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Financial Crises & Financial Derivatives

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Financial Crises & Financial Derivatives Financial Crises & Financial Derivatives: Government Use of Interest Rate Swaps From 2003 - 2012 DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Akheil Singla Graduate Program in Public Policy and Management The Ohio State University 2015 Dissertation Committee: Professor Charlotte Kirschner, Advisor Professor Robert Greenbaum Professor Trevor Brown Professor Martin Luby Copyrighted by Akheil Singla 2015 Abstract Despite getting coverage in the financial press, government use of financial derivatives such as interest rate swaps remains a fairly understudied area of public financial management research. Indeed, press accounts emphasizing the downside of these transactions are some of the only sources of information on the performance of these instruments. However, while headlines about termination payments totaling hundreds of millions of dollars may generate reader interest, they are far from systematic evaluations of these instruments. This research aims to remedy this situation by exploring how governments are using these instruments, the contexts in which these instruments are used, and how to develop systems that evaluate the use of these instruments as policy tools. The first chapter of the dissertation works to identify the scope of use of these instruments over a 10 year period. Broadly, it addresses three questions: 1) How did the largest city governments use debt-related derivatives over time? 2) How, if at all, did state and city use of debt-related derivatives differ over time? 3) How did government use of debt-related derivatives evolve over time? It finds that many cities were active participants in the debt-related derivatives markets. Second, it demonstrates that while there were some differences between state and city government use, these do not necessarily appear to be systematic. Third, it suggests that the evolution of use of debt- related derivatives was altered by the Great Recession, as many state and city ii governments ratcheted up their use of these instruments from 2003 to 2008 only to swiftly exit the market during and after the financial crisis. The second chapter builds on the analysis and data from the first chapter to explore the following question: What are the motivating factors for city governments choosing to use debt-related derivative instruments? It does so by using the data gathered and presented from the previous chapter in concert with additional data from city government Comprehensive Annual Financial Reports to examine the relationship between new use of debt-related derivatives and other characteristics of governments. The chapter finds that the characteristics of government most associated with new debt- related derivative use are size (as measured by total assets) and prior use of the agreements, with external market conditions also being an important factor. The third chapter takes a different approach than the first two chapters, instead discussing a framework for evaluating individual debt-related derivative transactions. The chapter leverages an extensive evaluation conducted by The Chicago Tribune, both as a lens for what to do, and as a means to identify additional areas for analysis. In sum, the chapter describes a method by which financial managers and policy makers alike can evaluate whether the instruments saved money in the long run and whether the decisions to use the instruments made sense at the time the decisions were made. iii Acknowledgments I would like to thank my friends and family. Without your help and support, this would have not been possible. iv Vita 2010 ...............................................................B.S. Government, Management & Business, Skidmore College Publications “A Descriptive Analysis of State Government Debt-Related Derivatives Policies” (Akheil Singla and Martin Luby) Public Budgeting & Finance, Summer 2014. “Blind, Broke, and Bedlam: Differentiating Fiscal Stress from Bankruptcy in California” (Akheil Singla, James Comeaux, and Charlotte Kirschner) Public Finance and Management, 14(3), 2014. “The Legacy of Dwight Waldo: Taking a Broader View of Public Administration” (Akheil Singla and Kristin Harlow). Book chapter in Mastering Public Administration by Raadschelders & Fry, 2013 Fields of Study Major Field: Public Policy and Management v Table of Contents Abstract ............................................................................................................................... ii Acknowledgments.............................................................................................................. iv Vita ...................................................................................................................................... v List of Tables ..................................................................................................................... ix List of Figures .................................................................................................................... xi Introduction ......................................................................................................................... 1 Chapter 1: Riding the Roller Coaster: Evolutions in Government Use of Debt-related Derivatives from 2003 – 2012 ............................................................................................ 5 Introduction ..................................................................................................................... 5 Background ..................................................................................................................... 8 Debt-related Derivatives .............................................................................................. 9 Design of Swaps ........................................................................................................ 10 Government Use of Debt-related Derivatives ........................................................... 16 Data & Methods ............................................................................................................ 17 Results ........................................................................................................................... 19 Discussion ..................................................................................................................... 26 Conclusion ..................................................................................................................... 32 vi Chapter 2: Fair or Foul: Motivations for Government Use of Debt-related Derivatives.. 35 Introduction ................................................................................................................... 35 Background: Justification for Debt-related Derivatives ................................................ 36 Hypotheses .................................................................................................................... 40 Data & Methods ............................................................................................................ 45 Results ........................................................................................................................... 53 Discussion ..................................................................................................................... 59 Conclusion ..................................................................................................................... 63 Chapter 3: A Framework for Assessing Government Use of Debt-Related Derivatives . 66 Introduction ................................................................................................................... 66 Program Evaluation ....................................................................................................... 68 Application of Framework to Debt-related Derivatives ................................................ 70 Evaluating the Treated Outcome ............................................................................... 73 Estimating the Untreated Counterfactual Outcome ................................................... 75 Program Effects and Causes of Effect Variation ....................................................... 77 Limits to Traditional Program Evaluation of Swaps & Alternative Methods............... 79 Conclusion ..................................................................................................................... 83 Conclusion ........................................................................................................................ 84 References ......................................................................................................................... 87 vii Appendix A: Notional Values ........................................................................................... 91 Appendix B: Additional Results from Chapter 2 .............................................................. 95 viii List of Tables Table 1. Types of Debt-related Derivatives ...................................................................... 14 Table 2. Types of Risk Associated with Debt-related Derivatives ................................... 15 Table 3. Data Collected & Description ............................................................................. 19 Table 4. Total Notional Value of Debt-related Derivatives, 2003-2012 .......................... 20 Table 5. Termination Payments and Notional
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