This story has started in 1987 when Hammersmith and Fulham entered into more than 600 interest rate swaps and other similar instruments totaling $9.5 billion. In dozens of these contracts, the local government accepted to get fix-rate interest payments from a bank, and make floating-rate payments to the bank. As interest rates increased, so did floating-rate payments, meaning that banks had profits from these contracts. Besides interest rate swap contracts Hammersmith and Fulham also sold many swaptions which give the right for its owner to enter in the contract in the future. Such speculative and superficial understanding of risks they were taking almost led to a collapse. When interest rates increased in United Kingdom Hammersmith and Fulham lost hundreds of millions pounds. Such alternative investment management solutions to the banks were worth hundreds of millions pounds as well.
Banks were concerned about the risk, and if Hammersmith and Fulham defaulted, banks would have to take a huge loss. However, everything turned to something different. A British court asked by Hammersmith and Fulham’s auditor concluded that interest rate swaps contracts settled by a government in London must be voided. This decision resulted in large losses for banks.
If a British court opinion was to extend swap contracts, then losses could reach $650 million. Financial institutions, which were affected by Hammersmith and Fulham’s alternative investment management solutions, in United Kingdom recorded losses of $75 million at the TSB Group and $40 million at Barclays Bank. According to spokesmen’s from Chemical Bank and Security Pacific losses were insignificant. Security Pacific had around $60 million in interest rate swaps, and possible losses amounted to $7 million.
This was the first case where local government used public law to tear down private contracts.