• Message to Mayor Emanuel: Play Hardball with Wall Street

    May 6, 2015Saqib Bhatti

    Last week, Mayor Rahm Emanuel announced that he plans to preemptively terminate a large portion of the City of Chicago’s remaining interest rate swaps, which will cost taxpayers $200 million in penalties. He is trying to sell this as a shrewd move that will protect Chicago from future risk and help return the city to financial health. Nothing could be further from the truth.

    Last week, Mayor Rahm Emanuel announced that he plans to preemptively terminate a large portion of the City of Chicago’s remaining interest rate swaps, which will cost taxpayers $200 million in penalties. He is trying to sell this as a shrewd move that will protect Chicago from future risk and help return the city to financial health. Nothing could be further from the truth. In reality, this is little more than a capitulation to Wall Street that will guarantee maximum profits for banks at taxpayers’ expense. This is the moment for the mayor to play hardball and force the banks to take significant concessions to protect the interests of the city’s communities and its bondholders alike. He can do this by suing the banks for misrepresenting risks associated with these deals, in violation of their duty to deal fairly with municipal borrowers, and by initiating a debt strike against the swap counterparties by strategically defaulting on the swap payments.

    Emanuel’s decision to pay the banks the full face value of the swap penalties is indefensible. When the termination clauses on Detroit’s swaps were triggered, a federal judge pushed the city to drive a hard bargain with the banks and forced them to take a 75 percent haircut on the penalties. The judge made clear that he believed the city had a strong argument to declare the swaps invalid and said the city would be “reasonably likely” to prevail if it took legal action to get out of the deals. The judge encouraged the city to stop making payments on the swaps and to sue the banks instead. As a result of these negotiations, the city paid just $85 million in penalties instead of $347 million.

    Emanuel similarly has a strong argument that the banks that sold toxic swaps to both the City of Chicago and Chicago Public Schools (CPS) did so illegally, and he should use both the legal and financial options at his disposal to get a better deal from the banks. Instead of giving away $200 million to banks, the mayor should launch a debt strike against the swap counterparties. He should refuse to pay them another dime on the city and school district’s swaps. Corporations often use this tactic, which they call a debt moratorium, to increase their leverage in negotiations with creditors. Emanuel should also sue the banks to recover $1.3 billion in past and future payments on these deals. This would give the city and CPS tremendous leverage to extract major concessions from the banks and renegotiate these toxic deals.

    The course that Emanuel has instead chosen, to preemptively pay the banks $200 million in penalties to terminate the swaps, will actually serve to maximize taxpayer losses rather than save the city money. The penalties are calculated based on the interest rate environment, and because variable interest rates are still at record lows, it means that paying the banks now guarantees that the city will pay a higher amount than if it has to terminate the swaps later. There is a growing consensus that the Federal Reserve will start raising interest rates soon, which will drive these penalties down. Now is the worst possible time to voluntarily pay these penalties, especially because the mayor actually has a lot of leverage to get a better deal for Chicagoans, if he chooses to exercise it.

    Playing Hardball with Wall Street

    The amount of the termination penalties is not set in stone. When a swap termination event occurs, municipal borrowers and banks typically enter into negotiations with each other, during which cities can use legal and financial leverage to get a better deal. The reality is that Chicago has a lot more leverage in these negotiations than its swap counterparties. For one, the city has a very strong legal argument that the banks that pitched its swap deals violated their legal duty to deal fairly with the city by downplaying and misrepresenting risks and failing to mention that many of them were rigging the interest rates that the swaps were based on. The city should take legal action to get out of these deals. But beyond that, the city also has tremendous financial leverage vis-à-vis the banks, because it could simply stop making its swap payments, which would actually free up money for the city’s residents, pensioners, and bondholders. In Detroit, a federal judge advocated both of these strategies, and the city was able to save $262 million on its termination penalties as a result.

