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Few observations on MCDX and the future of municipal bond market
- Berkshire Hathaway
- Bond
- Borrowing Costs
- Capital Markets
- CDS
- Census Bureau
- Collateralized Loan Obligations
- Credit-Default Swaps
- default
- ETC
- Financial Crisis Inquiry Commission
- Fitch
- Foreclosures
- Great Depression
- headlines
- Housing Bubble
- Illinois
- Markit
- Matt Taibbi
- Michigan
- Muni Bonds
- ratings
- Reality
- Recession
- Sovereign Debt
- Subprime Mortgages
- Tax Revenue
- Testimony
- Wall Street Journal
- Warren Buffett
I will keep it short today, since my attention is currently focused on World Cup and sleeping.
The issue I wish to discuss is MCDX [municipal bond index which tracks the CDS valuation of 50 most liquid municipal bonds; administered and data published by Markit] and municipal bond market in general.
Today Wall Street Journal issued a warning article on municipal bond market:
Investors are ignoring warning signs in the $2.8 trillion municipal-bond market, raising the risk of a reckoning, according to some market specialists.
Numerous municipalities are struggling financially.
A Rhode Island city recently said it faces insolvency. Harrisburg, the capital of Pennsylvania, is considering a municipal-bankruptcy filing. And famed investor Warren Buffett recently warned of a "terrible problem" ahead for municipal bonds.
But municipal-bond prices aren't reflecting much concern. Yields on municipal bonds maturing in 2020 stood at 3.15% Friday, up slightly for the week but down from 3.3% in April. As prices and yields move inversely, this indicates lessening concern among muni investors, even as the cost of insuring against defaults has been rising.
To be sure, just 223 out of more than 40,000 municipal issuers defaulted on their debt payments in the past year, says Matt Fabian, managing director of consulting firm Municipal Market Advisors. That represented about $6.4 billion, or just .002% of outstanding municipal debt, he says.
Still, some market specialists say the gaps between municipal revenue and expenditures are unsustainable.
"The day of reckoning is here," says Jeffrey Schoenfeld, chief investment officer of Brown Brothers Harriman. "But municipal investors continue to act as if there's no default risk in municipal bonds."
It could become more difficult for investors to weed out the dangers. Now, professionals put less credence in credit ratings, after ratings providers failed to spot risks in subprime mortgages during the housing bubble.
The ratings system "tends to rely on history, which is not a good guide," says Michael Aronstein, chief investment officer of Oscar Gruss & Sons Inc., which advises professional investors. "Not everybody is going to default, but investors need to do their own analysis and in-depth research to really understand what they are buying."
In recent public testimony Mr. Buffett said he was worried about how municipalities will pay for retirement and health benefits for public workers and that the federal government may ultimately be compelled to bail out states. His remarks were made during a hearing by the Financial Crisis Inquiry Commission, which is collecting information for Congress on what caused the nation's financial crisis.
Mr. Buffett's Berkshire Hathaway Inc. has trimmed its municipal-bond investments to less than $4 billion as of the first quarter of 2010 from about $4.7 billion at the end of 2008.
"I don't know how I would rate them myself," Mr. Buffett testified. "It's a bet on how the federal government will act over time."
Increasingly, municipalities are showing signs of deep financial stress. Harrisburg said it might file for Chapter 9 bankruptcy proceedings. And Central Falls, R.I., whose motto is "City with a Bright Future," handed control of its finances to a receiver, unable to pay its debt
The news helped to push up prices to insure municipal bonds through credit-default swaps.
Credit-default swaps, which allow even those who don't own bonds to bet a municipality will default, are traded on more than a dozen states and dozens of smaller municipalities.
A basket of 50 of these contracts trade through an index called Markit MCDX. The cost of insuring $1 million of five-year bonds rose 16% in the past week, to $20,000 a year.
The contracts are thinly traded, making their prices vulnerable to big swings. Still, says Michael Gormley, a Markit spokesman, "The widening is indicative of growing concern in the municipal market."
