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Note: for some arcane reason, the graphs refuse to show up on this post so here is a pdf version for the blogs registered users: Municipal Bond Market and the Securitization Crisis (242.88 kB 2008-05-14 18:09:27)

his is a DRAFT of part 5 of Reggie Middleton on the Asset Securitization Crisis – Why using other people’s money has wrecked the banking system: a comparison to the S&L crisis of 80s and 90s. As was stated in the earlier parts, I periodically have third parties fact check my investment thesis to make sure I am on the right track. This prevents the "hubris" scenario that is prone to cause me to lose my hard earned money. I have decided to release these "fact checks" as periodic reports. This installment covers consumer finance, an aspect at risk in the banking system that is both overlooked and underestimated, in my opinion.

I urge discourse, conversation and debate on this post and the entire series. To me, it is necessary to make sure the world is as I percieve it.

The Current US Credit Crisis: What went wrong?

1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. You are here => Municipal bond market and the securitization crisis – where do we stand
6. To be Published: An overview of my personal Regional Bank short prospects

The following municipal bond portion of the asset securitization crisis is also a tie-in to the prospects of the monoline insurance industry. The latest of my monoline analyses is the Assured Guaranty Report. You can also peruse the work I did on MBIA and Ambac starting from the inception of my short position in these companies last year.

1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton
2. Tie-in to the Halloween Story
3. Welcome to the World of Dr. FrankenFinance!
4. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion
5. Follow up to the Ambac Analysis
6. Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibili
7. More tidbits on the monolines
   
8. What does Brittany Spears, Snow White and MBIA have in Common?
   
9. Moody's Affirms Ratings of Ambac and MBIA & Loses any Credibility They May Have Had Left
10. My Analyst's Comments on MBIA/Ambac/Moody's Post
11. As was warned in this blog, the S&P downgrade of a monoline insurer reverberated losses through c

And now, on to the Muni report...

Municipal bond market and the securitization crisis – where do we stand

As defined by the Securities Industry And Financial Markets Association (SIFMA), municipal bonds (often called munis) are debt obligations issued by states, cities, counties and other governmental entities to raise money to build schools, highways, hospitals and sewer systems, as well as many other projects for the public good. The interest income generated from these bonds is free from federal taxes, state taxes, local taxes or all the above. However, not all munis are tax-free.

Municipal bonds generally are classified as general obligations and revenue bonds. General obligation bonds (or GO bonds) are mostly backed by the credit and the ‘taxing power’ (inflow of tax revenues) of the issuing municipality. They are generally considered one of the safest investments as they have governmental support.

Revenue bonds, on the other hand, depend upon the revenue generation capability of the project in which the bond proceeds are to be invested. Hence, they are generally perceived to be riskier than the GO bonds.

Out of a total market worth US$2.62 trillion municipal bonds outstanding, mutual funds hold the maximum (35.8%), while individuals hold the second highest amount (35.0%) of the municipal bonds in the US.

Municipal bonds breakdown - outstanding and issued in 2007

Source: Ambac

These statistics indicate that in the future, investment income is expected to play a big part in bond insurers’ revenues. However, increasing defaults in the municipal bodies as a result of the ongoing crisis and higher risk in the municipal bond market are likely to significantly affect the performance of the monoline insurers, from both an operating perspective, investment income perspective and a widening of spreads both in their investment portfolio and on their own single name CDS. Also, many state and local governments have entered into credit derivative transactions which, although worked well in the bull phase, are taking a massive toll when the tides have turned.

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