    Suing the Banks

    When the City of Detroit was placed under an emergency manager in 2013 and then filed bankruptcy, it triggered termination clauses on its interest rate swaps, which came with hefty penalties that stood at $347 million according to the city’s bankruptcy filing. Through negotiations, the banks agreed to settle for just $250 million. The bankruptcy judge rejected this settlement, and urged the city to either negotiate a better deal or file a legal challenge against the swaps. The city and banks went back to the bargaining table and came back with an offer to settle for $165 million. The judge again rejected the proposal, saying that, “In the absence of this settlement, the city might pursue an underlying claim challenging the swaps themselves,” and adding that the city would be “reasonably likely” to be successful in such a challenge. Ultimately, the judge approved an $85 million settlement, a 75 percent discount on the original figure of $347 million.

    This should be a lesson for Emanuel. Of course Detroit, unlike Chicago, got its swap termination penalties reduced during the course of bankruptcy proceedings. The judge’s legal rationale, however, was not tied to the specifics of the bankruptcy process. He believed the swaps themselves were likely invalid based on the facts of the underlying deals and that the city would have been on strong legal footing if it had stopped making payments altogether.

    Similarly, Emanuel should challenge the legality of the city’s swap deals and those of CPS and use that legal leverage to try to get a better deal. Whereas Detroit was able to make the banks take a 75 percent haircut on its penalties, Emanuel is proposing to pay the banks 100 cents on the dollar. That is financially irresponsible.

    Although city officials often worry that they will get cut off from the credit markets if they sue banks, these concerns are unfounded because the interests of bondholders and swap counterparties are actually at odds with each other. In Detroit, bondholders were actually advocating for the city to take an even harder line against the banks because the swap penalties would have left less money for the bondholders. Many of the city’s creditors objected even to the final $85 million settlement. In fact, taking legal action against the banks should theoretically improve Chicago’s standing among bondholders, because it would free up money for payments to bondholders.

    Instead of preemptively paying Wall Street $200 million in penalties to terminate the swaps, Emanuel should sue the banks to recover nearly $800 million in past and future payments on the deals for the city and $500 million for CPS. The banks that pitched these deals like violated the fair dealing rule of the Municipal Securities Rulemaking Board by misrepresenting or omitting “the facts, risks, potential benefits, or other material information” with respect to these deals. Emanuel has several legal options at its disposal to recover that money, including filing a lawsuit in state court for breach of contract.

    Launching a Debt Strike

    In addition to suing the banks, Emanuel should also follow the Detroit bankruptcy judge’s advice and refuse to make any more payments on the swaps. The banks have little leverage to compel the city to pay. The worst they can do is terminate the swaps and demand the city pay $200 million in penalties, but since Emanuel already stands ready to pay them that, the city really doesn’t have much to lose. In fact, Emanuel should coordinate with the city’s other governmental units that also have interest rate swaps and launch a coordinated debt strike against their swap counterparties. Corporations routinely use this tactic, which they call a debt moratorium, to increase their leverage in negotiations with creditors and compel them to write down debt.

    Chicago Public Schools is already facing more than $260 million in penalties because the termination clauses on its swaps have already been triggered. The city’s enterprise funds also have swaps tied to their debt that could carry penalties of more than $200 million if the funds’ ratings are downgraded. Between the city, its enterprise funds, and CPS, Emanuel controls more than $660 million that the banks want. This represents money that is pure profit for the banks—they have not lent the city or CPS any money against this amount. Instead, interest rate swaps are side deals that simply involve an interest rate exchange between two parties—an exchange that has turned into an unexpected windfall for banks as a result of the financial crash that they caused.

    If Emanuel were simply to withhold this money, the banks would be at a loss. Banks cannot compel municipalities to file bankruptcy to try to recover this money (and in Illinois in particular, municipalities are not allowed to file bankruptcy anyway). They could seek a court order, but if Emanuel were also to take legal action against the banks, the judge could very well grant a stay on any payments until the court case was resolved, which could take years and would involve a discovery process that would likely be embarrassing for the banks. That would leave the banks with two options: strike a cheaper negotiated settlement like Detroit’s counterparties did, or risk an adverse court ruling through which they could actually be forced to pay back the city and CPS all the money they have already made on these deals—up to $1.3 billion.

