Tuesday, January 22, 2008

boom goes the bond insurance market

Well... boom go all the markets this morning it seems. Looks like Bernanke has started the counterflooding. I have said in the past that the pension funds for the City of Pittsburgh will not really survive a bad year in the markets... but I usually meant that hypothetically. If you read this PG article from the fall," the city's portfolio is too heavy on stocks." Too heavy on stocks? Not pretty in the equity markets these days. Of course the alternative suggested was that the city ' "should triple its stake in "alternative investments" like real estate, venture capital funds and private companies.'. Real Estate? Frying pan go talk to the fire?

But I really started to point out that Fester again gets to the heart of the matter on how the implosion in the municipal bond insurance market connects directly to local city finance issues. Last week the bond rating agencies started to downgrade the municipal bond rating agencies. The first to tip was Ambac which was downgraded from AAA to AA on Friday and remains on a negative watch portending possible future downgrades. From what I read, nobody expects this to be the end of it. The whole bond insurance imbroglio remains pretty much the most important story to the economy that you just don't read about.

Why do we care? Ambac is one of just a handful of bond insurers and has insured large chunks of city debt in the past. Per the article linked above the consequences of this downgrade include:

"The downgrade likely means Ambac will not underwrite any more business, said John Flahive, director of fixed income for BNY Mellon Wealth Management. "
Fewer suppliers of bond insurance can only be bad news for the pricing and thus for the consumers of bond insurance, consumers like the city. As Fester points out as well, impending balloon payments in the city's existing debt schedule will eventually necessitate refinancing. It will be at that point that the turmoil in the muni bond insurance market will be an issue.

More generally, the last quote in that article explains the big picture for Pittsburgh and all local government entities with debt:
"At the very minimum the troubles of the insurers will drive up borrowing costs of cities and other local entities at a time when many are strained by weaker tax revenue, said John Atkins, a fixed-income analyst at IDEAGlobal.com."

There is a side story of sorts... not exactly a silver lining, but because of the hit on equity markets of late, money has been going into bonds. Thus bond rates, and in particular municipal bond insurance rates are being depressed. It could potentially be a good time to refinance chunks of municipal debt. One criticism of city debt offerings in the past is that there have been issuances with limited provision to refinance, something that makes the bonds more valuable to the purchaser... but more costly to the issuer in the long run. If I had time it would be an interesting exercise to see if the city has any refi options at all at this point and whether the rate regime is enough to offset the costs of either higher bond insurance costs, or the costs of borrowing at the city's lower innate credit rating.

With that, the wonk-alarm goes off.... about 5 paragraphs too late I know. Lest I start waxing poetic on cubic splines I will leave it at that. Also, my longer recent ramblings on the impact of bond insurance Will Warren Buffet Someday Own Pittsburgh... and a little farther back I ranted some more in: Sic Semper Ero Debitum.


Blogger fester said...

Hurrah for municipal bond market wonkery :)

How bad is the 90% scenario for the city pension funds in a bear market? Will they go down to 20% prefunding? 30%?

If that happens, look for another city ratings dip as well as the kibosh on any other consolidation/merger talk beyond buying shared paper clips.

Tuesday, January 22, 2008 8:47:00 AM  
Anonymous Anonymous said...

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Friday, June 27, 2008 6:22:00 AM  
Anonymous Anonymous said...

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Friday, June 27, 2008 6:23:00 AM  
Anonymous Anonymous said...

This could have a substantial effect on people who are getting bonded, and as 'fester' says, the city ratings dip is a real possibility and this could have a knock-on effect on the rest of the market.

Friday, June 27, 2008 6:32:00 AM  

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