etting ready to write about the future of Lyric Opera a couple of weeks
ago, I was scrolling through its latest annual report when three words
caught my eye: interest-rate swaps. The swaps are a financial management
strategy that was popular among governments and nonprofits in the early
years of this century. But for the last decade they’ve looked like a costly
Two years ago a group called the ReFund America Project issued a laudably
readable report on the hundreds of millions of dollars Illinois was (and
still is) paying on complicated financial swap deals it entered into during
the Blagojevich years.
As the report explained, the swaps were sold as a kind of insurance—a way
to protect borrowers using variable-rate bonds from rising interest rates
on those bonds in the future. As in home mortgages, the adjustable rate is
usually cheaper than a fixed rate to begin with, but if interest rates
climb, it can turn out to be much more expensive.
In the case of multimillion-dollar variable-rate bonds, steeply rising
rates can turn into the kind of budget-busting interest payments that keep
chief financial officers up at night. And this is where the swap agreement
comes in: it’s a side bet that can turn a variable rate into a fixed rate.
Here’s how it works: The bond borrower agrees to pay the opposite party in
the swap, usually a bank, a flat rate of interest (along with a fee for
entering into the agreement). The bank, in turn, will pay the bond borrower
the fluctuating, variable rate of interest.
If interest rates rise, as they did in the early years of this century, the
bond issuer will never have to pay more than the agreed-upon fixed rate.
But if interest rates swoon, as they did after the economic collapse of
2008, and if they remain very low for a decade, as they have, the bank will
pay almost nothing, while the bond borrower will shell out a fortune.
This is the pickle the city, the state, and—it turns out—many of our major
cultural institutions have found themselves in.
Lyric Opera entered into a swap agreement in 2006 to cover $40 million in
bonds. The fixed rate that Lyric’s paying is 3.8 percent, while the
variable rate it’s getting in return is now 1.58 percent. Over the 12 years
that the swap has existed, Lyric’s paid about $16.8 million for it. During
that same period, the cost of interest on the bonds amounted to about $4
But Lyric is hardly alone in this. A look at financial statements from a
few randomly selected cultural organizations suggests that it’s the rule
for our major institutions, not the exception. The Chicago Symphony
Orchestra, for example, spent $2.8 million on swaps in 2017, and $3 million
on them the year before. Interest payments on its bonds for the same years
were only $950,000 and $135,000 respectively.
The Chicago History Museum, with an annual operating budget of only $9
million, paid $2.1 million in interest last year on a swap that runs
through 2035. Over the last decade the swap has cost the museum $18.6
So, in a low-interest environment, why not pay the swaps off and refinance?
If only it were that simple. The agreements are generally equipped with
early termination fees hefty enough to thwart escape. For example, in the
case of the Field Museum—which is paying 3.7 percent and 3.4 percent
interest on two swaps totaling $88 million in coverage—it would have cost
$18.6 million to opt out at the end of 2016. And both of those swaps run
Saqib Bhatti—who coauthored the ReFund Illinois report and is now
codirector of a new nonprofit, ACRE (the Action Center on Race and the
Economy)—recently told me, “The use of interest-rate swaps by nonprofits
has been riddled with a lot of the same issues that government swaps have.
“In the corporate world, interest-rate swaps are much shorter—say three to
seven years—which limits the potential liability,” Bhatti continues. “For
governments and nonprofits, these deals end up being 20, 30, even 40 years
long, which gives them much more exposure. In pretty much all cases,
nonprofits would have been better off if they had not entered into the
swaps. Conventional 30-year fixed-rate bonds are still the safest
But Carl F. Luft, academic director of DePaul University’s Arditti Center
for Risk Management, says the people who bought the swaps were making “a
hedging decision,” like buying insurance for your car: “What they were
doing was eliminating the need to worry about rising interest rates.”
Also, says Luft: “Hindsight is 20/20. Nobody knows what will happen to
interest rates in the future.”
Right now, in the Trump moment, it looks like they’re headed up. v