Bonds

Would you buy $4 billion in bonds from this man? That's the question facing Gov. Schwarzenegger. He's made himself the voice of a radio effort to sell bonds to cover the state's short-term operating expenses. It's a tough time to sell bonds, in the middle of a credit crisis. Standard & Poor's Ratings Services has publicly questioned whether the state will be able to sell the bonds. S&P put California's bonds on negative credit watch as well. (California's credit rating also has suffered from persistent deficits).

If Schwarzenegger can convince people to buy the bonds, it would prevent the state from encountering a cash crisis in the next few weeks, as some, including S&P, appear to be anticipating. But if he can't, it's a body blow to the state -- and to Schwarzenegger's credibility. The S&P report says: "Without a successful infusion of cash over the next six to eight weeks, however, we believe, the state may be required to defer spending by executive order, schedule a special session of the legislature and/or possibly slow payments to local units, including school districts." (The S&P does end with an oddly hopeful note; California is so accustomed to managing bad budgets that it will probably muddle through this as well.)

The governor considers himself a top-notch salesman. This may be the most important test of salesmanship that he's ever faced.

Here's a link to the S&P report. A free registration is required.

The costs of financing state and municipal projects such as hospitals, schools and public transit, are rising as the credit crisis cripples states’ often used source of credit – auction-rate bonds. The lack of demand for these bonds, which allow states to finance long-term projects over a period of time, has frozen the market and forced states to pay much higher interest to creditors.

Snapshot asks, when will liquidity return to the state and municipal bond market?

Bond insurer FGIC, the third-largest insurer of both municipal bonds and structured securities composed of subprime mortgages, was forced to split these two parts of its business after being stripped of its AAA rating by Moody’s and not receiving a government or private bailout.

New York Governor Elliot Spitzer gave all bond insurers 3-5 days to save the profitable municipal bond portfolio of bond insurers and to isolate the heavy losses due to subprime mortgages. Snapshot asks: what will happen to the business of insuring structured securities?

Eric Danillo New York State Insurance Comissioner – Testimony Feb 14, 2008
Financial Times – Bond Insurer FGIC Tells Regulator It will Split
Wall Street Journal – Spitzer Warns Bond Insurers
Bloomberg – Muni Regulators Seek Disclosure on Auction-Rate Bonds
Financial Times – FGIC Downgraded by Moody’s
Bloomberg – Muni Regulators Seek Disclosure on Auction-Rate Bonds

Warren Bufffet has agreed to insure $800bn in municipal bonds guaranteed by bond insurers Ambac, MBIA and FGIC. These insurers are in danger of losing their AAA ratings due to subprime losses. Buffet’s $5bn offer comes after creating his own bond insurer in late January.

When asked why he hasn’t bought shares of other financials at ‘cheap’ prices, Buffett responded, “Well there’s other things I feel I understand better. Just because something’s down fifty percent from where it was doesn’t mean it’s cheap. We try to stick with things we understand.”

CNBC – I Will Reinsure $800B in Municipal Bonds VIDEO
Wall Street Journal – Futures Rise on Buffet’s Offer
Bloomberg – Buffett Offers to Assume Muni Liabilities of Insurers
Bloomberg – Bond Insurance Turns Toxic for Munis as Rates Soar
CNBC – NY Insurance Superintendent Eric Dinallo makes a pitch to Warren Buffett VIDEO
Securities Industry and Financial Markets Association (SIFMA) – Municipal Bonds Credit Report

The credit crunch currently constraining consumers and financial institutions threatens to spread to high-grade corporate bonds, according to analysts. Defaults on corporate bonds are at an all-time low at 1%, but more corporate bonds may default in 2008. Moody’s predicts default rates to rise to 10% in 2008, well above the historical average of 5%. Constrained corporate credit may may be another signal of the looming recession.

Financial Times – Default rates fail to detect cold front approaching
Financial Times - Default rates ‘to surge from 26-year low’
Bloomberg – CDO Losses Driving Credit-Default Swaps to Record, Analysts Say
Wall Street Journal – New Hitches In Markets May Widen Credit Woes
Wall Street Journal – Credit Jitters Hit Leveraged Loans
Bloomberg – Junk Bond Default Rate to Rise Ninefold, Altman Says
Fitch Ratings (free login) – Developments in the US Leveraged Loan and CLO Markets