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A Muni CDS Market Primer

Tyler Durden's picture




 

With increasing confusion over the cash muni bond market, very little has so far been said about the even more confusing muni CDS market. However, as municipal bankruptcies are likely about to take the country by storm, it is really the synthetic market that should be occupying investors' attentions. This is especially true with yesterday's disclosure that the bankrupt city of Vallejo is offering recoveries of only 5-20 cents to its sub creditors: it means that muni insolvencies will be not only a "survival" issue but one of recovery as well, considering assumptions embedded in cumulative loss forecasts that predict 80% recoveries by default. Below we present the most comprehensive report we have read so far on the matter of muni CDS, which should serve as a primer to anyone who wishes to be abreast not only of events in the muni cash space (where cash outflows are now comparable to what happened to equities following the flash crash), but in the wonderful world of synthetic paper.

From Santhosh Bandreddi at Bank of America

The Muni CDS Market

Municipal bond spreads have been under pressure since the advent of the European sovereign crisis because of the similar negative credit headlines around the fiscal woes of muni issuers. Investors use muni CDS (MCDS) and MCDX indices to hedge muni bond exposures by buying protection or, alternatively, monetize this risk premium in the muni CDS market by selling protection.

CDS contracts on Munis started trading back in 2003-04 but traded more actively since 2007-08, after the downgrade of the monoline insurers during the crisis. Some of the municipal bonds were insured by these monoline insurers and their downgrade meant higher counterparty risk for those muni bond holders.

Volumes in MCDS, although still low compared to corporate CDS, have been picking up this year with the increased interest in this market. Figure 2 shows the most actively traded MCDS names, since Jul ’10 when DTCC started publishing CDS trade volume data. Figure 3 aggregates the total volume across these 8 names for each week. Because of the lower liquidity in muni CDS, a similar notional trade can result in a bigger move in spreads in MCDS versus corp CDS.

Muni CDS still trades with a floating coupon or as a “Par CDS” i.e. if an investor sells/buys protection at 120 bps, the investors gets paid/pays 120 bps per annum carry with no upfront cash exchanged. Both US/EU corporate and sovereign CDS currently trade with a fixed coupon. However, efforts are currently on to design a “Big Bang” style protocol that includes fixed coupon convention and an auction settlement process for MCDS. Figure 4 shows a sample run of some of the liquid MCDS names, which are most liquid in the 10 year tenor (5y is the most liquid tenor in corporates).

Muni CDS Basics

Similar to corporate CDS, a muni CDS contract transfers the risk of a muni default from one party (the protection ‘buyer’) to another (the ‘seller’). The protection buyer pays a periodic premium to the protection seller, in return for providing protection against a credit event of the municipality.

If there is no credit event over the life of the CDS contract, the premiums are the only cash flows exchanged. However, if there is a credit event, the protection seller compensates the protection buyer for the loss on the underlying debt (exchanges par for the delivered bond). The protection buyer has the option to deliver the cheapest bond with a maximum maturity of 30 years, similar to a
sovereign CDS even though sovereign CDS incorporates cash settlement via an auction mechanism. Figure 5 and Figure 6 recap the cash flow exchanges that happen in a CDS contract.

Different types of MCDS

A MCDS contract may have either a Full Faith & Credit obligation (GO) or a revenue obligation as the reference obligation. While most single-name MCDS contracts currently traded are on U.S. states and reference a GO, some of the entities in the MCDX index reference a revenue obligation.

General Obligations

A general obligation (GO) is generally secured by a full faith and credit pledge of the issuing entity. Typically, the entity is a state or local government which pledges its full taxing power to payment of the bonds. While this pledge is strong based on the taxing power of the entity, it does not create a lien on any revenues or property of the public entity. In the event of failure to pay, the bondholder can pursue a lawsuit to seek payment. In addition to pledging its full taxing power, issuers may also define a priority of payments for general obligation bond debt service or provide strong remedies in the event that funds appropriated for debt service prove to be inadequate. The general obligation pledge for an issuer including debt limits, priority of payments, and bondholder remedies is typically defined under the issuer’s state constitutional or statutory laws.

