Cerno fossorex suus viaticus *

I know I should be outraged by the revelation that some investment bank sold the city of Saint-Etienne a financing package which included an embedded option that had the city “...playing the dollar against the Swiss franc until 2042” as a means of lowering their borrowing costs.

But in this case I can't. The derivative contracts entered into by Saint-Etienne had nothing to do with the financing of the city.

In an article on Bloomberg this morning they quoted "More than 1,000 municipalities in France had 11 billion euros in “risky” contracts at the end of 2009, according to Paris-based Finance Active. In Italy, about 467 public borrowers faced losses of 2.5 billion euros on derivatives as of the end of September, according to the Bank of Italy."

The same article went on to say "In Germany, Deutsche Bank sold contracts based on the difference between long- and short-term rates to about 50 municipal governments and utilities. Local authorities also bought swaps from regional banks and Commerzbank AG. No national consolidated figures exist, according to Roland Simon of Simon & Partner, a law firm in Duesseldorf."

Saint-Etienne apparently saved 126,377 Euros. They are currently in arrears around 1.2million Euros. To unwind the swaps would cost around 100million Euros.

What was the treasurer of Saint-Etienne thinking? Or any of those responsible for municipal financing? Any number of them took on risk speculating on the shape of the yield curve-short term vs long term interest rates. Note the word "speculating". Why were any of these people speculating with municipal finance?

It is common to blame the derivative instruments in the first instance and then to blame the investment banks for selling them. I maintain that the buyers too should be held to blame.

Lest anyone think I am being soft on investment banking however, look to today's title. Investment bankers had to seek out the fools whom they could separate from their money. In three countries alone they were able to find over 1500 fools who took on risks-probably after an extensive dinner-which lined the pockets of the investment banks and are now tearing massive holes in the fabric of municipal finance.

*Separate a Fool from his Money