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Municipalities Should Ditch Wall Street Derivatives Deals: Lawmaker

On Wednesday JPMorgan Chase (JPM) announced a 53% jump in fourth-quarter net income, helped by increased mortage lending. Forbes reports that the bank logged its third straight year of record profits and beat the Street’s estimates with its fourth-quarter results.

Related: What’s Inside America’s Banks? No One Knows, Says ProPublica’s Jesse Eisinger

While a bank like JPMorgan appears to have recovered from the misadventures of the financial crisis, some cities and counties are still struggling to make a comeback after getting saddled with millions of dollars in debt from complex derivatives deals that Wall Street sold to them.

Dealing with the aftermath, The Bond Buyer reports some Pennsylvania lawmakers don’t want their communities involved in these types of deals anymore, specifically interest rate swaps.

Pennsylvania State Senator Mike Folmer is proposing legislation that prohibits municipal swaps altogether. In an interview with The Daily Ticker he explains why.

“My argument is these are really risky investments,” Folmer says. “If you want to invest your money, God love you, invest any way you see fit, just buyer beware. But when you’re investing other people’s money, tax dollars, you need to be held to a whole different standard.”

These swap deals were designed to allow municipalities to hedge against the risk of rising interest rates. But if rates go the wrong way, they can backfire. Lawmakers like Folmer have experienced the fallout of swaps deals firsthand. Harrisburg, Pennsylvania filed for bankruptcy in October 2011 (the case was later dismissed by a judge) and as of last November was still facing more than $340 million in debt. Interest rate swaps were a key component in the debacle.

It’s not just Harrisburg. According to The Bond Buyer, Philadelphia could see up to $500 million in swap-related losses.

Jefferson County, Alabama, made history as the largest U.S. municipal bankruptcy in November of 2011. Faced with vast debts from a sewage project, Jefferson County turned to JPMorgan for financial assistance, according to The New York Times. The bond deal devised by the bank included swaps -- but Jefferson County's situation got worse after the swaps blew up.

Bloomberg reports last month that a judge in Milan convicted JPMorgan and three other banks of fraud in selling the city derivatives, a decision the firms plan to appeal.

Related: JPMORGAN PROVES IT: Wall Street Is Just Kids Playing With Dynamite

Folmer explains that these dubious deals are often approved because local officials don't fully realize the risks associated with the deals.

“The average citizen who gets elected to a city council seat or school board seat really wouldn’t be able to understand them, so you’re going to rely heavily on the ‘experts',” Folmer says.

While the so-called financial experts may walk away with their fees, in many cases the taxpayers end up saddled with the collateral damage left in their town.

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