Suddenly the lunches are not so good. Some days you don’t even get a lunch. You say to the fat kid, hey, this whole lunch swapping thing isn’t working out, we should just abandon this. Now, if you’re the other kid, what are you going to say? Fuck no. That’s ridiculous he says, we made a deal and why should I cancel it because you’re getting the raw end of it?
What we’re seeing in the City of Oakland is Goldman Sachs as the fat kid. The city of Oakland bet the interest rate would rise. In the past year it has dropped nearly 20%. They lost their bet, they deserve to lose. Right? That’s how I see it, but that’s not how the public sees it. Public opinion looks at Goldman Sachs as the demonic bank responsible for the financial crisis, who in their mind is stealing money from the City of Oakland, all of those fire fighters and government workers, to line the pockets of their CEO.
But what if the swap went in the other direction? What if the fat kid’s lunches were better than anything your mom could pack? What if Oakland was receiving $4 million a year in swap payouts? Could Goldman Sachs knock on the door of the City and say, “hey we want to re-negotiate this derivative because it’s unfair.” The public would cry, this is totally ridiculous, look at the greedy bank trying to steal money from the city that they are making off a legal contract. Is the double standard becoming clearer? Debates like this are happening across the country, with the city of Detroit another municipality calling foul against Morgan Stanley. In fact, a city councilor in Detroit went as far to say, “There are moral implications here.”
Now this case looks like it may be headed to some sort of arbitration. What if it is upheld that Oakland and Detroit don’t have to pay the money back, that they are exempt from payment? What does this say to other banks around the country? Would you be willing to give out a financial derivative to a municipality if these were the rules? It’s heads I win, tails you lose, zero sum game. The market for derivatives would collapse, although these are incredibly beneficial for municipalities looking to control their level of risk. These are the kind of issues dealt with in the financial sector, and they continue to linger with public opinion on the financial sector at an all-time low.