TOPICS > Economy

Across the World, Woes of Collapsed Bank Spread to Borrowers

November 3, 2008 at 5:26 PM EDT
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A European bank that lent millions to borrowers around the world, including a Wisconsin school district, needs a massive bailout, which has triggered financial woes among its clients. Charles Duhigg of the New York Times and Adam Davidson of NPR explain the trail of the crisis and the struggles ahead.

JIM LEHRER: Finally tonight, the ripple effects of the global financial crisis. Jeffrey Brown has that story.

JEFFREY BROWN: A local school district in Wisconsin, a German bank operating out of Ireland, collateralized debt obligations, and many millions of dollars that may now be gone, for the last months, we’ve talked a lot about the global financial crisis and its web of consequences.

A pair of reports by the New York Times and National Public Radio present a case study that may well stand for many more around the country.

Here to tell us about it are Charles Duhigg of the Times and Adam Davidson of NPR’s Planet Money team.

So, Charles Duhigg, this all started with a fairly common problem. A local school board, in this case in Whitefish Bay, Wisconsin, wanted to prop up its teacher retirement plan?

CHARLES DUHIGG, New York Times: Exactly. The Whitefish Bay, Wisconsin, school board and four other local school boards had what many states and school boards and municipalities have, a problem propping up their retirement funds.

The health care costs were growing, and they needed a way to put some money aside to deal with the future, so they turned to their financial adviser and asked him for his advice.

And he told them about something called a collateralized debt obligation, or a CDO, which is one of the most complicated financial products that’s out there, although they didn’t know that at the time.

JEFFREY BROWN: And, you know, in reading your account, to the question of why they would turn to these very complicated instruments, it almost sounds like, well, that’s what everybody was doing.

CHARLES DUHIGG: That’s how it was presented. And, you know, until recently, if you’ll remember, basically everyone thought that there was an opportunity to get rich in the global economy.

We’ve been hearing about New York — Wall Street bankers getting rich, and governments and cities being able to solve their problems by turning to the stock market, and these more and more exotic financial products. And the school board members thought this is their chance.

Public financing business risky

JEFFREY BROWN: And it is very complicated to explain these things, but basically the idea is they borrow a lot of money to guarantee other debt. It works through various instruments at the same time. But they're hoping to make a good profit, right?

CHARLES DUHIGG: Exactly. They borrowed -- the five school districts borrowed $165 million from a small German bank that was located in Ireland and put in $35 million of their own money to buy essentially -- or to sell essentially what was insurance on a collection of bonds. And then they expected to get income every quarter.

JEFFREY BROWN: All right, Adam Davidson, let me bring you in. We mentioned this bank, Depfa. Now, it, I gather, tried to make itself into kind of a global player. Tell us its role in this.

ADAM DAVIDSON, National Public Radio: Yes, Depfa was a small German bank. It actually was started by the Prussian state in the 1920s. And it eventually moved to Dublin a few years ago to become this global powerhouse in public finance, basically helping municipalities all over the world.

They went from really not existing outside of Germany to having offices in dozens of cities and countries around the world and, in a very short period of time, became central to how U.S. municipalities, school boards, and park districts, and sewer districts all over the country find funding to fund their products.

Basically, Depfa focused on this single-mindedly. We can now look back and see that they rode this big financial bubble to big heights.

And having one line of business, this public financing line of business, is not such a good place to be right now. It might have been wonderful for the three or four years that it allowed them to grow so fast.

Foreign bank financed U.S. projects

JEFFREY BROWN: Well, Adam, tell us what -- I mean, the obvious question is, what went wrong? I mean, how did something affecting a bank in Ireland then spring back and come and start affecting school districts in Wisconsin?

ADAM DAVIDSON: Yes, well, the school district in Wisconsin affected the bank in Ireland by taking out this loan. And they still are paying, we should say, they still are paying their loan fees. But the fact that they are likely to be in a position where they can't pay the loan back means that Depfa has to write down the value of that loan.

