Financial crisis means much higher interest costs for small towns that bought bond derivatives

In Lewisburg, Tenn., population 11,000, the town was having difficulty paying interest on loans for new sewers. Investment bank Morgan Keegan & Co. was the town's financial adviser and host of a state-sponsored seminar on the risks and benefits of municipal bond derivatives, which the city bought to lower its interest rates. With the credit crunch, however, the town's annual interest payments have skyrocketed from around $250,000 to $1 million.

Many other small towns have had similar experiences, Don Van Natta Jr. reports for The New York Times. Those in Tennessee blame the state and its relationship with the investment bank. Tennessee supposedly has strong regulations on bond derivatives, but critics say that the regulations actually made it easier for the Memphis-based firm to sell towns the investments without fully explaining the risks, and that the seminar downplayed the risks that towns would face with the derivatives.

“We’re little,” Lewisburg Mayor Bob Phillips told the Times, “and we depend on people wiser than us in financial ways to keep us informed, tell us what things mean, and I really didn’t think we got that.” The investment bank denies wrongdoing, saying it provided towns with lower interest rates for years. (Read more)

Yesterday, Gov. Phil Bredesen admitted that state officials did not do enough to protect small towns from the investments. “There are places where derivatives make sense,” Bredesen said. “I think that perhaps with more guidance from the state and approval from the state, and some better education that some forms of these can still be useful.” Van Natta writes, "Asked if it had been a conflict for Morgan Keegan to serve as adviser and underwriter of the bonds, the governor said, “I think that really is probably at the core of what went wrong here.” (Read more)