Fiscal Risk: Jefferson County, Alabama and Recanati, Italy

Municipal debts are rising on both sides of the Atlantic and for similar reasons. The Washington Post reports that the same risky credit swap deals that led Jefferson County, Alabama into default are riddled in the finances of an estimated 519 municipalities in Italy. These towns face $1.3 billion in losses from poorly-constructed interest rate swaps.

Recanati, Italy agreed to take out contracts on $106 million in municipal debt agreeing to pay the bank a fixed 5 percent interest rate. The banks agreed to pay an adjustable rate (tied to an interest rate index) in return.

European interest rates were high in the mid-2000’s. Recanati realized $400,00 between 2001 and 2008 in interest rate payments. Then rates dropped. The city had to pay the bank 5 percent, while getting less than 1 percent in return.  In one year, Recanati wiped out all of its previous gains. This year the town will lose $700,000.

While Recanati officials  blame the banks for “taking advantage” of them. Another point is worth making. Governments are not private firms. The financial risks borne by governments present a fiscal risk to taxpayers. It is as true of badly-designed interest rate swap deals as it is of how some governments have invested workers’ pensions.