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Tuesday, February 19, 2008

Munis And Chickens

It truly worries me that the financial chickens are coming home to roost in a major election year. I'm sure we're going to see more and more wild ideas about how to reverse the entropy of bad debt. It is impossible to reverse the entropy of bad debt, just as it's impossible to make time flow backwards. You can convert so-so debt into more manageable debt by cutting the rates on it, but that's all.

The Alt-A and prime overleveraged stuff is going down, and it will deliver more of a punch than subprime.

As I wrote at the end of January, the final event was the demise of the monolines, and that impact is slowly trickling through the financial system. Calculated Risk is doing a great job covering the undignified brawl, but no one is discussing the one essential and basic point. Insurance regulators are just as incompetent at anyone else at assessing the risk on these complicated securities and of the funny-money mortgages. Therefore they are stuck cleaning up the wreckage, and I still believe that they will split most of the firms. They have no option other than to get the banks to pony up to recapitalize the firms, but if the banks have to pony up for the insurance and then essentially pay for the payouts, it's hardly a benefit. So the regulators are using the split to try to force the banks to change covenants and ante up, and now the banks are starting to threaten to litigate.

In the end the regulators will win on the basis of necessity.

The weirdness of Credit Suisse announcing that whoops! some traders mismarked some things, so now we have to change the figures we just released is probably going to generate some additional financial heartburn. They say they may have to restate 2007.

The overall picture is that no one knows the sum of the losses out there, or where they are hiding. So it's not as if banks and financials are going to feel comfortable about lending to each other.

And that observation brings us to the current situation with auction rate munis. The auctions are failing now. When the auction fails, a default rate goes into effect. The recent problems have sparked calls for more disclosure on the auctions. I think the suspicion is that some institutional buyers are going on strike, which has opened the market to manipulation by some players. Take, for example, the case of U of Pittsburg's Medical Center:
The hospital offered to buy back $91 million of its debt yesterday, and will make similar offers for almost $340 million more, according to Tal Heppenstall, UPMC's treasurer. Holders have until March 19 to sell the bonds back for $100.01 of par value plus accrued interest, according to a notice posted on Bloomberg.

Funding costs soared nationwide in the $330 billion market for auction-rate securities as banks from Citigroup Inc. to Goldman Sachs Group Inc. stopped bidding for the debt at the periodic sales they organize.
After repurchasing the auction-rate securities using local bank credit lines, the Pittsburgh hospital plans to issue long- term, fixed-rate debt, Heppenstall said.

``We put up with this for a week, but that's enough.''
Needless to say, the draw on the bank funds takes money away from other lending, although it is profitable business for the local banks. Since the last two auction rates were over 16%, a bank can make a nice chunk of change and will. Presumably the local lines will be paid back when the debt is rolled over to long-term debt.

There are some genuinely bad munis out there, but a lot of them are along the same lines as this one. Not gold quality, but not junk debt either. Much more of this could have an incredibly strong effect on the US banking and financial system.

..."The weirdness of Credit Suisse announcing that whoops! some traders mismarked some things,..."

maybe the bonus checks cleared !!!
Yep. Maybe those bonuses will be taken back, maybe they won't - maybe the top guys liked their bonuses. Maybe CS has no effective internal controls, maybe not. Maybe they look like fools.

Obviously the errors went one way.

It's not really a great time to be a shareholder....
The problem is the belief that the new rates are the ones that are incorrectly priced.

Specific to your example. California this week unilaterally cut doctor reimbursment for Medi-Cal (Medicare) by 10%. UPMC paying 16% probably reflects some of that. Now they want to buy it back at 100.01? They want a free do over because things didn't work out. Why in the world would anyone redeem these for a penny when they can pull 16% instead?
Rob - if they can get bank credit for less the rates are not correctly priced.

I agree with your underlying point, though. In this environment, virtually no hospital debt is AAA. We've got an election in which one party's candidates are all campaigning on delusional plans for socialized health care, and fudging the cost bit entirely. It bodes ill.

So I guess the CA docs are going to be paying off some of Casey Serin's bills, eh? And they think that bank fraud's a "victemless" crime!
What a bunch of lying crooks in this Ponzi scheme.

Vallejo, CA is considering a Chapt. 9 bankruptcy.

That is only the first in my estimation.

For a long time now thought that from Federal on down will have to declare pension emergenies and ratio all the salary& benefit false promises to Soc. Sec. levels.

Smart Independent
Anon - that is exceedingly possible in many areas.
Well, that would fit with this being the end of a K-wave. The last one did a thorough job of wiping out pensions and savings (Great Depression), and one can see the potential for things to go very badly indeed if the wrong choices are made this time around.

Rob Dawg: if things break badly, taking the $100.01 is going to look very smart indeed. 16% of bankrupt is zero, or close enough not to matter.
Not Vallejo! Say it isn't so! That's where DH grew up. It didn't look to me like his folks place went up in price all that much.
I can think of three or four California counties that are likely candidates for bankruptcy off hand,and quite a few cities as well.lessee,Solano,Stanislaus,Merced,Contra Costa,Alameda Counties.Elk Grove,Lincoln,Patterson,Stockton and so forth.Off the top of my head.
There's a CR thread on Vallejo.

The linked article says that they expect to be out of money in April, and that 80% of their budget goes to fire and police. They want all gov employees to take at least a 5% cut, but firefighters to take 15%. Oh, and the kicker is that the firefighters and police have to agree to their emergency plan to avoid bankruptcy. It does not sound like a very friendly town at the moment.

Teri, believe me, Texas and Georgia have proved that you can produce massive foreclosures without a price increase. We're special. The Atlanta area decided to compete in the Special Housing Olympics this time around.

Joking aside, if there are few zoning restrictions but greatly loosened credit standards, the result is that demand increases but supply increases with it so that there is not the huge price run up. But when credit standards tighten, gurgle, demand drops and there is still an oversupply - which means flat to lower prices.

It sounded to me like Vallejo's problems was a long term imbalance in the fire/police funding. Once retirements start hitting....
What my EN article on Vallejo from YESTERDAY wasn't good enough? ;-)

Merced is absolutely going down.

These are real short term instruments. They'd have been smarter to either go even shorter and roll over the problem like the $71m the NE PAtriots rebid or just sucked it up for a month while looking for more appropriate bond formulae.
Rob, I didn't see it. I probably got stuck laughing too hard on Trail of Tears and Anger, which was brilliant.
This economy is in the tank excepting a few sectors.

No way these govt. entities are going to wall paper
over their messes any longer.

No way the most citizens are going to go along with paying for all these collusive deals made by politicos & govt. unions. Besides, the money isn't there.

See all --past,present, future--cut back to Soc. Sec. ratio.

I see dominoes falling all over.
Additional info.discovered:

Vallejo's personnel costs are 80% of their Budget. Tried to reduce those costs a few years ago and an "Arbitrator" wouldn't permit.
All members of this massive collusive thieving govt. systems.

Not a care if a city/county, etc. eliminates basic services (reason for a govt. entity.

Must be stopped even if a special type of bankruptcy is used to unload the obligations and put all on Soc. Sec. ratio. All--past, present, and future-- not just the future while the rest laugh all the way to the bank while bankrupting these cities, counties, states, and fed. govt. more. These entities are already bankrupted. Consider L the Bonds Casino they been playing in for many years already.

Smart Independent
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