Denver Schools: Derivatives Don’t Make The Grade

Denver has a derivative problem – a big one. In 2008, Denver’s public school system sought the assistance of JPMorgan Chase to refinance a pension fund. The “solution” that bankers at JP Morgan proposed was an investment deal designed to supposedly raise $750 million for the school system and save tens of millions of dollars annually in debt costs.

JP Morgan’s predictions never came to fruition, however. The school district issued variable-rate Pension Certificates with a hedge in the form of an interest-rate swap. If prevailing interest rates fell, Denver schools had to make up the difference to the banks. If interest rates rose, the deal would protect the school system from having to pay higher debt costs.

When the financial crisis of 2008 hit, Denver immediately felt the repercussions.  So far, the school system has paid $115 million in interest and other fees, which is at least $25 million more than it originally anticipated.

Denver’s only recourse is to try and renegotiate its deal. But to do so means paying the banks $81 million in termination fees, or about 19% of its $420 million payroll.

Denver now has the dubious distraction of joining other cities, states, and counties such as Wisconsin, Jefferson County, New Jersey and Philadelphia that have been burnt by derivatives.  Interestingly, JP Morgan’s name is attached to several of those deals, including the one in Jefferson County, Alabama. Last year, the state’s largest county almost went bankrupt from a $3 billion sewer-debt refinancing that collapsed during the credit crisis.