Browse the BusinessWeek Archive
Thiollière leaves a press conference after losing his mayoral reelection bid in 2008 Philippe merle/AFP/Getty Images
In 1995 an ambitious Frenchman from the Loire city of Saint-Ã?tienne took a trip to Baltimore. Michel Thiollière had been elected mayor that year, and he was visiting faded industrial citiesâ??Cleveland, Pittsburgh, Glasgowâ??to pick up urban renewal ideas he could apply in Saint-Ã?tienne, a coal and textile town of 180,000 that had been in decline for decades. A former English teacher at the Lycee Honoré d'Urfé, Thiollière came home with big ideas but needed capital to implement them. By 2001, with the help of his deputy mayor for finance, Antoine Alfieri, he began buying complex financial products to reduce the city's debt and free up cash.
The productsâ??interest rate swaps and other derivatives whose values were based on such exotic metrics as the difference between long-term rates in the U.K. and short-term rates in Japanâ??performed as advertised for a while. Thiollière and Alfieri cut finance costs by 12 million euros as the city signed deals with French banks Dexia, Natixis, and Crédit Agricole, and foreign lenders Depfa, Royal Bank of Scotland, and Deutsche Bank. The moves allowed Saint-Ã?tienne and its neighboring towns to build a design center, a 7,200-seat theater, a second streetcar line, even a new business district near the train station. Four years ago, Thiollière was named the fifth-best mayor in the world by City Mayors, a London-based think tank.
Saint Ã?tienne's luck changed in 2008 as the global financial crisis turned interest rates on their head, sparked wild currency swings, and made some banks unwilling to renegotiate contracts. Thiollière was turned out of office. And, inevitably, the bills started coming due. The first arrived this month, two years after he left, as the embedded financial obligations he agreed to began to blow up.
The 800-year-old town owed 1.18 million euros ($1.61 million) to Deutsche Bank as of Apr. 1. The new administration, led by Mayor Maurice Vincent, refused to pay; last November it filed a lawsuit arguing that the bank hadn't adequately explained the risk and that Thiollière didn't have the right to sign the contract. (Deutsche Bank disputes those claims.) The move dodged, for now, the fallout from one of the 10 contracts still in force, deals so exquisitely speculative that no bank will buy them back, says Cedric Grail, 38, who was brought in as municipal finance director in October 2008. The 10 contracts, he says, would cost about 100 million euros to cancel today.
The savings Saint-Ã?tienne generated were far smaller than the risk it loaded onto itself during what Grail describes as "a constant sprint to stay out front. It wasn't a race to keep the city hedged. It was a race to mask potential losses, because the more risk you take, the more potential losses you can hide." Sitting in his office in Saint-Ã?tienne's 19th-century city hall, a grand stone building whose arched facade is inscribed with the words Liberté, Egalité, Fraternité, Grail points to a chart of the 10 contracts. "It's a joke that we're in markets like this," he says. "We're playing the dollar against the Swiss franc until 2042."
Saint-Ã?tienne is one of thousands of public authorities across Europe that tried to shave borrowing expenses by accepting derivatives deals whose risks they couldn't measure. Now they may be on the hook for billions of euros in debt, a burden that will likely plague them for the next generation. From the Mediterranean to the Pacific coast of the U.S., officials in government, public agencies, and nonprofit institutions have lost billions of dollars because of transactions they didn't grasp. Harvard University last year agreed to pay more than $900 million to terminate swaps that assumed interest rates would rise. Jefferson County, Ala., almost went bankrupt two years ago because of interest rate swaps it bought to hedge a portfolio of variable-rate bonds. Swaps and other complex, unregulated derivatives are what Warren Buffett famously called "financial weapons of mass destruction." (Another form of credit derivative, the synthetic collateralized debt obligation, is at the heart of the SEC's civil suit against Goldman Sachs.)
Post a comment about this story in Reader Discussionâ?¦
Track and share business topics across the Web.
RSS Feed: Most Read Stories
RSS Feed: Most E-mailed Stories
RSS Feed: Most Discussed Stories
About Advertising EDGE Programs Reprints Terms of Use Disclaimer Privacy Notice Ethics Code Contact Us Site Map Press Room
©2010 Bloomberg L.P. All Rights Reserved.
Read Full Article »