So sad, too bad...

From Bloomberg, we have Deutsche Bank Swap Makes Pennsylvania Taxpayers Lose.

The Reading, Pennsylvania, school district, which has 18,323 students, this week must pay $230,000 to Deutsche Bank AG, Germany's largest bank, because it's on the losing side of a wager that long-term interest rates will rise faster than short- term interest rates. In April, the board rushed approval of the so-called interest rate swap in eight days after its adviser said the transaction may earn the district $16 million by 2034.

While Reading's taxpayers are liable for the loss, bankers and advisers already have pocketed $1 million in fees for arranging the swap, enough to buy 11 Mercedes-Benz S-550 sedans. This week's payment to Deutsche Bank would have covered the school district's monthly utility bill.

``It was all done in a real hurry,'' said Keith Stamm, the only member of the board to vote against the deal. ``The whole board is so desperate to try to find a way to raise money, they see this floated in front of them as a big-time amount of money and they want to go forward with it.''

Wow, this school board is filled with retards. Then again, if they were actually smart, they would be working for DB, not teaching the little asses and jennies in Pennsylvania.

The adviser said that the transaction "may" earn $16M by 2034. Did they ask themselves why DB took the opposite side of that transaction. After all, the people DB employs are many levels of smart more than some silly school board in Pennsylvania.

The school board paid Frankfurt-based Deutsche Bank $575,000 to arrange the contract, known as a constant maturity swap, and awarded $400,000 to its financial advisers, including Reading-based Concord Public Financial Advisors Inc. and lawyers for arranging the trade, school officials said.

Concord principal Mike Setley didn't return calls seeking comment.

Hmmmm, looks Concord Financial Advisors took the money and ran! Who wouldn't?

The blunt truth is that "pension funds", and "school boards" are just sitting ducks for such derivative transactions.

DB probably got to offload its interest-rate risk in some other offsetting transaction, and collected the fees from both sides. (Alternately, DB can easily hedge the other side of its transaction for a much smaller fee, and keep the difference between the the two fees.)

Why exactly did the board "rush" into the transaction in 8 days? Also, what made them think they can predict rates of change of interest rates out to 2034, no less?!?

Hell, I can't predict the probability that there will be an attack on the US in the next year (and I assure you, that if that were to happen, that would definitely impact interest rates!)

The Reading contract is based on $103 million of zero- coupon bonds issued by the district in 2003 that come due from 2026 to 2034. Reading is required to pay Deutsche Bank the equivalent of 67 percent of the one-month London interbank offered rate, a lending benchmark, plus 0.3 percent every Jan. 15 and July 15. That amounts to about $2 million for the period ending this week.

In return, Deutsche Bank must give the district a rate equivalent to 66 percent of the so-called five-year swap rate, which is the interest rate a borrower is willing to pay to exchange fixed payments for those that reset each month. That totals about $1.77 million for the period. The difference amounts to the $230,000 the district owes Deutsche Bank. Only the net payment changes hands.

The contract became a money loser because the five-year swap rate has declined to 5.145 percent from 5.5945 percent in July. Meantime, Libor dropped to 5.32 percent from 5.37 percent, according to data compiled by Bloomberg.

Reading's schools will profit if five-year rates are higher relative to one-month yields. That's been the case 80 percent of the time during the past 10 years, according to Citigroup Inc., the biggest underwriter of municipal debt.

"So long as interest-rate relationships return to normal conditions, this transaction should provide a significant financial benefit to the school district,'' Concord said in a memo to the district May 22. While Reading is paying now, it may earn money on the swap over time.

Here's the heart of the problem. If things return to normal, they will make money. And yes! most likely over 30 years, they will. But the real question is will the board remain solvent enough before then? DB has the balance-sheet to ride out this transaction for a very long time. The school board does not. I predict a bankruptcy in this school district's future.

Basically, these boards all suffer from the principal-agent problem. If things go wrong, the taxpayers lose their shirt, but as far as the people who made the decision (the idiots who sit on the board,) they don't care. They will collect their salary, and keep on truckin'. There are no consequences attached to their bad decisions.

The blunt truth is that most of these people also suffer from the "do something, anything!" syndrome. Hell, my own friends and family suffer from it! Nobody likes to hear that the correct thing to do is to do nothing. Sit tight with your money in a conservative fashion. Oh, no! they must "do something" even if that something is a furiously speculative transaction. (I have a lot to say on this subject but that will have to wait for a future post.)

So what's the solution the board has for the problem?

Dennis Kelley, the school district's director of finance, said he was "surprised" to learn he owes $230,000. He said the district would pay the money using proceeds from another interest-rate swap.

Wow, they are fuckin' incredibly stupid! They got their ass reamed in the casino, and the solution is to put more money into the casino?

I really feel sorry for the children! I really do!

Un-fucking-believable!

Expect a lot of such sob stories from boards (particularly pension funds) all around the world in the next few years. They've all been speculating furiously in the derivatives market. Thanks to this speculation, risk premiums are at historical lows even in the riskiest tranches, and things always come unhinged at some point.

Oh well! Banks collect the fees, and if things go bad, well, mugs will be mugs!