Borrow-short lend-long strategies have caused more pain and grief than nearly any play in the book. They are virtually guaranteed to blow up given enough time if the duration mismatch and leverage is too great.



For those who do not know what I am describing, a couple examples below will help explain. The first example is a look at "cost of funds" and guaranteed profits that banks can make. It is not a borrow-short lend-long strategy but will morph into such a scheme as I vary the parameters.



Citigroup CDs



Inquiring minds investigating Citigroup's cost of funds note that Citigroup 5 year CDs yield a mere 1.5%. For this example, Citigroup's cost of funds is 1.5%, the rate it pays depositors. Here are a few snips from Citi's website.



Who said there are no guarantees in life?



Some things in life are a sure thing. Like a Citibank CD, which offers a guaranteed—and highly competitive—interest rate. You also get a wide range of terms, from 3 months to 5 years.





Guaranteed Ripoff

Rates at Bank of America, Northern Trust, JPMorgan Chase

Guaranteed Free Money

There is no duration mismatch. The banks secure funding for 5 years and invest that money for 5 years. The US government is not going to default no matter what nonsense you may hear elsewhere.

Borrowing-Short and Lending-Long

The Next Borrow-Short Lend-Long Guaranteed to Blow Scheme

Banks are setting aside billions of dollars to do something that until now was rarely heard of: making big loans to cities, states, schools and other public borrowers that otherwise might have turned to the bond market.



When Riverside, Calif., was ironing out a bond offering recently to expand its performing-arts center, several banks pitched a radical idea: Why not take out a loan instead? The city scrapped the bond plan and borrowed $25 million from City National Bank in Los Angeles.



"This was a method we'd never even heard of before," says Scott Catlett, the city's assistant finance director. He says Riverside now intends to seek a bank loan for a conference center that it had planned to build with bonds.



J.P. Morgan Chase & Co. is devoting billions of dollars to direct loans this year to both refinance deals and for new projects, according to a bank official. Last year, the bank made a few hundred million dollars of direct loans to municipalities. Now, the bank would consider making a single loan for hundreds of millions of dollars, the official said. It also is dispatching teams to explain the concept to wary public borrowers.



Citibank also is courting municipal borrowers with direct loans, according to several bond issuers. A spokesman for the Citigroup Inc. unit declined to comment.



"This used to be unheard of," says Eric Friedland, managing director of public finance at Fitch Ratings, noting that in the past, banks would occasionally loan a municipality less than $1 million to finance projects too small for a bond offering. For bigger loans, they would form a syndicate with other lenders.



It remains to be seen what land mines may be lurking for lenders and borrowers. Some municipalities are going through significant struggles, raising questions about whether they will prove good credits. And direct loans are less liquid, meaning banks can't sell them as easily as bonds.



For banks, this is a potentially lucrative business at a time when they are sitting on cash that isn't earning huge interest and are reluctant to make loans for mortgages and other areas they see as risky.



In the event of a bankruptcy, analysts say, it is unlikely that a bank extending a direct loan would be given priority over bondholders.



The city saved hundreds of thousands of dollars in issuance costs, says Mr. Catlett, the assistant finance director. Plus, he says, the interest rate is 3.85% versus at least 5% if it had floated a public offering. The term is slightly lower—21 years versus perhaps 30 years in the bond market.



"This was all new to us," he says. "I don't know now when we'll go back to the bond market. This is easier."

Fed or FDIC Should Stop this Fraudulent Scheme Now

They are too big too fail

The Fed will bail them out

Cities won't default but who cares anyway because the Fed will bail them out

They have a hot pile of cash the Fed crammed down their throats at 0% and they want to put it to use

They got burnt badly on mortgages and home equity loans so they need to find something new

One idiot bank made an absurdly risky deal so like sheep they all want to do it



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