Meantime, some investors argue that current municipal-bond analyses don't take into account the liability of citizens in each state for their share of federal debt.
Investors typically look at the amount of debt a state holds compared with its economic output, known as the "gross state product."
In Illinois, for example, the ratio is about 4%. But federal government debt will be paid by individuals through income taxes and federal taxes levied locally, such as gas and highway taxes. This would make it more difficult to raise taxes to pay all these debts.
"Ultimately, you're going to support debt at a national level as well," says Lyle Fitterer, managing director who oversees municipal bonds at Wells Capital Management, a large investment firm. So, in reality, he says, Illinois owes 65% to 70% of its gross state product.
John Sinsheimer, Illinois director of capital markets, says the state isn't responsible for federal debt and therefore the national deficit doesn't affect its ability to pay bonds, though citizens are resistant to tax increases in general.
Fitch Ratings's ratings consider overlapping debt of local governments but not each individual's proportionate responsibility for federal debt, says Amy Laskey, a managing director at the ratings provider.
Fitch, along with Moody's Investor Service, recently recalibrated its municipal-bond ratings, to bring them in line with other securities, such as corporate and sovereign debt. This lifted the ratings of thousands of municipalities.
The move was designed to balance municipalities' historically low default rates with increasing financial obligations and declining tax revenue.
It also helped reconcile municipal ratings with those of corporations, potentially lowering municipalities' borrowing costs and making municipal-bond navigation easier for investors who typically buy corporate bonds.
Of course this doesn't need to indicate anything is wrong with all municipalities [due to the way the MCDX is structured], but if the ABX family is any indication as to how these indexes can help in predicting the next massive implosion, we are in for a heap of trouble.
The problem is that municipalities income depends mostly on RE taxes; and since the rate of foreclosures is steadily climbing for the past 2 years [with no indication it will change direction] it is expected municipalities will have a harder time issuing new debt, and servicing the old one.
The problem is more than evident if one takes a closer look at California, New York, New Jersey and Michigan. The annual deficits can not be managed any longer and some really hilarious methods are employed to pay for old liabilities.
But the problem with MCDX as a trading vehicle is that, although it was announced as the next big thing in the derivatives market when it debuted, the chronic lack of liquidity displayed in the market when the spreads are this high made it good only to serve as an arbitrage vehicle.
It has diverged from CDX.NA.IG significantly and instead of becoming a way to trade muni debt risk it has become a laughing stock and an arbitrage opportunity in case of a doomsday event.
It is easy to see why that is so. Even AAA IG debt risk should, theoretically, trade wider than any debt risk which is serviced by taxation; since muni debt is practically a form of sovereign debt. But with the implosion in housing that order of things has decoupled seriously and my belief is that the market is now irrational and that in the end AAA IG will trade wider than muni debt.
I base my belief on the expectation that the Federal Government will either be used to enhance municipal credit or the FED will structure a facility similar to Maiden Lane which will accept municipal bonds as collateral. One, less possible, outcome is that an SPE, fully backed by the Federal Government [Treasury or the FED], will be created and take muni debt off banks balance sheets.
Of course this is yet not required due to accounting practices which are currently being used in asset valuation, but if the structured instruments [with cash flows coming from municipal IR payments] start to show a rapid deterioration in their cash flows, the contagion could spread and there are ways [easier than to play the MCDX indexes] to bet on single names and/or legacy tranches [legacy tranches being most likely hybrids consisting not only of municipal debt, but various other instruments such as CDOs, CLO etc etc]. The contagion due to the problem with muni debt could be several times greater than what we have seen in the fall of 2008.
This is the outline of the MCDX structure [for informative purposes only]:
And just to add more insult to the injury; there is this:
Eight U.S. states, including Illinois, California, Pennsylvania and New Jersey, risk lower credit ratings because they lack completed budgets less than three weeks before the start of their new fiscal years. A ninth, New York, has operated without one since its year started April 1.
