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Wednesday, 1 February 2012

Building cooperative Vestia, based in Rotterdam, The Netherlands plays ‘hedgefund’ with the banks and might lose €2.5 bln. Who is to blame: the banks or the cooperative itself?

Shocking news today: the large Dutch building cooperative Vestia in Rotterdam might lose a mindboggling €2.5 bln in an interest rate swap investment gone awry. Vestia, owner/ real estate manager of 89,000 houses in the Rotterdam area and therefore an extremely important party for housing in the port city, is now on the brink of defaulting.

On top of that, there is the problem that this issue must be handled with kid gloves by the Dutch authorities, to prevent the banks from withdrawing their investments from Vestia. The latter would probably mean that the whole real estate portfolio would end in the hands of the banks that took the other end of the interest rate swap deal of this cooperative.

Today, the Dutch financial newspaper Het Financieele Dagblad ( wrote on the shocking story of Vestia. Here are the pertinent snips, translated to English by me:

Minister Liesbeth Spies of the Interior is not able to intervene directly at the building cooperative Vestia in Rotterdam.

When the minister puts the Rotterdam-based building cooperative into custody, then escalation looms for the financial issues of Vestia. The cooperative worked itself into deep trouble by investing and trading in exotic financial derivatives.

There is a clear reason that the Minister is reluctant to intervene in Vestia: the banks that took the counterparty risk for Vestia’s derivatives can immediately demand their money, as soon as Vestia has been put into custody. The Minister leaves it therefore to the other building cooperatives to keep Vestia afloat, but plays a decisive role in the background.

The risk of enduring larger financial damage explains the restraint and discretion in which the Christian-Democrat Minister Spies handles the problems at Vestia. MP’s are only informed confidentially about the situation at the building cooperative and keep their mouths shut meticulously.

Vestia covered the risk that it should pay higher interest in the future, at its banks. It didn’t pay an insurance premium for this deal. Instead it choose for taking over the banks’ risk of having a lower interest rate in the future. Thus the cooperative turned into an insurer for €5 bln.

Now that the interest is unusually low, Vestia has to deposit money in order to give security. In this way the banks are certain that they receive their money when the derivatives mature and the interest rate is still under the negotiated level. When the interest rate increases sufficiently in time, the damage can be limited.

The deposits for giving security aggregated to €2.5bln, according to insiders in the matter. It is unclear yet either if this whole amount should be handed out to the banks when Vestia will be put into custody, or only a share of this amount. In the meantime, the building cooperative got into serious liquidity problems, when its own reserve of €1 bln had been exhausted and the Guarantee Fund Social Housing (WSW) warranted an additional loan of €1 bln, in order to deposit extra security money. Last weekend five other building cooperatives jumped into the void, enabling Vestia to make an extra deposit of €500 mln.

In March 2011, Vestia entered into a contract with the British derivatives specialist SuperDerivatives ( for the risk management of its interest derivatives.

And Het Financieele Dagblad writes also in an insightful and informative editorial:

Simplified, the building cooperatives borrow money, build houses from this money and meet their financial obligations with the yields of renting these houses.

The interest rate is therefore important for cooperatives. The higher the rate is, the more difficult it is to offer houses at low fixed charges. Cooperatives borrow at low rates, as they are covered by the WSW, which is covered itself by the Dutch state.

Especially larger cooperatives try to fix the interest rates for long periods of time. Then they are secured of fixed interest rates for a number of years, which is very important for their core activities. They cover themselves for interest fluctuations using the so-called interest rate swaps. To put it simple: when the interest rises the yields of the swaps compensate the higher interest. In the opposite case when the interest drops, the advantages of a low interest rate disappear as a consequence of the losses on the swaps.

The real competence is to find balance in what risks you hedge with swaps or not. It seems that Vestia took a much bigger bite than it could chew. The sheer size of their interest rate swaps stood in no relation to their daily business. It looked at lot like speculation.

To be honest: I don’t know much about interest rate swaps. I don’t know the exact type that was used by Vestia and I don’t know what the particular risks of this type of swap were.

What I’m quite certain about, however, is that the chance that the interest rates in Europe (i.e. Euribor rate) will rise dramatically in the coming months or even years, is that of ‘a snowball in hell’. The crisis might last for another number of years and during that time the interest rate probably won’t be increased  at all. Please take another look at the picture that I already printed in The Dutch Pension Funds that have been battling

Chart courtesy of
Click to enlarge
I restate here that the ‘Japan scenario’ for a prolonged depression is followed to a tee by the ECB and the European leaders. And Japan has already had an interest rate close to zero for more than 16 years.

If you read the red and bold text in the first article again, then you realize that Vestia can probably wave their deposit money goodbye, if the Japan scenario is indeed followed in Europe, with the interest rates close to zero. And it are the tenants and taxpayers that must foot the bill; not only through Vestia (€1bln), but also through the other building cooperatives (on the hook for €500 mln) and the WSW that is on the hook for €1 bln. That is a very bad perspective.

It seems that the banks made a very favorable deal for themselves while negotiating with Vestia on the terms for the interest rate swaps. It looks like the classic fight of a sea-lion that is surrounded by sharks; in the end the sharks win!

In this kind of cases, it is always a question of who is to blame?! Vestia for being utterly clueless and for trading in derivatives that it knows too little about; in other words, for gambling with other people’s money?

Or the banks for selling this stuff to people that they might consider being amateurs in this line of business. 

I blame both parties and I hope it will lead to severe legal penalties at both sides.

The sad thing is that it probably doesn’t matter who is right or wrong. In one way or another, the taxpayer foots the bill: either via saving the banks or via saving the building cooperatives. It’s like being stuck between a rock and a hard place.

And the worst thing is; this is not the first time that building cooperatives endure enormous damages from a speculative frenzy. Already about twenty years ago, building cooperatives discovered the stock option as a hedging AND speculative tool. Totally clueless treasurers invested and lost millions in stock option trades that went awry; in one case up to €25 mln. But this is peanuts, compared to the amount of money that is at stake today.

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