It was the trades that went off the rails

IT HAS been called “the worst trade ever”. Shortly before the financial meltdown of 2008, Metro do Porto and three other Portuguese public-transport companies entered into a series of interest-rate swaps with Santander, a Spanish bank, in hopes of reducing interest payments on their debts. But they soon discovered why these particular derivatives were dubbed “snowball swaps”.

The firms’ losses exploded to several times the underlying debts, and by all accounts continue to swell today. They sued Santander, but in March an English court ruled the bank’s way. Though some documents “do the bank no credit”, the judge concluded, the transport companies could have been in no doubt about the scale of risk they were taking on. Santander did not coax them into signing contracts it thought would be contrary to their interests. The companies were not its clients, owed a fiduciary duty, but its counterparties, on the opposite side of the trades.

In the go-go years before the crisis public-sector entities were sold plenty of complex derivatives that subsequently went badly...Continue reading