    Some may have concerns that strategically defaulting on the swaps would cause the city’s credit ratings to slide further. However, the city’s bonds are already trading at junk levels. Moreover, the rating agencies have already made clear that they intend to further downgrade Chicago’s credit rating anyway when the state’s blatantly unconstitutional “pension reform” bill is overturned by the Illinois Supreme Court. Ironically, a strategical default on  swap payments could actually improve the city’s credit rating, since it would free up more cash for payments to bondholders, as mentioned above.

    The Termination Penalties Maximize Bank Profits

    Instead of using the city’s leverage to drive a hard bargain with the banks, Emanuel is proposing to preemptively terminate the swaps and pay $200 million in penalties. The mayor’s contention that doing this will protect the city against future termination risk is illogical. In effect, his argument is that he is eliminating the risk that the city could be forced to pay banks $200 million in the future by paying them $200 million now. He isn’t eliminating the risk; he is realizing it by voluntarily signing a $200 million check to Wall Street. This may be proactive, but that’s cold comfort to the Chicagoans who need that $200 million to fund essential services in their communities like mental health clinics and libraries. This $200 million payment isn’t just bad for communities, it is also bad finance.

    The standard interest rate swap contract has termination clauses built in. If any “termination events” take place, then the bank has the right to terminate the swap and collect termination penalties. These termination events include credit rating downgrades below a certain threshold, among other things. In the case of Chicago, further downgrades in the city’s credit rating could trigger termination clauses on the its swaps. Conversely, if a municipal borrower wishes to terminate a swap, it may do so at any time by paying the termination penalty to the bank. This is what Emanuel has decided to do.

    These termination penalties are equal to the fair value of the swap at the time that it is terminated, which is calculated as the net present value of all future payments on the swap over its remaining life, based on the current interest rate curve. What that means is that these penalties guarantee the banks all of their future profits on the swaps. The standard way the penalties are calculated does not change regardless of which party terminates the swap or for what reason. Emanuel is not saving Chicago any money by terminating the swaps, but instead is simply choosing to absorb those losses now, so he can claim he was proactive.

    In reality, the city is actually likely to save money if he waits. Variable interest rates have been stuck at historic lows since 2008, when the Federal Reserve slashed rates to near zero in response to the financial crisis. This has caused taxpayer payments on all traditional interest rate swaps in the country to balloon. Chicago now pays approximately $70 million a year on its swaps, and CPS pays another $36 million a year. Because the termination penalties represent future payments based on the current interest rate curve, this has also caused the penalties to skyrocket. As the Federal Reserve gradually increases interest rates, which it is widely expected to do, these penalties will come down. By paying the banks $200 million now, while rates are still at historic lows, Emanuel will guarantee that the banks get a larger payment than they would if the swaps were terminated six months or a year from now.

    Furthermore, the mayor plans to issue new debt to pay off the $200 million. What that means is that Chicago taxpayers will also be stuck paying interest on this $200 million for the next 30 years or so. On traditional 30-year bonds, the interest ends up being roughly equal to the principal, which means these termination penalties could end up costing taxpayers around $400 million.

    * * * *

    Emanuel is trying to spin his decision to pay the banks $200 million to terminate the city’s swaps as a bold move that will save the city money in the long run. This is untrue. Paying the banks now would amount to little more than a handout to Wall Street that would maximize their profits at taxpayers’ expense. First of all, there is no financial benefit to paying the banks early since interest rates are expected to rise, which would cause the penalties to decline. Secondly and more importantly, the city has tremendous legal and financial leverage to get a better deal from the banks and could likely bring the $200 million penalty down to a fraction of itself if Emanuel played hardball. If he sued the banks, the city could win nearly $800 million in past and future payments and CPS could win $500 million. If he launched a debt strike against the swaps, the banks would have limited recourse. Instead of paying the banks $200 million in a feeble attempt to put the swap fiasco behind him, the mayor should take legal action against these toxic swaps and immediately cease all payments on these deals. That would be the bold thing to do.

    For more bold solutions that Mayor Rahm Emanuel can pursue to bring new, progressive revenue into Chicago’s coffers, see the ReFund America Project’s report, Our Kind of Town: A Financial Plan that Puts Chicago’s Communities First.

