The MSU Spartans Kept On Swapping Their Money for Nothing

Michigan State University (MSU) ventured into the jungle of the Swap Mania on July 1, 1998. Ambac Financial Services wrote the first contract requiring MSU to pay interest at a fixed rate of 4.604% and receive the Municipal Bond Average Interest Rate (SIFMA). The first annual report to disclose the status of swap contracts was in 2005 because the accounting rules adopted by MSU (Governmental Accounting Standards) did not require making such disclosures earlier. The disclosure reveals a costly experience with interest-rate-exchange (swap) contracts because in 2005, the termination (fair) value of this contract was a loss of $6.7 million, which was about 13% of the notional amount ($52 million). In simple terms, the only benefit the swap contract offered to MSU was the promise, not guarantee, to keep a ceiling of 4.074% for the interest rate on the related debt. MSU could not terminate that contract before its expiry date in 2022 without paying Ambac the entire fair-market value of $6.7 million, which is relatively low as compared to what will come. A losing enforceable, and noncancelable contract written to last one-quarter of a century could not be considered to favor MSU under any circumstances because Ambac did not write a contract to lose on average so that MSU would gain…