All are gripped by political stalemates over how to cope with a collapse in tax revenue that included a $67 billion decline in the 12 months ended June 30, 2009, according to the Census Bureau. The Nelson A. Rockefeller Institute of Government called that the biggest on record.
Governors and lawmakers already chopped billions of dollars from previous budgets in the deepest recession since the Great Depression. Delays in new spending plans could cut off credit and slow payments to schools, local governments and public employees, Moody's Investors Service said. Some states may need emergency solutions like California used last year, when it paid vendors with IOUs as a $26 billion budget gap went unresolved.
Read the rest of the article here.
If you are interested in what kind of practices WS banks used in order to collect their fees issuing muni bonds, you only need to read the article Matt Taibbi published in Rolling Stone. You can find it by clicking here.
Expect for the problems in municipal market to replace European debt problems and take the central spot in MSM headlines. Of course, every major economist, banker and CEO will tell you "no one could foresee these problems 2 months ago". They will be wrong.
So, ladies and gentlemen this is it from me for the foreseeable future. I will go back to writing on a more regular basis when the WC is over and/or extreme events grasp the arcane world of derivatives and debt.
Until then, good luck and Godspeed.
P.S.
Go Deutschland.
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As suggested earlier, the EURUSD daily chart is giving bullish signals.
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My favorite play from yesterday was when the Paraguay keeper and an Italian went up for a high cross which the keeper snagged, but on the way down, the Italian punched him in the head.
No call, of course.
'Go Deutschland?'
Thats a wierd comment for an Englishman to make...
It is. I know of no Englishman[ maybe one of the Windsors *wink wink*]who would say such a thing.
But, Im not one, so, GO DEUTSCHLAND.
yeah i read your thread the other day where someone insinuated you were English. glad you saw the sarcasm!
I grew up in australia. I know the ausi back line is useless but you guys looked good. and you play much nicer football than the english, your coach has it correct - they (English) have reverted to chip and chase and its as ugly as it is ineffective.
Maybe this story (true story) is being stirred up just now to hurt the dollar. It's a race to the bottom after all, and government personalities worldwide are talking down their currencies with reference to various giant crises in their economic zones. I'm talking prime ministers, finance ministers, central bankers(more stealthily), etc; people who normally wouldn't make a spectacle of how bad finances are in their country...
CB, why are you constantly in here with the doomsayin, bro? They got insurance, chief! Don't ABK and MBIA got this isht? Or Buffett? The Fed is on top of this, nigga
Another good article. No wonder in the previous post you said you had little sleep - and i was wondering why!
How do the different ranks of debt trade in the US? Here in Canada we have (high to low y) munis, provis, then Federal bonds. Is this the same case, or would a certain extremely rich municipality (i wanna give an example and say somewhere in Cali but then again, i wont) have a lower yield because its safer than that state's bonds?
I also would like to see in the coming future IG trade (significantly, hopefully) wider than munis - always chasing that yield!
Essentially, if the gov would keep the muni bond market afloat, would that be like synthetically backing up one's positions in MCDX? This hasn't been done in ABX (or any of its arms) correct?
Enjoy the WC. Personnally, I'm glad to hear you're taking some time off. I don't arrive at ZH expecting to read about butterflies and unicorns, but some of the stuff you find is downright terrifying. *shudders* Have fun!
Thank you for your work CB. The Dalmation coast is one of the most beautiful places on earth, I have been twice, driving inland from Dubrovnik to Medjugorje to see the ongoing apparitions. Mir, mir, mir, cb. God bless, a kraut in Canada.
Read the rest of the article here.
http://www.dailyherald.com/story/?id=387737
____
I did.
If this is Capitalism, bring on Socialism any day of the week.
Awesome post.
I just busted the City of Berkeley's ass for trying to float a huge bond for pool renovations. 23 million bond-for 30 years. Plus a 3.5 million a year parcel tax on homeowners to pay for the bonds and maintenance.
The City was playing a numbers game-trying to free up money in the general fund for pension obligations etc. The City is 16 million in Debt and they want to spend the next 30 years paying 109 million dollars for pools!