Revenue Obligations

In contrast to general obligations, revenue obligations are secured by a discrete revenue stream in accordance with a Resolution or Indenture. The Resolution or Indenture creates a lien on the pledged revenues and may include liens on property as well. It also defines a priority of payments. A senior lien revenue bond can have a gross revenue or net revenue pledge. In case of a net revenue pledge, payments towards senior lien debt service come second only to operations and maintenance although this is not always the case. On the other hand, in the case of a gross revenue pledge the total revenues are applied for debt service on the bond.

The general obligation pledge is generally assumed to be stronger than the revenue pledge given the powers and resources of the GO issuers. This translates to lower probabilities of default (Figure 7) as well as higher assumed recovery values (see Figure 8). While this is true in the case of, for example, revenue bonds on toll roads, it may not necessarily be true for revenue bonds on water and sewer utilities.

Chapter 9 Municipal Bankruptcy

Municipal bankruptcy is covered under Chapter 9 of the U.S. Bankruptcy Code versus Chapter 7 and Chapter 11 that are resorted to on the corporate/taxable side of the markets. The greatest distinction between municipal bankruptcy and corporate bankruptcy is that municipal bankruptcy is voluntary on the part of the municipality. No other parties may put a municipal entity into involuntary
bankruptcy. From the outset, the municipal entity under consideration has a considerable amount of control in the proceedings. Since municipalities generally do not cease to exist, the motivation for a filing is often to seek relief and to invoke an automatic stay. The ultimate goal of the municipality is to work on a plan for recovery while seeking relief. In many municipal bankruptcies, but certainly not in all, existing bondholders have been made whole on principal (this circumstance tends to be more the case in the tax-backed sector versus some of the other sectors). There may exist other pressing matters that need to be resolved away from any debate as to whether or not to pay bondholders. Most issuers will do their utmost to see to it to pay bondholders because bondholders in general and for subsequent issuances are often part of the resolution of the circumstances that have contributed to the filing. 

Although filings by municipal entities are voluntary, state law determines whether that municipal entity is authorized to file or not. States, themselves, may not file for bankruptcy. The law varies considerably in this regard from state to state. According to research done by James Spiotto at Chapman & Cutler, LLP, the status of the ability to file or not must be broken down into several groups of states.

  • According to this legal research, a total of 16 states specifically authorize municipal entities to file. The list is as follows: AL, AZ, AR, CA, FL, ID, KY, MN, MO, MT, NB, NY, OK, SC, TX, and WA (We would state that after the New York City fiscal crisis in the 1970’s, the law was modified to require entities in NY to seek permission to do so).
  • Once again, according to the same legal research, a total of 7 states conditionally authorize municipal bankruptcies including CT, LA, MI, NJ, NC, OH, and PA. In the early 1990’s Bridgeport, CT, after filing for bankruptcy, was forced to withdraw the petition as the state maintained that the city was not authorized due to some clauses embedded in a bond transaction and due to the determination that the city was not insolvent.
  • A total of three states grant limited authorization under specified circumstances and in some cases for only specified credits: CO, OR, and IL.
  • Two states have an outright prohibition: GA and IA. However, concerning IA, a filing is permitted if insurance proceeds are not sufficient to cover existing debt in an involuntary circumstance. Presumably, the circumstance would be due to a natural hazard of some sort.
  • According to the law firm, the remaining 22 states either do not possess clarity or have no stated authorization in regards to the ability of a municipal entity to file.

We conclude from the legal analysis that in many states it is not a straightforward matter whether a municipal entity has the right to file or whether permission must be sought from the state or the courts in the state where the filing is contemplated before any such intended filing.

Another important aspect in the discussion of municipal bankruptcy is the matter of the “special revenue” doctrine. The bankruptcy code has been changed on occasion in important ways that pertain to municipal filings. Starting with the bankruptcy modifications made in 1988, a revenue that is pledged to the repayment of outstanding bonds may not be clawed back or intercepted by the host issuer. Let’s take the case of a hypothetical city, viz., Star City. Let’s consider the case where Star City has faced consequential financial difficulties that have forced the city to file. In the case where Star City has an enterprise system with revenue bonds outstanding that has the security pledge of the revenue stream generated by that specific enterprise, said revenues may not be diverted to pay Star City’s other obligations that are subject to the bankruptcy filing. If we say that the enterprise is a water system, revenues of the water system may be applied to the payment of outstanding water revenue bonds even while the host community, Star City, is in receivership. This doctrine is very important due to the fact that some sixty to seventy percent of issuance each year in the municipal market is in the form of revenue bonds. (Last year, revenue bonds accounted for 62% of the volume.) Conversely, it is also true that general fund moneys may not be forced to pay the revenue bonds unless the revenue bonds feature some kind of back up pledge from Star City or Star City elects to pay the revenue bonds from its own funds on a voluntary basis.

