Here’s a Bloomberg article about how banks made money by doing interest rate swaps with Detroit, and now Detroit is sad, because like a lot of municipalities Detroit swapped its floating rate bonds to fixed to hedge the risk of rates going up, and rates went down, and now the PV of Detroit’s swap liabilities is like $350mm, which is big, and that’s sort of that. I’m generally unmoved by the notion that municipalities should be able to get out of swaps that move against them for free, and while I’m sure there’s some nefarious record of mis-selling and fee-inflating in here somewhere, which would justify you getting all mad at Detroit’s banks, Bloomberg has not dug it up. The evidence so far is “rates went down,” so whatever.
Still this a pretty interesting story. The normal posture of these swaps cases is:
- City has floating-rate bonds and swaps to fixed.
- Rates go down but city is still effectively paying high fixed rate.
- City says “WTF, why don’t we stop doing this?”
- City goes to bank and says “remember that swap? never mind”
- Bank says “we’d be happy to tear up the swap, just pay us a $400 million termination fee.”
- City freaks out, calls press, etc., shouts about windfalls, etc.1
But Detroit is different! Detroit, to its great credit, doesn’t want to tear up its swaps. The banks do. But they’re not exactly pushing it: Read more »
We talked the other day about municipalities and the Libor shenanigans. Quick recap:
1) Municipalities wanted long-term fixed-rate debt.
2) They got it indirectly by selling long-term floating-rate debt and buying interest rate swaps from banks.
3) At first, this was cheaper than issuing fixed-rate debt.*
4) Later, though, sometimes it turned out to be more expensive than having issued fixed-rate debt, or at least more expensive than it should have been, because municipalities pay a floating rate based on weekly reset auctions of their debt and that rate tends to track an interest rate called the Sifma swap rate,** while they receive a floating rate based on a percentage of Libor, and in 2007-2008 those rates diverged in weird ways.
5) Specifically, banks messed with Libor.
6) You can imagine tons of derivatives counterparties who could get screwed without politicians getting that worked up about it, but poor beleaguered Nassau County is not one of them.
Anyway an informed reader wrote in with some comments, of which this was my favorite: Read more »
There is a line forming to the left for people to beat up on Libor-manipulating banks, and it’s a long line so your beating time is limited and you have to make the most of it if you want anyone to care. Today’s the day for U.S. municipal borrowers. How’d they do?
The municipalities are important because they are the unusual case of a large class of politically sympathetic customers who would have been systematically disadvantaged by low Libor rates, as opposed to you and that mortgage that you won’t shut up about, on which Liborgate probably saved you money. Stephen Gandel nicely sums up the situation here: the problem was that, in astonishing droves, U.S. cities and counties borrowed at variable rates, paying their own idiosyncratic floating SIFMA rate, but they then swapped to fixed, receiving a floating rate based on Libor. This led to badness, as muni credit blew up and SIFMA spiked, while bank credit blew up and Libor mysteriously didn’t, because of the manipulating. So cities who had expected to pay a fixed 5% or whatever a year ended up paying 5% plus the suddenly widening gap between SIFMA and Libor.
Here is a graph I made you, comparing the SIFMA rate that munis paid to their bondholders versus a proxy for the Libor-based rate that they received from their banks*:
So that sort of looks okay outside of 2008, which looks sort of … not okay. Here is perhaps a more suggestive thing: Read more »
The crisis in the auction rate securities market continued this week. While some issuers are preparing to refinance auction rate securities that have the highest interest rates, the suddenly turbulent market for muni bonds may leave many investors stuck in their illiquid positions.
“About 61 percent of auctions failed to attract enough bidders yesterday, in line with the average since mid-February, according Bloomberg.
The recent rally in the muni market, however, may make it easier for ARS issuers to refinance the products. Many auction rate securities are issued by government agencies. In order to repurchase the securities from investors, these agencies would likely have to issue plain-vanilla municipal bonds.
Accrued Interest has a good discussion of the breathtaking rally.
“On Monday, retail buyers (i.e., mom and pop investors) started coming out of the woodwork to buy bonds,” he writes. “The State of California came with a $1.7 billion deal on Monday. Demand was so strong that the underwriter cut the interest rate by 15bps across the board, and still $1 billion of the deal was done retail. Now maybe there has been $1 billion of a deal done retail in the past, but I sure as hell don’t remember ever hearing of such a thing. Smith Barney, Citigroup’s retail brokerage arm, supposedly had the best day for selling municipal bonds in their entire history on Monday. One large dealer I talk to regularly said they had sold every bond in their inventory by 11AM.”
Munis Rally as Highest Yields Since 2004 Lure Buyers [Bloomberg]
Municipal Bonds: Yeeeeaaaaahooooooo! [Accrued Interest]
We get called contrarian often enough that we’re nearly resigned to the label. From our perspective, of course, we’re not contrarians at all. We’re so deficient when it comes to having a decent respect for the opinions of mankind that we aren’t even aware of the prevalence or rarity of the positions we take. If we seem contrarian, we suspect it’s just because so many others are wrong so often.
The debate over municipal bond ratings is a good example of this. Over at Portfolio—published out of an august tower located in Times Square—they are convinced that Moody’s, Fitch and the like assign ratings that are too low to municipal bonds. This supposedly forces our towns, cities and states to pay higher interest rates or purchase bond insurance to achieve higher ratings. Jesse Eisinger, who holds the esteemed title of Senior Writer at Portfolio, estimates that this costs municipalities around $5 billion a year.
Read more »
Although it looks like MBIA is now out of the woods, rival bond insurer Ambac’s fate is still murky. Reports indicate that the ratings agencies are now considering the rescue plan worked out by banks and state insurance regulators. The plan may be revealed as early as this week, and will probably involve splitting Ambac in two to segregate the municipal bond insurance business from the less healthy business of insuring riskier credit products.
Last week Holman Jenkins pointed out that segregation is unfair to customers who bought insurance on CDOs because it would “retroactively award municipal clients privileged status at the expense of other clients with equal claim on the insurers.” Bill Ackman, who has been shorting the bond insurers for years, raised a similar point. Indeed, Jenkins expects that the policy holders left with guarantees from the suddenly even more precarious side of the business will launch lawsuits to prevent the break-up.
There’s also a much stranger objection to the segregation plan, one stemming from an objection to the very existence of municipal bond insurance. We first heard about it in Portfolio, of all places. In the latest issue Jesse Eisinger argues that municipal bond insurance is a scam, and it’s victims are municipal governments. This will no doubt come as a surprise to state regulators and treasuries who have been on knife’s edge fearing that the collapse of the bond insurers would make raising money costlier or, in some cases, perhaps impossible. If the governments are the victims here, why exactly are they working to keep the victimization going?
Read more »
The bond insurers have all rocketed today on the expectation that a bailout from the banks will be announced any time now. But this has hardly tempered the words of their critics. Everyone from Bill Ackman to Warren Buffett has criticized bond insurers for guaranteeing complex derivatives whose underlying risk they seem not to have understood. Even the core business of the insurers—guaranteeing municipal bonds—has come under fire.
In this month’s Portfolio, writer Jesse Eisinger argues that bond insurance is a racket, basically a tax-payer rip-off carried out by the collusion of bond insurers, Wall Street firms and credit rating agencies. It s a pretty extraordinary claim, for which Eisinger offers no real evidence other than the allegations of a Attorney General who hopes to be the next Eliot Spitzer and a claim that the ratings agencies consistently assign municipal bonds ratings that are too low.
Read more »