New Jersey Losing $22,000-a-Day With Swap for Bonds Never Sold

New Jersey taxpayers are being saddled with a bill of about $657,000 a month from Bank of Montreal for an interest-rate swap approved by state officials and linked to bonds that were never sold.

The 11th-largest U.S. state by population, which is cutting expenses to close a $1 billion budget deficit, will pay Canada’s oldest lender $23.5 million. The sum, about the same as the salaries for 113 teachers over three years, will allow it to avoid a $50 million penalty for canceling the contract, which was tied to planned sales of school-construction bonds.

The interest rate swap, an agreement between borrowers to exchange fixed and variable-rate payments on a set amount of debt, was arranged in 2004 to protect taxpayers against rising borrowing costs. The strategy backfired after officials decided against issuing the securities.

“This is a classic case of a strategic error,” said Robert Brooks, a finance professor at the University of Alabama- Tuscaloosa and author of a book on derivatives. “It’s arrogant to believe that you have such a command of the future that you know with certainty what is going to happen.”

The payments, which work out to $21,892 a day for three years,

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