But municipalities all over the U.S. have had to call on Depfa, have had to basically call bonds back to Depfa, which is forcing Depfa into a massive liquidity crisis.

A few weeks ago, when all these banks were having trouble in the U.S., Depfa came very close to collapsing. They're based in Dublin, but the Irish government just said, "Hey, you're not our problem. You're owned by some German bank. We're not getting -- we're not having anything to do with you."

The German Government quickly realized that, if Depfa, this Irish bank went down, they would bring down their parent company, one of the biggest banks in Ireland, Hypo Real Estate, and then that would truly collapse the German economy.

And then it springs back. That's what so fascinating about this tale. It goes from Wisconsin to Ireland to Germany, then back to the U.S., because Depfa was so central to how municipalities fund themselves that their near collapse -- and now they haven't collapsed, because they were saved by the German government, but they're much -- their operations are much smaller -- municipalities all over the U.S. are having a harder time finding funding, which means -- it means fewer hospitals, fewer parks, fewer sewers in the U.S.

Schools make deep budget cuts

JEFFREY BROWN: So, Charles Duhigg, what are the consequences then for the school district, in terms of the retirement fund, in terms of potential budget cuts? And does it have any legal recourse at this point?

CHARLES DUHIGG: The school districts have filed suit to try and get their money back. The recourse is that, if they lose this $200 millions that they've invested, they can very well be in a situation where they have to start not replacing teachers who retire or cutting classes that are non-essential to students' education, like art or drama.

And there's another consequence to this, which is that, as Adam was saying, all of these municipalities, such as the New York Metropolitan Transit Authority, the guys who run the subway, or agencies in Colorado and California who help homebuyers get low-cost loans for their first home, all of them are now having to pay extra fees because Depfa is in trouble.

And that's a shockwave that moves through the American financial system and impacts all of these states all over the country. And so what we're going to see, not just because of Depfa, but Depfa as an example of this, is over the next couple of years massive numbers of cities, and states, and local counties, and municipalities are going to be telling people, "Either we have to raise taxes or we have to cut services, because we've been impacted by the global economy in a way that never would have happened even a decade ago."

Crisis will hit other areas

JEFFREY BROWN: But, Charles, you talk to many of the people who were originally involved in the school district. For example, stay with Wisconsin. Do they tell you that they didn't know what they were getting into? I mean, what are they saying now?

CHARLES DUHIGG: Well, what they say now is they say that they had a financial adviser who misexplained this investment to them. And they'll fully concede they got this huge prospectus, three inches thick, that explained the investments.

But they're school board members. They didn't read it. They relied on the advice of their adviser, and their adviser, in turn, says that he didn't really understand what he was selling them in the first place.

You know, all over the country, there's these small school boards and other municipal boards, these are essentially volunteer positions. People get elected, but, for instance, in Kenosha, Wisconsin, you get paid $4,200 a year to sit on the school board. Everyone else has another job. In another school board, there's housewives on it and local salesmen.

And so it's not -- they're not prepared to read these thick documents and really understand the global financial system. And unfortunately there was no one else that had an incentive to really educate them.

JEFFREY BROWN: So, Adam, just in our last minute, clearly some people made a lot of money and no doubt in this case, as well. But you're both expecting that we're going to hear many more of these kinds of stories around the country, I guess, in the coming days and weeks.

ADAM DAVIDSON: Yes, because I don't see any particular villains here. I think pretty much everyone, from Wisconsin to Ireland to Germany, back to the municipalities here, they were just all part of this global kind of mass belief that this bubble represented.

And, yes, it is far bigger than the institutions we've talked about here. This is just one thread. It is a fully woven rug of despair that, you know, reporters like us will continue to pick at.

JEFFREY BROWN: All right, Adam Davidson of NPR, Charles Duhigg of New York Times, thank you both very much.