Finally, we would like to emphasize the role of a reference obligation in a MCDS contract. A reference obligation represents the  seniority of the deliverable obligations. Any bond that is pari passu or senior to the reference obligation can be delivered into the contract upon a credit event, as long as the bond has a tenor less than 30 years at the time of settlement. It is also important to note that both tax-exempt and taxable bonds can be delivered as long as they reference the same entity and have similar seniority as described above.

Credit Event Triggers for Muni CDS

  • Failure to pay - A muni issuer misses a payment of interest or principal on an obligation, beyond any grace period allowed on the obligation indenture (not more than 30 calendar days). If no grace period is specified on the indenture, a grace period of 3 business days is used. However, similar to most corporate CDS except Latin American ones, the protection buyer is not paid anything if the CDS maturity falls within the grace period.
  • Restructuring - Alters the principal amount, coupon, currency, maturity, or the ranking in priority of repayment of an obligation as a consequence of deterioration in credit worthiness or its financial condition. Unlike corporate CDS, bonds up to 30 year maturity can be delivered in the case of a muni default. This provision is usually called cum-Restructuring or old Restructuring.

We think Bankruptcy is not a credit event in an MCDS contract due to the following reason. Bankruptcy does not apply to U.S. state GOs because, as mentioned above, a state entity typically does not have the legal ability to declare/file for bankruptcy. While the non-state municipal entities can file for bankruptcy, chapter 9 gives them the power to modify or abrogate debt agreements which would be classified as a “Restructuring” event and hence should be covered by the MCDS contract.

Settlement

Currently, all MCDS contracts are expected to settle physically i.e. upon a credit event, the buyer of protection can deliver any bond up to a maximum maturity of 30 years and receive par from the protection seller. The biggest hurdle to a physical settlement process is typically the existence of a higher notional of CDS contracts than the total eligible deliverable bond notional. However,  there haven’t been any credit events so far on MCDS since the inception of this market, and hence the settlement process is yet to be completely stress-tested.

An auction process, similar to the one in the corporate CDS world is in the process of being designed to enable cash settlement and avoid any bond squeeze in case of the CDS notional exceeding the outstanding deliverables. Market participants are still discussing the possible risks of implementing a cash settlement process as the protection buyers could deliver low/zero coupon 30 year bonds that trade at low dollar prices. They fear that this may result in a much lower recovery than the current recovery assumption for muni CDS of 80%. While the Western European sovereign CDS has similar issues, that market uses a recovery assumption of 40%, and that reduces the downside risk for a protection seller.

CDS-Cash Basis in Munis

Theoretically, MCDS is equivalent to a financed purchase of a muni bond with an interest rate hedge and, therefore, the MCDS spread should track the muni bond spread. However, like in the corporate market, there could be a basis between the two spreads based on demand/supply and transaction cost considerations. One other difference specific to the muni market that could contribute to a wider CDS-Cash basis in the MCDS market is that investors cannot short tax-exempt muni bonds by law and there isn’t an efficient repo market available for taxable BAB bonds.

Tax exempt muni bonds are usually quoted as a spread over the MMD curve, which is the AAA muni curve. For the purposes of comparison to a CDS, however, we need to first gross up the yield to a taxable bond equivalent yield level i.e. tax-exempt bond yield divided by 65% (or 1-tax rate). On the other hand, the BAB bonds are typically quoted directly on a taxable basis. Once we have a taxable yield level for the muni bond, we can then compute the spread over Libor (z-spread or CDS Par equivalent spread) to compare with the MCDS spread.

Figure 11 shows the current CDS-Cash basis for select state/muni CDS w.r.t both tax-exempt bonds (T/E) and Figure 12 shows the same versus BAB bonds. The T/E basis for Illinois and Massachusetts CDS is a big negative as the reference bonds used were 30 yr bonds while the CDS had a 10y tenor. The BAB bonds, on the other hand, should have had a big negative basis as all the Bab bonds  used were roughly 30y bonds. But the very small basis in the BAB bonds reflects the demand for these bonds that drove their spreads much tighter.