    Saqib Bhatti is a Roosevelt Institute Fellow and Director of the ReFund America Project.

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  • L.A. Port Truck Drivers Put Their Jobs on the Line for Decent Pay and Cleaner Air

    May 5, 2015Richard Kirsch

    Following the most recent work stoppage by port truck drivers in southern California, Los Angeles Mayer Eric Garcetti announced the formation of a new employee-owned trucking company, which will be a model for good pay and protecting the environment. The announcement takes the port drivers' ongoing protest of low-wages and exploitative working conditions to a new level.

    Following the most recent work stoppage by port truck drivers in southern California, Los Angeles Mayer Eric Garcetti announced the formation of a new employee-owned trucking company, which will be a model for good pay and protecting the environment. The announcement takes the port drivers' ongoing protest of low-wages and exploitative working conditions to a new level.

    Eco Flow Transportation’s founding came out of a long-running dispute between port drivers and Total Transportation Services, which had fired some 35 drivers who had filed claims for their unlawful misclassification as independent contractors and for illegal deductions from their paychecks.

    The new company, breaking with the widespread, illegal practice of treating drivers as independent contractors, already employs 80 drivers with a goal of expanding to 500 within a year. The firm promises to be neutral in efforts by its employees to join the Teamsters Union, which has been supporting the drivers’ protests and legal actions against misclassification as contractors.

    Eco Flow also aims to address diesel pollution from port trucks that are not maintained at standards, established in 2008, which aimed at drastically lowering the environmental health threats from the trucks. A court ruling in 2010 effectively placed the cost of maintaining clean trucks on drivers. The port drivers, who are forced by the trucking companies to be “independent contractors,” work an average of 59 hours a week, with take-home pay of under $29,000. The drivers’ low-pay makes it difficult for them to keep trucks at a level to meet clean air standards. But because Eco Flow owns the trucks, it assumes full responsibility for maintaining the fleet’s clean air standards.

    Eco Flow is also working to introduce a new model for the ports, called “free flow” cargo, which can help move cargo out of terminals more rapidly and increase the velocity of Port of Los Angeles terminals. The benefits will be less pollution from idling trucks and less port congestion. More efficient deliveries will also make it easier for the firm to pay the drivers a decent salary. This is a sharp contrast from most port-trucking companies who, by treating drivers as contractors, pay them by delivery and so pass on the cost of idling time to the drivers.  

    What does it take for workers to risk their jobs in actions that often result in retaliation by employers? I talked with Nick Weiner, an organizer at Change to Win, about the transformation that port drivers went through over several years, which led them to go from accepting their status to protesting.

    Q: What has been the barrier to port drivers taking actions?

    Weiner: The Teamsters have tried over the last 30 years but failed because we’ve allowed the illusion that drivers are independent contractors to drive strategies in the past. The drivers had used the language of the boss—calling themselves independent owner-operators. Part of the helping them come together was to use different language, so they could engage one another.

    In ’96 in L.A. there was a big strike. And there were smaller ones. All failed, because drivers didn’t have right language, and didn’t engage government officials to enforce law. We learned our history.

    Sometimes they said, ‘we want to be reclassified as employees.’ But they weren’t saying – ‘we are your employees now.’ That’s what’s needed to go from defensive. It’s not just we want to be employees and everything is fine. It’s by being employees, we can join a union and negotiate a contract. The end is not being an employee; there are a lot of employees not doing well.

    We have this term misclassification—a very wonky, inside-baseball but now it means something. ‘Yea, we know we’re misclassified. It means taking away our rights, employers stealing from us.’ New language has been liberating.

    Q. How do drivers get an understanding of how they could do better through organizing?

    Weiner: Drivers see that [unionized] longshoremen get treated well: they are paid well, get time off. While the drivers sit for hours on line [at the ports], without getting paid. They’ve come to see that the do critical work and are the largest set of workers in the port economy who are left out of the prosperity of the port economy.

    We’ve worked to tie those things together, being employees and the union. They thought they needed to deal with misclassification and then organize. Instead, needed to get them to understand you’re an employee now, you can organize now.

    It takes time for drivers to undo the brainwashing. To engage in collective struggle. 

