DERIVATIVES SPECULATION

Risk Comes Home to Roost

  • Why it matters

    Why it matters

    Although 800 local authorities in Germany have used swaps to hedge against a rise in borrowing costs, this is the first time a case has gone to court.

  • Facts

    Facts

    • The transactions in question took place between 2006 and 2008 and were advised by JP Morgan Chase.
    • The lion’s share of losses were recovered through previous settlements; this trial relates to the costs and fees incurred by the transactions, totaling €14.3 million.
    • One of the key legal issues is whether the councilors breached a ban on speculation by local authorities.
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    Audio

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Prozess um Millionenverluste
The former mayor of Pforzheim, Christel Augenstein, and her lawyer, Jürgen Leibold, meeting Tuesday in a Mannheim court. Source: DPA

It’s not often that the victims of bad financial advice and their advisers both find themselves as defendants in the same courtroom. But that’s exactly what’s happening in Germany this week. A trial has begun in Mannheim against former councillors of the city of Pforzheim, who conducted interest-rate swaps between 2006 and 2008, and two of the bankers who advised them.

Former mayor Christel Augenstein, her former finance officer Susanne Weishaar and the latter’s then deputy, Konrad Weber, have been charged with breach of trust. The two bankers from JP Morgan Chase, the US bank that advised on the deals, are accused of aiding and abetting. The city lost around €57 million ($67 million) due to the transactions.

There are shades of the subprime mortgage crisis of 2008, triggered after investors had swarmed into risky, high-yield instruments they didn’t understand. The case has also cast a spotlight on a little-known fact: that many German local authorities used such swap transactions to hedge against rising borrowing costs. It also raises ticklish issues of liability. Are local authorities allowed to use highly speculative financial instruments to improve their budgetary situation? And who is liable if things go wrong – solely the taxpayers, or the decision-makers as well?

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