MCDX Index

MCDX is a portfolio of 50 equally-weighted MCDS referencing both GO and revenue obligations. The MCDX index was launched in May 2008 and trades in 5y and 10y maturities. While the index traded as different series over time, from S10 in Mar 2008 to S15 now, the constituents have not changed in this index over time - like the SOVX WE index. Among the 50 constituents in the index, 26 reference GO and 24 reference Revenue obligations. Figure 13 shows the growth in MCDX notionals over time but it should be noted that these are extremely small when compared to the CDX/iTraxx index notionals outstanding. For example, the total outstanding notionals across all CDX IG series is about 257x on a gross basis and 81x on a net basis, relative to the notionals outstanding on all  MCDX series. On the other hand, the gross and net notionals outstanding on global SOVX indices in comparison to MCDX indices is 17x and 4x respectively, which is more comparable.

MCDX is quoted on spread like the CDX IG index and can be valued through the CDSW screen on Bloomberg (Figure 14). Unlike MCDS, MCDX trades with a fixed coupon (100 bps) like the CDX index family.

As only half of the reference entities in the MCDX index (the 26 GO names) trade liquidly in single-names (MCDS), it is not easy to determine a fair value for the index. This also precludes index basis arbitrage trades and makes it difficult to accurately gauge if the index is wider or tighter to single names.

Figure 15 below shows the list of constituents of the MCDX index and if each CDS refers a GO (state) or revenue bond.

 

 

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Thu, 01/20/2011 - 11:42 | 889996 Miramanee
Miramanee's picture

Here is a video primer on CDS in general:

http://www.youtube.com/watch?v=Ui0u_caWAFI

Thu, 01/20/2011 - 11:49 | 889998 hedgeless_horseman
hedgeless_horseman's picture

Tax exempt muni bonds are usually quoted as a spread over the MMD curve, which is the AAA muni curve. For the purposes of comparison to a CDS, however, we need to first gross up the yield to a taxable bond equivalent yield level i.e. tax-exempt bond yield divided by 65% (or 1-tax rate).

For a primer, the above should be in bold.

Also, doesn't Moody's still have Star City at Aa?

 

 

Thu, 01/20/2011 - 11:44 | 889999 oh_bama
oh_bama's picture

hehe... maybe another bailout in the cooking.. so again BTFD!!

Thu, 01/20/2011 - 12:15 | 890080 SheepDog-One
SheepDog-One's picture

I wouldnt count on the FED bailing out Muni bonds at all. Sure theyll 'bail out' some companies and banks, those theyll end up owning. What do the central banksters care about owning some old retired pensioners for? For the states and cities, its sink or swim, the FED doesnt care.

Thu, 01/20/2011 - 11:45 | 890005 snowball777
snowball777's picture

Tax-free ain't what it used to be. And that index is weighted in truly bizarre fashion...a grab bag of almost random issuance.

Thu, 01/20/2011 - 13:06 | 890264 jm
jm's picture

Muni bonds have been considered pretty risk free, so there really was no incentive to create subindices like you see in corporate names.  Munis do have their own senior-sub type characteristics, based on revenue stream.    

Converting existing CDS into fixed coupon with upfront will have headaches.

Protect the name, sell the index?

Thu, 01/20/2011 - 13:26 | 890342 snowball777
snowball777's picture

Presuming you can find the darling among the deadbeats.

Thu, 01/20/2011 - 13:30 | 890355 jm
jm's picture

Ummm.... well... <cough, cough>...

Thu, 01/20/2011 - 11:55 | 890011 plocequ1
plocequ1's picture

Whatever.. Just put up the POMO chart. I need a CUSIP #

Thu, 01/20/2011 - 11:51 | 890016 Spitzer
Spitzer's picture

It should be quite obvious to all that if Banana Ben will bail out Harley Davidson, Bank of Montreal and buy car loans that he will backstop this whole muni market.

Bernanke is dead set on spending all the purchasing power that already exists.