    The collective struggle has taken two forms. The first has been a series of unfair labor practice pickets, aimed at specific companies, which block access to the ports of those companies trucks. The second is legal action under California law. Drivers have filed more than 400 claims against companies under California’s wage and hour law. The first 19 rulings resulted in an average award of $66,240, largely for wage and hour violations and illegal paycheck deductions for items like truck leases.

    The drivers are also filing complaints with the National Labor Relations Board (NLRB), which governs union organizing.

    Slowly, the organizing is paying off. One firm, Green Fleet, avoided being picketed last week by reaching a comprehensive labor peace agreement with the Teamsters. After a U.S. Department of Labor ruling, another firm, Shippers Transport Express, reclassified its "independent contractors" as employees and in February signed a contract with the Teamsters, which resulted in higher pay and fully paid health care benefits for the drivers.

    The growing militancy of exploited workers, from Uber drivers to Wal-Mart “associates” to home care workers and many more is building a new movement of workers to challenge the 21st century economy, in the same way that workers built the labor movement 100 years ago. Their organizing and militancy helped drive the New Deal economic reforms which built the middle class in the 20th century. The fight of today’s workers is laying the foundation for the reforms we need to rebuild the middle class today in an economy based on good jobs and environmental sustainability. 

    Richard Kirsch is a Senior Fellow at the Roosevelt Institute, a Senior Adviser to USAction, and the author of Fighting for Our Health. He was National Campaign Manager of Health Care for America Now during the legislative battle to pass reform.

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  • Will the 2016 Election Include a Real Debate About Racial Justice in America?

    May 1, 2015Andrea Flynn

    Hillary Clinton's bold speech was a good start, but events in Baltimore show we're still a long way from addressing inequities.

    Earlier this week Hillary Clinton used the first major policy address of her campaign to speak passionately about the systemic inequities and injustices that afflict communities of color in the United States, and presented herself as a markedly more progressive, empathetic, and authentic candidate than we’ve seen in the past.

    Hillary Clinton's bold speech was a good start, but events in Baltimore show we're still a long way from addressing inequities.

    Earlier this week Hillary Clinton used the first major policy address of her campaign to speak passionately about the systemic inequities and injustices that afflict communities of color in the United States, and presented herself as a markedly more progressive, empathetic, and authentic candidate than we’ve seen in the past.

    Clinton’s remarks at Columbia University come against the backdrop of protests and unrest in the streets of Baltimore following the death of Freddie Gray, whose spine was nearly severed while in police custody. As Andrew Rosenthal wrote in The New York Times yesterday, our nation’s leaders should be at the forefront of a national conversation on “race, policing, and the crisis that exists in so many of our cities.” In many ways, Clinton’s remarks show she knows what the contours of that conversation should be, and that she has what it takes to elevate it to the forefront of our national consciousness.

    “From Ferguson to Staten Island to Baltimore, the patterns have become unmistakable and undeniable,” she began, as she listed a handful of the men whose lives have been cut short as a result of police violence. Walter Scott of Charleston. Tamir Rice, the 12-year-old from Cleveland. Eric Garner of Staten Island. And now Freddie Gray in Baltimore.

    “We have to come to terms with some hard truths about race and justice in America,” she said, adding that there is something “profoundly wrong” when Black men are more likely to be stopped and searched by police, charged with crimes, and handed longer prison sentences than their white peers; when 1-in-3 young Black men in Baltimore are unemployed and approximately 1.5 million Black men are missing from their families and communities as a result of incarceration and premature death.

    Clinton could have kept her remarks limited to the broken criminal justice system, but she ventured further, acknowledging that the fractures in that system are just one cause—and also a symptom—of deep social and economic injustices that must be corrected if communities of color are to live safe, healthy, and economically secure lives. 

    We also have to be honest about the gaps that exist across our country, the inequality that stalks our streets. Because you cannot talk about smart policing and reforming the criminal justice system if you also don't talk about what's needed to provide economic opportunity, better educational chances for young people, more support to families so they can do the best jobs they are capable of doing to help support their own children…

    You don't have to look too far from this magnificent hall to find children still living in poverty or trapped in failing schools. Families who work hard but can't afford the rising prices in their neighborhood. Mothers and fathers who fear for their sons' safety when they go off to school—or just to go buy a pack of Skittles. These challenges are all woven together. And they all must be tackled together.

