State Rep. Lori Ehrlich: Swaptions: A train wreck coming down the Pike

State Rep. Lori Ehrlich

The current transportation debate has put a spotlight on how we restore and protect the integrity of our transportation system but should also illuminate the road that brought us here — specifically, the amount of risk accepted by our agencies and the integrity of the decision-making process.

Back in 2001, options on interest-rate swaps, commonly known as “swaptions,” from UBS were used by the Massachusetts Turnpike Authority to generate cash in the short run while gambling on interest rates in the future. Swaptions are derivative instruments (exotic, usually high-risk investments speculating on everything from the weather to the spread between various interest rates) and are largely unregulated by the SEC. The MTA struck another swaption deal in 2002 with Lehman Brothers to offset some of the risk of the UBS swaption. This provided short-term cash payments for the MTA but, with 35 percent of its debt in derivatives, exposed the Commonwealth to extreme market risk and potential termination penalties in the hundreds of millions of dollars. The rating agency Fitch warned about serious financial risk associated with this decision in 2002.