Thu, 01/20/2011 - 12:12 | 890077 SheepDog-One
SheepDog-One's picture

I still dont see it...bailing out some equities and banks was in Bens interest because in the end, they own and control it. Market takeover. I see no benefit at all to the central banksters to 'bail out' local municipalities so 70 year old pensioners can get a check. How in any way does this do the central banksters any good at all?

Thu, 01/20/2011 - 11:56 | 890029 tecno242
tecno242's picture

It's cracking me up watching the cabal send out the troops on CNBC calling Meredith Whitney unprofessional, a fear monger, unethical.. etc.  LOL

They need mom and pop to stay in their muni's so they can dump all theirs on them.

I love it when those fuckers are left holding the bag.

Thu, 01/20/2011 - 12:07 | 890051 hedgeless_horseman
hedgeless_horseman's picture

Meredith Whitney is the next Marilyn Chambers?

Immediately prior to the movie's release she was the "ivory soap girl", having modeled for the Ivory Snow soap and detergent packaging holding a baby. The brand was sold under the slogan, "99 and 44/100's % pure." 

After the release of the movie, the advertising industry was scandalized, and Procter & Gamble recalled all Ivory Snow products and advertising materials featuring her, unintentionally adding to the movie's hype.

http://en.wikipedia.org/wiki/Behind_the_Green_Door

 

Thu, 01/20/2011 - 12:25 | 890106 SheepDog-One
SheepDog-One's picture

Man I really love it too seeing these smug jerk Wall St cheerleaders lose their damn grins and are suddenly quite worried when theyre holding a bag of toilet tissue.

Thu, 01/20/2011 - 11:59 | 890040 cocoablini
cocoablini's picture

I'd like to point out that getting 5-20 cents on the dollar for a muni bond in Vallejo is a deflationary occurence- massive deflation of 90% of value and 90% of that money goes to money heaven. As an asset with collateral, its being gone means money supply and leverage is gone.
If this happens more, deflationary forces will be huge and QE3 trillion is guaranteed. As people run to cash and their margins get called, the dollar may get a run on it and gold will be sold off to about 1300- 1290.
It may be time to ride a sell off wave down with the banks in a panic over muni bond losses.
Notice, even today, FAZ is still going lower. Total BS etf.
Is this the "grey swan" we have been waiting for?

Thu, 01/20/2011 - 12:03 | 890048 goldmiddelfinger
goldmiddelfinger's picture

It's also marks a return visit of Mr Max Pain and his mother-in-law Maxine to the Insurance Carriers. Buckle up on the annunity providers too 'cause we ain't finished with the punishment

Thu, 01/20/2011 - 12:10 | 890066 Bastiat
Bastiat's picture

What muni bond holder in Vallejo is getting 5 - 20 cents?   The 5 - 20 cents is for UNSECURED creditors.

Thu, 01/20/2011 - 12:16 | 890084 SheepDog-One
SheepDog-One's picture

But what are the 'secured' creditors really secured by?

Thu, 01/20/2011 - 14:35 | 890550 Bastiat
Bastiat's picture

That depends.  Utility bond holders are secured by revenues of the utility system for instance--they've been getting full debt service.   Typically a revenue bond has a coverage requirement: like 125% (in some cases 200%) of the maximum annual debt service in pledged revenues.  That test is based on current revenues, not projected revenues, btw -- so current revenues divided by max future debt service.   The bonds will require that service rates be raised in order maintain at least 100% debt service coverage.

In addition there is a debt service reserve, typically 10% of the face value of the outstanding bonds. 

Thu, 01/20/2011 - 13:29 | 890351 shortus cynicus
shortus cynicus's picture

I don't understand, how defaulting on debt should trigger deflation. Here is my longer question on forum:

http://www.zerohedge.com/forum/defaulting-debt-and-amount-fiat-money-issue

 

Thu, 01/20/2011 - 14:06 | 890465 Spitzer
Spitzer's picture

So why doesn't the Euro rally when there is debt distruction and money "going to heaven" there ?

It is comparable to the dollar.

Thu, 01/20/2011 - 12:00 | 890043 Xibalba
Xibalba's picture

100cents on the $

Thu, 01/20/2011 - 12:02 | 890046 Cleanclog
Cleanclog's picture

Was at an economic forecasting event last night and all the featured economists were giggling and putting down Meredith Whitney's call on munis, saying there would not be big problems and that revenues for munis would be improving though higher interest rates might be required for non G.O. bonds.