    She enumerated the real marks of a nation’s prosperity: how many children can escape poverty and stay out of prison; how many can go to college without being saddled with debt; how many new immigrants can start small businesses; and how many parents can get and keep jobs that allow them to “balance the demands of work and family.” These indicators, she said, are a far better measurement of our prosperity “than the size of the bonuses handed out in downtown office buildings.”

    In many ways, it is a sad commentary on the state of our nation’s politics that Clinton’s speech feels significant. But given our political discourse on race (or lack thereof), and the gender, race, and social and economic inequities that continue to rage on unchecked, it did indeed feel significant.

    Of course, Hillary didn’t have far to climb to pass the low, low bar that has been set by Republicans. This week we saw members of the GOP blame the protests and uprising in Baltimore on everything from President Obama inflaming racial tensions (thank you, Ted Cruz) to the legalization of same-sex marriage (that gem of wisdom from Representative Bill Flores of Texas). GOP presidential hopeful Rand Paul blamed the “breakdown of the family structure, the lack of fathers, the lack of sort of a moral code in our society” and remarked on how glad he was that his train didn’t stop in Baltimore because it’s depressing, sad, and scary. And Jeb Bush proposed that there be a rapid investigation into the death of Freddie Gray “so that people know the system works for them” (even though—as Rosenthal pointed out—it clearly doesn’t).  

    Clinton’s remarks were of an entirely different caliber than we’re hearing from the GOP (not that rising above that nonsense alone should win one points). But she still has a steep road ahead to convince justifiably cynical voters that she will run her campaign—and the nation, should she become our next president—with the same commitment to racial and economic justice that she espoused yesterday. The 2008 campaign left a bitter taste in the mouths of many progressives, especially those in communities of color. And, as Bill Clinton himself said yesterday, it was the tough-on-crime policies of his own administration that led to the over-policing and mass incarceration that his wife criticized.

    It remains to be seen if yesterday’s speech will mark a real evolution in her long political career, and not, as some suspect, a calculated political pivot to appease the voters she will need to win this campaign. All things considered, it was a bold start to what will be a long campaign. This is the Hillary many have been waiting for. This moment requires a leader who will boldly challenge the inequities and injustice in our society—whether at the voting booth, on the job, in our neighborhoods, or within our criminal justice system—and lay out a clear path forward. That's the challenge and opportunity for Hillary; we don't yet know if she will accept it.

    Andrea Flynn is a Fellow at the Roosevelt Institute. Follow her on Twitter @dreaflynn.

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  • Bo Cutter: Universal Pre-K Is the First Step Toward the Next American Economy

    Apr 29, 2015Laurie Ignacio

    Our series on “The Good Economy of 2040” continues this week with Next American Economy Director and Roosevelt Senior Fellow Bo Cutter.

    Our series on “The Good Economy of 2040” continues this week with Next American Economy Director and Roosevelt Senior Fellow Bo Cutter.

    If Cutter could pick one policy solution to ensure a good economy in the future, he’d call for universal pre-K through secondary school to "bring up children from low-income households" and teach all children "the element of imagination, creativity, and innovation to make their way in the world that's coming."

    Read more about the case for universal pre-K here:

    "Pre-K for All" (US News & World Report)

    "Arne Duncan: High-quality preschool is a sure path to the middle class" (WashPost)

    Bowman Cutter is a Senior Fellow at the Roosevelt Institute and Director of the Next American Economy Project. He was a managing director of Warburg Pincus, a major global private equity firm headquartered in New York City, between 1996 and 2009, where he served both as the firm’s economist and as a leader in its international business, with particular reference to Asia. He has served with distinction during two Democratic presidencies: as director of the National Economic Council and Deputy Assistant to the President during the Clinton presidency; and as Executive Director for Budget during the Carter presidency. He also served as leader of the OMB transition team after the election of President Obama.

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