By Harvard Zhang

The state of Illinois should take legal action against bank holding companies to cancel investment deals that are costing the state $6 million every month while it skips social services payments amid its continuing budget impasse, according to a research report released Tuesday.

Co-authors and supporters of the report, dubbed “Turned Around: How the Swaps that Were Supposed to Save Illinois Millions Became Toxic,” called on Illinois to petition the federal Securities and Exchange Commission or sue the bank holding corporations for “fraudulent concealment or misrepresentation” on interest-rate swap deals. The “swaps” are agreements entered into by the Blagojevich administration in an effort to mitigate the risk of interest-rate fluctuations.

“We believe the banks that pitched these deals to the state misrepresented the risks,” Saqib Bhatti, co-author of the report and director of the ReFund America Project supported by the New York City-based think tank the Roosevelt Institute, said in a Tuesday press conference in downtown Chicago. “We are calling on the governor to take legal action against them to get back our money so that we can properly fund services in Illinois.”

The state of Illinois, facing the same financial problems as the city of Chicago and Chicago Public Schools, has spent $618 million on those swap deals, and would pay a total $1.45 billion on the swap deals ending in 2033, according to the report.

Some of the interest-rate swap deals dated back to October 2003 when the state of Illinois at the helm of then-Governor Rod Blagojevich came to agreements relating to a $600-million variable-rate bond issuance with five financial services firms — Bank of America, Merrill Lynch, Bank One, American International Group and Lehman Brothers. Because of bank failures and mergers, three of these swap deals are now held by Loop Financial, JPMorgan Chase and American International Group, and the other two are held by Bank of America, which absorbed Merrill Lynch.

“Governor Rauner inherited these swaps from Governor Blagojevich,” Governor Bruce Rauner’s spokeswoman Catherine Kelly wrote in an email statement. “The Governor’s Office of Management and Budget is doing an in-depth analysis of these swaps in order to reduce the State’s payments and minimize its financial exposure.”

In a typical interest-rate swap, government entities pay financial institutions a fixed rate of interest in exchange for the institution’s paying a variable-rate interest to bondholders. In this way, the state of Illinois was able to lock in a fixed interest rate without having to worry about the fluctuation or surging of interest rates in the future.

But the state would suffer if interest rates drop, which was exactly the case when the Federal Reserve slashed interest rates in response to the 2008 financial crisis.

The report showed Illinois had to write a check to its banking partners of approximately $1.8 million every month in net swap payment from November 2008 through June 2015 for it 2003 variable-rate general obligation bonds.

More urgently, Springfield would have to pay $124 million in termination penalties as early as November, if any of the banks that had provided additional guarantees for the 2003 bonds refused to renew the letters of credit amid the state budget logjam and Illinois’ poor credit ratings, the report shows.

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The report also shed a light on a conflict of interest involving JPMorgan Chase & Co. The banking giant is a letter of credit provider for the 2003 bonds but also a counterparty to one of the swap deals. If JPMorgan Chase refuses to renew the letter of credit in November, that could trigger a termination penalties for the State of Illinois of $11 million.

JPMorgan Chase declined to comment.

The Chicago City Council last Wednesday rebuked Mayor Rahm Emanuel’s plan to borrow $200 million to cover similar termination costs associated with interest-rate swap deals.

For providers of low-income child care, youth programs and many other programs, a lack of state funds because of the budget impasse is almost unbearable. Participants in the Tuesday press conference voiced their discontent with the state’s decision to skip payments to social services while paying banking firms.

“If we do not see payments for another month, we will almost certainly be forced to enact contingency plans that would immediately cut services to more than 80 households, most of them families with children,” said Evan Cauble-Johnson, chief development officer at Chicago-based Inspiration Corp. that provides job training and other services to homeless and low-income Chicagoans.