I asked if they didn't think some city and county munis wouldn't strategically default by claiming bankruptcy in order to rework or even void some of the out of control pensions and not one of the 5 economists appeared to ever have heard of such a thing.  Blew me away.

Thu, 01/20/2011 - 12:19 | 890090 SheepDog-One
SheepDog-One's picture

I dont think the economists will be giggling for long as local municipalities are utterly bankrupt. Theyre shutting down ploice and fire departments...do you know here theyre telling you the police will no longer respond to accidents, burglaries, vandalism, etc? HOW do these giggling economists think the bankrupt cities and states will shortly be OK? Theyre insane!

Thu, 01/20/2011 - 13:07 | 890271 shortus cynicus
shortus cynicus's picture

No, they are very sane. They are a part of a scam.

Thu, 01/20/2011 - 12:05 | 890052 youngman
youngman's picture

Look at MUB....down quite a bit the last 4 months..

Thu, 01/20/2011 - 13:45 | 890396 buzzsaw99
buzzsaw99's picture

MUB is down less than my treasury bond fund. Compare MUB to VUSTX before you start freaking out about it. Wall Street wants you to sell your bonds on fear.

Thu, 01/20/2011 - 12:16 | 890083 rlouis
rlouis's picture

"Increasing confusion".... (?) lol... makes me just shake my head to contemplate the Rube Goldberg Municipal Contraption, the contortions and abstractions that had to be made to support debt that never should have been taken on by politicians influenced by bankers and unions. Vallejo x 2.5qd100 = squid bait

Who dares to hit the reset button.

Thu, 01/20/2011 - 12:22 | 890101 SheepDog-One
SheepDog-One's picture

BTW, wheres Harry today with his guarantee that S&P 1284 was as impenetrable and springy as a new trampoline? Like all troll bulls lately, theyre very quiet when their 'BTFD' is suddenly not working.

Thu, 01/20/2011 - 13:57 | 890440 John Law Lives
John Law Lives's picture

BTFD worked pretty well since March of 2009.  In case you hadn't noticed, the Dow Jones rallied over 5,000 points since then.  I hope you didn't keep your head buried in the sand with the rest of the doom-and-gloomers and miss the rally.  It was easy money.

Thu, 01/20/2011 - 14:09 | 890475 Spitzer
Spitzer's picture

Inflationist doomers like Marc Faber have NEVER been bearish on equities. Peter Schiff has never been bearish on equities

Thu, 01/20/2011 - 12:29 | 890123 Ancona
Ancona's picture

I say it's time for everyone to hit the reset button and return to sane purchasing practices which include spending no more than your current revenue stream.

That alone would probably implode the entire financial system. Think of hte tangled mess of interwoven agreements and swaps on top of swaps that will have to be dug through.

Thu, 01/20/2011 - 12:50 | 890198 SheepDog-One
SheepDog-One's picture

Sure it would implode this financial system based upon debt.

Thu, 01/20/2011 - 12:49 | 890193 bingaling
bingaling's picture

The Fed is going to treat this exactly like Lehman . Ignore it , let a huge deflationary event take place and the they will come in and bailout .The dollar would crash today if Ben came out and said he would do this ,but in a crisis event  he can print like there is no tomorrow and the dollar will stay afloat . I expect the EU will be doing a printoff at the same time .

Thu, 01/20/2011 - 13:30 | 890353 Greater Fool
Greater Fool's picture

Thanks for posting this--very handy insight into a corner of the CDS market I'm not as familiar with.

Thu, 01/20/2011 - 13:35 | 890363 Mercury
Mercury's picture

Great post, especially for those of us that don't live and breath munis every day.

Thu, 01/20/2011 - 13:53 | 890426 John Law Lives
John Law Lives's picture

Muni bond neophytes,

Take note of the pie chart in Figure 7 in the article.  According to the data, a whopping 2% of the munis that have defaulted since 2000 are General Obligation bonds.  As I said yesterday, the specific events in Vallejo have nothing to do with the investment worthiness of munis issued in other US States.  The unfortunate circumstances in Vallejo do not have bearing on how GO bonds issued in Texas (for example) will perform.  When evaluating specific GO bonds issued in Texas (for example) for their worthiness, the fiscal condition of Vallejo IS IRRELEVANT!  That was precisely my point then and now.

