What does San Francisco's Metropolitan Transportation Commission (MTC) have to do with fixing the financial system? The San Francisco Chronicle has the story.
Judging from the piece by Philip Matier and Andrew Ross, the transportation commission did exactly what tens of thousands of state and municipal governments did in the years leading up to the financial crisis. It relied on the triple-A credit rating of a company called a "monoline," a fancy name for bond insurer, to help it with its debt issuance and its attempts to protect itself from rising interest rates.
For a fee, MTC borrowed bond-insurer Ambac's Triple-A credit rating. The rating comforted investors and other long-term "counterparties" who did financial business with the transportation body.
But Ambac used its Triple-A credit rating to back more than muni deals. Via derivatives, it backed bad mortgage securities, too. Ambac lost its sterling rating once this mistake became clear.
It turned out, then, that MTC had paid big bucks to "borrow" a great reputation that had been based on nothing. The transportation officials decided to pay $120 million upfront to cut its losses and get out of its long-term agreements.
Who's to blame here?
At first glance, this stuff seems like "exotic" financing -- but it's really not. MTC's transactions were pretty boring.
To blame MTC for relying on Ambac would be like blaming a homeowner who buys fire insurance upfront and then loses out because her fire-insurance company goes bankrupt.
Sure, maybe MTC should have wondered about Ambac's other commitments and how they would impact its muni promises -- just like maybe you should wonder whether your fire-insurance company is in some risky businesses.
But it's hard to blame a transportation commission or a homeowner for this lapse and not, say, the country's state insurance regulators, or Hank Paulson, or Ben Bernanke.
San Francisco's tale should remind readers why, exactly, the Bush and Obama administrations moved to guarantee so much of the financial industry starting in 2008.
The problem wasn't houses. The problem was that financial firms such as AIG and Merrill Lynch had used houses as a base upon which to create hundreds of billions of dollars' worth of derivatives.
If the derivatives went bad (as they did), the big financial firms that used them to make un-payable promises, too, would fail. That failure would ruin those firms' "good" commitments, including to innocent parties such as San Francisco's transit provider.
The government let Ambac fail, more or less -- and the failure caused ripple effects across the country.
Imagine if, say, Citigroup had failed.
That's why forcing derivatives off banks' private books and onto clearinghouses is a good idea.
Clearinghouses aren't perfect -- nothing is -- but they can help ensure that financial firms keep their various commitments to entities like MTC separate rather than tied all together with commitments on mortgage-backed securities.
Derivatives regulators, to their credit, are trying to achieve this fix (even though Republicans in Congress are trying to stop them).
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