Turmoil In Munis: Yields Soar To 20%

Bloomberg is reporting Auction-Bond Failures Roil Munis, Pushing Rates Up.

A wave of bonds sold by U.S. municipal borrowers with rates set through periodic auctions failed to attract enough buyers in recent days as banks including Goldman Sachs Group Inc. and Citigroup Inc. that run the bidding wouldn't commit their own capital to the debt.

Rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, with bidding run by Goldman, soared to 20 percent yesterday from 4.3 percent a week ago, according to data compiled by Bloomberg.

"It's the beginning of the end for the auction-rate market," said Matt Fabian, a senior analyst with Concord, Massachusetts-based Municipal Market Advisors. "Banks have stopped supporting the market."

Auction bonds have interest rates that are determined by bidding that typically occurs every seven, 28 or 35 days. When there aren't enough buyers, the auction fails and bondholders who wanted to sell are left holding the securities. Rates at failed auctions are set at a level spelled out in official statements issued at the initial bond sale.

Local governments are obliged to pay the high rates until either the auctions start attracting more buyers or they arrange to convert the bonds to some other form of debt. The 20 percent rate for the $100 million of Port Authority auction bonds will cost it $388,889 until the next weekly auction, up from $83,611 last week.

"This market has been under a tremendous amount of stress," said Alex Roever, a JPMorgan Chase & Co. fixed income analyst. "Without the dealers providing an active secondary bid, it's very hard for these transactions to clear."

Unsuccessful auctions have hurt companies that bought those variable-rate securities as short-term investments with excess cash, and are unable to sell their holdings. Bristol-Myers Squibb Co., the New York-based maker of the anti-clotting pill Plavix, announced on Jan. 31 a $275 million writedown of its auction-rate holdings related to subprime debt, which totaled $811 million at the end of 2007.

About a third of 449 companies polled in a survey last May for the Association for Finance Professionals said they had investments in auction-rate bonds.

100 Failed Auctions Yesterday

The number and size of the auctions failing is simply stunning. Professor Sedacca is commenting on that in 100 Muni-Bond Auctions Fail.

There were over 100 failed auctions in Auction Rate Securities yesterday, notably some in the closed end space. This is a first and it is important.

Why? Imagine you had a margin account where you were forced to pay a higher margin rate and your bonds were falling in price? It is a lethal combination.

If I could borrow these funds I would short them, but they are notoriously hard to borrow. The sad part is that these funds were more financial alchemy by the folks on Wall Street. There are approximately $265 billion outstanding.

I know this: If I owned 'em, I would blow 'em out. If I could short 'em, I would, in size. This is a mess and mom-and-pop retail won't likely find out about it until it's too late.

Cash Equivalants

Professor Zucchi is talking about cash equivalents today. Let's take a look:

Yesterday I got a call from the broker who handles my "cash equivalent" assets, telling me not to worry about the possibility that some of the auctions on my student loan auction rate securities (ARS) might fail. I am not really worried because these are 98% guaranteed by the state and the federal government, so there is little credit risk there. Furthermore, when these auctions fail, holders get a awarded a "penalty bid" interest rate for the following period (usually 35 days)which is much higher than what one would expect at auction. Lastly, I don't need the cash anytime soon.

Now put yourself in the shoes of those holding non-guaranteed ARS', who may need the cash ASAP, and/or who are using those instruments to prop-up margin requirements. Gulp!

Where's The Liquidity?

Those who think the Fed is pouring on the liquidity spigot need to think again. 100 failed municipal auctions in a single day is proof enough. As the Credit Default Swap Tsunami Approaches, the "beginning of the end of the auction-rate market" is now underway. Yields on treasuries are going to plunge, but it will not do a thing for the solvency crisis we are in.

It's time for a slogan change in this corner. For quite some time I have been saying Things That "Can't" Happen Will Happen.

My new tune is Things That "Can't" Happen Are Happening Now.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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