(MintPress) – Residents of Oakland, Calif. are working to cut ties with Goldman Sachs because of an interest rate swap that costs taxpayers a reported $4 million per year. Oakland, like many American cities, has struggled with a shrinking tax base, high unemployment and stagnant economic growth following the 2008 financial crisis. The decision to end the unfavorable relationship with the banking giant could save the city much needed money in the short-term, but could negatively affect the credit rating of the Bay Area city.
The deal
The city of Oakland decided to take out a loan in 1997 to issue $187 million in bonds to make payments to the police and fire pension fund. These bonds were underwritten by the creditor, Goldman Sachs, one of the largest banking and financial security services firms.
The city opted to accept loan Goldman’s offer with an artificial fixed rate of 5.6 percent. Although this was higher than the current national interest rate, city officials agreed that this was favorable since it insulated taxpayers from the variable, unpredictable rate. By locking in at a fixed 5.6 percent many believed that this would save the city money since interest rates were climbing steadily in the years before the loan was issued.
For the first few years, the agreement did actually save taxpayers money. However, interest rates, which had been increasing steadily during the late 1990s, soon crashed and remain near 0 percent because the Federal Reserve had artificially depressed the rate of interest following in the 2008 financial recession.
Yea-Mo Chen, Professor of Finance at San Francisco State University describes the problem further in a recent interview, saying, “So any time when interest rates drop, then the city of Oakland will still have to pay for the fixed amount of payments on the interest swap. But they would receive less and less and less from Goldman Sachs.”
Like many cities hit hard by the 2008 financial crisis, city officials have searched for ways to quickly obtain cash that will help their cities. However the unfavorable terms of the loan have adversely affected taxpayers who have already paid $26 million in interest payments to Goldman Sachs.
Under the current terms of the agreement, taxpayers are obligated to continue making interest payments to Goldman until 2021.
Community members fight back
In response to the problem, community members, including clergy, labor unions and members of the Occupy movement, have joined together to form The Coalition to Stop Goldman Sachs. Dedicated coalition members have spoken out at city council meetings, gathering the support of citizens and elected officials alike.
Tim Thomas, a member of the group, speaks about the group’s demands in an interview, saying, “Our demand on this money is to get it back into the city and that it needs to be put toward the most disadvantaged sectors of our community.”
Deborah Santana, Professor of Ethnic Studies at Mills College added, “We want Oakland to end this relationship. End the swap. We want them to pressure Goldman Sachs not to force them to pay a penalty on ending the swap, and also to return all the money that they took from Oakland since 2005.”
On July 3, 2012 the Oakland City Council passed a resolution to see the cancellation of the interest rate swap with no cost to the city. According to the resolution, if Goldman Sachs refuses the deal or if no suitable outcome is reaching within 60 days, Oakland will cease all further business with Goldman Sachs.
Cities go bankrupt
The problem in Oakland is a salient one given the similar plight of cities across America, many of which have declared bankruptcy in the face of bleak economic circumstances. For Oakland residents, the warning hits close to home considering Stockton, Calif. became the latest American city to declare bankruptcy.
The Stockton City Council voted 6-1 last month to declare bankruptcy because of an outstanding $26 million debt that the city has been unable to repay. With a population of 300,000, the Southern California city became the largest U.S. city to declare bankruptcy.
Similarly, Oakland has an increasing debt, and any broad cuts to public sector employee salaries, pensions and benefits are likely to be met with vehement opposition. While the fight to cancel rate interest rate swaps may save the cash strapped city of Oakland money in the short run, critics point out that the decision will likely have a negative impact in the future.
Lending institutions, whether they are a major bank like Goldman Sachs or a local credit union, are likely to view this cancellation negatively, classifying the city of Oakland as a higher risk borrower.