Muni Madness
It’s not even March and the madness has begun. Now it’s municipals that are feeling fouled and close to out of the game.
In the world we used to live in, governments and institutions would issue debt for long-term projects. They could issue long-term bonds at a tax-free fixed rate that would hold steady until maturity or redemption. Or, they could issue "auction rate notes" at a (typically) lower floating rate that reset every 7-30 days, depending on the issue. The rates would be insured by FGIC, AMBAC, and MBIA, who are in the sleepy business of providing this insurance and, more importantly, their AAA rating, so that buyers at these auctions would show up for the game. Buyers loved the paper, as they got tax-exempt yield with no risk and great liquidity. Why, you could get your money out in a week, or perhaps a month.
Not anymore.
In a rather stunning turn of events, at reset date, no one is showing up, and not because they are worried about the underlying cities, towns, hospitals or universities. Rather, they are worried about the insurers! Oops. It seems the insurers jumped into the mortgage-backed game as well, insuring large swaths of this paper. Toxic insurers, they now appear.
What’s a muni to do, other than to pay the default pricing that was part of the agreement, but never – ever! – triggered in the past. The muni issuers are faced with much, much higher interest costs on the one hand, or, in a cruel twist of fate, onerous prepayment penalties imposed by the original arrangers, often investment banks, that have recently decided not to step in to stabilize the market by buying the paper themselves. Investment bankers are more than happy to arrange new municipal long-term fixed-rate financing – just pay us our termination fees on this old paper and our origination fees on the new issue.
I’ve got an idea! For the good of the country (after all we are talking about hundreds if not thousands of municipal issuers) why not just waive those prepayment fees – now that’s a move we could all stand up and cheer for! Oh, and if you were hoping to get at your tax-free money … hmm, it seems it isn’t liquid after all. You must wait for the market to return, or for the issue to refinance. I am told the phones are ringing off the hook at municipal desks everywhere.