Each bond must be evaluated on its own merits.  What happened in Vallejo is no more of  a harbinger of a muni crisis across America than your kid's sneeze is a harbinger of a flu pandemic that will rival the Spanish Flu.

Thu, 01/20/2011 - 14:40 | 890567 Bastiat
Bastiat's picture

I agree.  With the failure of the muni bond insurers, the illusion of fungible muni bond credits is gone.  It is all very specific and local now. 

That doesn't mean muni bonds are a good investment. If real rates are negative, putting money in long-term, fixed income bonds of any kind is losing proposition, by definition.   In hyperinflation it is a total wipeout.

Thu, 01/20/2011 - 15:00 | 890617 John Law Lives
John Law Lives's picture

Yes, we do agree.  The worthiness of each bond offering must be evaluated based upon the fiscal condition and circumstances of the state or municipality which issued it.  That was my point from the beginning.  What happened in Vallejo has no bearing on my muni holdings (none of which were issued in California... or Illinois... or New York...).

Thu, 01/20/2011 - 16:57 | 891159 SmittyinLA
SmittyinLA's picture

"States, themselves, may not file for bankruptcy"

Untrue, a more accurate statement of fact would be "states themselves may not file for bankruptcy under federal rules".

The reason there is no rules or law for a federal bankruptcy of  a state is the federal government and Congress lack the authority to dictate terms to the states-they're sovereign entities, in theory state legislatures or in the case of CA where the citizens have a referendum right the state citizens can write their own bankruptcy law and terms-just like foreign states can and do with the only recourse being the debt holding entity boycotting a further extension of credit-which in most states would be a good idea for the voters and taxpayers.

  

 

 

Thu, 01/20/2011 - 17:01 | 891181 SmittyinLA
SmittyinLA's picture

"States, themselves, may not file for bankruptcy"

Untrue, a more accurate statement of fact would be "states themselves may not file for bankruptcy under federal rules".

The reason there is no rules or law for a federal bankruptcy of  a state is the federal government and Congress lack the authority to dictate terms to the states-they're sovereign entities, in theory state legislatures or in the case of CA where the citizens have a referendum right the state citizens can write their own bankruptcy law and terms-just like foreign states can and do with the only recourse being the debt holding entity boycotting a further extension of credit-which in most states would be a good idea for the voters and taxpayers.

  

 

 

Fri, 01/21/2011 - 06:33 | 892707 bk1037
bk1037's picture

As far as I'm concerned, these media reports are coming out in anticipation for the expiration of federal support to the states in April as part of the stimulus and rescue. Realzing how deep the major states are in the hole, the options seem to be 4:

1) Default or declare bankruptcy and force creditors to take a major haircut;

2) Continue to borrow to prolong the Ponzi structure and the day of reckoning;

3) Rely on the Fed and begin to monetize the muni market when these bonds roll over; naturally this requires the Ponzi to continue;

4) Raise taxes and attempt to gain fiscal responsibility by matching revenue with expense more closely;

There may be a combination of 2 or more of these ultimately implemented, but I don't really see an attractive solution to any of it. The Dems seem to favor option 2 since the unions continue with the current structure, everything else be damned more or less. The GOP seems to be championing option 1 more, but we all see the limitations to that as well as the screaming and hollering from the bond vigilantes.

The issue of the baby boomer pensions coming into focus is only a down payment on what will happen in a few years with Social Security with the general population. Will they have to monetize that as well?

This is all something that should have been able to forecast, and plays into the general ignorance of the population. Politicians continue to spend over what they take in because it is sexy to do so with the people in general, where austerity is not sexy. Everyone realizes the issue but no one wants to accept their share as to what it will take to bring this under control. As long as the United States remains effectively divided, there will be no real solution and a lot of infighting back and forth between the factions. I'm glad I am not a politician, and I have no idea what drives some of these people to run for office.

 

 

 

Fri, 01/21/2011 - 07:40 | 892741 Horatio Beanblower
Horatio Beanblower's picture

Does anyone have a link to a site that shows how much each state and/or municipality actually owes?  Thanks.

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