Another great article and comments ! Thanks.
I looked at and this wondered, "And famed investor Warren Buffett recently warned of a "terrible problem" ahead for municipal bonds" - Was this after Buffett's (investment) company made money charging the muni's for triple A ratings ?
His warning was as big as Hollywood's about the taking action on the GoM oil catastrophe. Thanks Penn, Jolie, Clooney et al for playing mute paraplegics. Thanks for helping to collect money for the families suffering and affected by the disaster (oh wait a minute, these are U.S. citizens ...better get permission from Chavez and Castro first).
Okay. What is the best way to to keep them from taking taxes on your income automatically? I already claim M+5, so if I change it to +10 , will it make any difference? Is there a limit to how many you can claim? Rather have my money now, than later. TIA
Well, you could develope your own independant income streams AND keep your own books while changing accounting pratices as the need arises...that's what "they" do afterall...LOL...there is a down side however, by not having some of the biggest guns on the planet...I'm starting to think a coup in some nondescript backwater somewhere.
Somewhere in South America or maybe Kyrgyzstan ;-)
Cheeky,
Just sleep during soccer (yes, soccer). If you tivo it you can fast forward to the exciting parts. Should only take 8-10 seconds per game.
The annoying hum of the horns actually turns into nice white noise for a good nap.
I'm aware my nom de plume in this case is misleading.
Love your stuff though,
Jean
I actually bought a TV just to watch WC. I haven't owned one a week ago. I dont have any recording devices to actually record the games. But as a die hard football [yes football] fan I dont really notice the boredom anymore. Its just .... football.
Why buy a TV?
http://atdhe.net/
Cheeky:
I appreciate all your work and comments, very insightful.
Just so you know you can watch all the matches online for free on the ESPN 3 website. They keep them on for awhile so if you miss them you can watch later. They have the broadcasts in different languages too, no need for a tele.
Nederland supporter
The video quality on ESPN3 has been very poor when I watch it. Is this just my ISP, or do you have the same problem?
I have had different results with different matches so I don't really know for sure. The Italy match today was terrible quality but the Netherlands game was fine. I think it is mostly my connection. The video quality bars are full when I have a good connection but only has 1 bar other times.
In short, its probably the connection.
I do try to appreciate the international pagentry of it and the players' skill. I just can't seem to get past what appears to me to be the greatest skill the players posess: The ability to instantly grab the body part that just received the slighest of contact, grimmace and writhe in pain all before crumpling to the ground in a fraction of a second. It's too much of a contrast to my favorite spectator sport, hockey, in which Duncan Keith just reciently lost 7 teeth and was in for the next shift.
Now that you have a TV, try to find an NHL game next fall.
portugal plays tomoro and you will see the best playa in the world
http://www.youtube.com/watch?v=nKerPxjACro
that was a very c 0_0 l
vid.
damn, men are good with their feet†
We'll see. He needs to have a good World Cup.
+1000
The states will get bailed out hardcore, but the process will further de-legitimize the US government and the Federal Reserve.
The political risk is just too high for multinationals to continue residing in the US. Capital flight will provoke changes - not the political process.
Hey CB,
Appreciated it.
Btw, I thought you support the Oranges (err, the Netherlands) at the WC.
No?
CB, Germany will be Germany both in footbal and exports no matter
what happens in the world, I believe.
All the best..
Germany because of my mother, Croatia [if it had qualified, goddamn sons of bitches] because of my father. Since no CRO, then GER.
No PLN this year either:( Quite sad, especially how GER's 2 best players are Polish born! (Go figure, guess which players had the goals today!)
I have few Croatian friends, they're die hard
footballers and know how to drink as well.
Enjoy the games, and trash your TV box
celebrating whomeever wins the cup.
Do the banks pay the property taxes on properties they now own and if so wouldn't they have to pay the marked to model that they are claiming on their books? Hopefully municipalities are'nt stupid enough to let them not pay property taxes .
I am serious I am very curious to know if banks pay property taxes if anyone knows.
As said by this commentator. http://thehive.modbee.com/node/14928#comment-95500
I dont know seems like in this situation it might be better to deny the deferal -if the bank tries to get the taxes lowered that should be denied unless the banks can provide proof that is the value they hold on their own books for the home . Someone has to play hardball with corps they are not people and it's not like you can hurt their feelings . And at this point it's do or die .
Maybe it's time to tax church properties as well? A sales tax equivalent for each State on the passed basket in the old Baptist church on the hill? Boy, that could be a whole 'nother topic!
Cheeky,
In reference to the second paragraph in your excerpt, I live in RI and don't know which town/city faces insolvency... But that's only because there are several cities that could make the same claim. Plus, the state gov is completely fucked as well.
BTW, how does a person submit an article to be posted on this site? I have a couple of articles I'd like to add to the mix, but can't figure out where the submission form is. Any help is appreciated.
I hope your health is coming along!
Peace
go to create content - and put articles in the forum area . Cheeky has a different status than us normal ZH addicts where he is also a contributor. (he deserves it because he knows his shit) .I am pretty sure you have to prove yourself here to get contributor status.
Hogwash.
"Governors and lawmakers already chopped billions of dollars from previous budgets in the deepest recession since the Great Depression"
I dont know about other state's but CA's budget grew over last year's budget.
Cuts in projected increased or desired increases are NOT cuts, a "cut" is a reduction in spending from the prior year.
CA is spending more now than we did at the peak of the real estate bubble, and what's worse CA has a 1.4 billion dollar RE slush fund specifically for reducing the number of taxable homes, (they're using federal/state funds to buy private homes and permanently remove them from the state tax roles)
in other words CA is spending over billion dollars of borrowed money to remove over a billion dollars worth of real estate from the tax roles, in addition to reducing CA's taxable real estate by over a billion dollars this will add billions to CA's expenses (owning low income real estate to rent at a loss is an expensive endeavor).
I don't care if Matt Taibbi uncovered that investment bankers sacrificed live human babies to get AAA ratings - municipal governments have done this to themselves and they deserve to go belly up. Couldn't happen to a nicer bunch of folks really. If the Feds bail out insolvent munis that will be a moral hazard at least one order of magnitude greater than any TBTF bank bailout.
why one order of magnitude (or any) greater than tbtf?
Well you're talking about 40,000 different municipal issuers in the country and all the employees who work for those municipalities and related agencies. That's a lot of jobs and money at risk. TBTF status would send the signal to those local & state governments and agencies that they could essentially grow themselves to any size (not that they need much encouragement) regardless of what underlying private wealth and business bases can support.
Yeah, I'd say that would be at least 10 times as big of a problem as the combined threat of the TBTF financial institutions but it depends on exactly how and what you measure of course.
We'll soon find out!
less morally suspect though, IMO, as the taxpayers of these munis had less choice than the stockholders of the TBTF banks.
"If the Feds bail out insolvent munis that will be a moral hazard at least one order of magnitude greater than any TBTF bank bailout."
Exactly. Although more like 2-4 orders of magnitude.
However, it is most surely going to happen. There is no other choice.
Well if you listen to Barney Frank federal backing is coming.
no spank you
What about all the FHA insured munis? Back by the full faith and credit of Uncle Sam. Bullet proof!!! lol.
http://www.businessweek.com/news/2010-06-14/fannie-freddie-fix-at-160-billion-with-1-trillion-worst-case.html
That's why Fannie needs a royalty off of every Cap and Trade transaction defined in their patent.
Growth cut due to reduced spending by state and local govt:
http://www.bloomberg.com/apps/news?pid=20601087&sid=a_rI0JsDjgvI&pos=7
SPX is twitching down in response.
They are full of shit; look at the BABs volume, participation in total volume and the amount issued in 1 year only.
If he wants to impose fiscal discipline, then he should slow the fuck down with issuing new muni debt. Any gain in reducing borrowing cost [which is why and how BABs are structured] is wiped out with the $ amount issued.
The table below should make you vomit.