AAA, Insured Municipals at Extreme Risk

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It used to be that one sure way to put away chunks of money safely and enjoy double or triple tax free income was to invest in municipal bonds. Sure, you paid a slight premium to buy triple A bonds and even a bit more to buy those insured by such dependable giants as MBIA and Ambac. Munis that were triple A, insured were a safe bet, and one you could hold for long periods of time and sleep well. Because they were so highly rated and insured, one never felt the need to look closely at the credit worthiness of the underlying entity, be it hospital, electric authority, city, or university. But those have turned out to be all wrong assumptions in today’s world of credit problems and huge write-offs. It is much the same as if apple pie and motherhood suddenly fell from grace. Much the same, except that in the case of municipal bonds, huge amounts of money (money people felt was safely put away), are at great risk.

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It used to be that one sure way to put away chunks of money safely and enjoy double or triple tax free income was to invest in municipal bonds.  Sure, you paid a slight premium to buy triple A bonds and even a bit more to buy those insured by such dependable giants as MBIA and Ambac.  Munis that were triple A, insured were a safe bet, and one you could hold for long periods of time and sleep well.  Because they were so highly rated and insured, one never felt the need to look closely at the credit worthiness of the underlying entity, be it hospital, electric authority, city, or university.  But those have turned out to be all wrong assumptions in today’s world of credit problems and huge write-offs.  It is much the same as if apple pie and motherhood suddenly fell from grace.  Much the same, except that in the case of municipal bonds, huge amounts of money (money people felt was safely put away), are at great risk.

 

All this is because the companies that insure municipals (MBIA, Ambac, and others) were also insuring the structured credit instruments behind the subprime mess.  They went into this area to boost their own returns – even though their principal mission was to insure municipals.  Their decision to insure the new structured credit stuff will almost certainly cause them to become the next shoe to drop in the endless chain of credit market casualties.

 

These companies, of which Ambac and MBIA are the biggest, are in serious threat of defaulting – their stock value has dropped over 70% in recent days.  If they default, overnight some $2.5 trillion of insured bonds would reverse back to the ratings of the issuers.  Just imagine the impact on the economy and the bond market – especially the previously safe municipal market –  were $2.5  trillion in assets downgraded.

 

For those with municipals, there is real trouble ahead.  If these companies go out of business, the municipal market will spin and lots of money – previously thought to be safe – will loose value and/or become worthless.  However you look at it, the scenario is bleak indeed.

Comments


Sam Cass, December 21, 2007


It looks like the agencies dropped the ratings on these agencies today. ACA Financial is now rated as junk. It's not making the headlines but it should.

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Rob, November 08, 2007


Most of the CDOs were also rated AAA up until they became junk. I don't put much weight on ratings these days because Moodys, etc. were in on the game. I do need to take a better look at Ambac and other insurers before I decide if there is a real problem though.

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Robert, November 08, 2007


The bond insurers certainly are not in serious threat of defaulting. There is a remote possibility of temporary downgrade from AAA to the next level down, in a doomsday scenario where mortgage default rates go well beyond what any analysts have been predicting to date.

There's a big difference between a remote possibility of going from AAA to AA, and defaulting.

The stock price drops are irrational panic, plain and simple, because people don't understand these companies and how they are different from the mortgage originators and investment banks.

Morningstar for example still has Ambac rated 5 stars with a fair value of $111, reiterated a few days ago. Just because people are insane and dump their shares well below value, doesn't mean those people are right. It means they are irrationally panicked.

Unless you think we're headed into a truly deep recession, it's a great time to buy these companies - which are AAA-rated mountains of cash. Even if we are headed into a truly deep recession, the companies are probably undervalued.

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soczie, November 08, 2007


Bill Gross of Pimco was suggesting that there is real risk here as well. This is an excellent time to check the underlying credit of the municipals that you own and to unload those that have poor ratings.

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Eros Mazzillo, November 08, 2007


Yes, we may be entering a very scary time, even for those who said "to hell with the stock market" and thought that the vehicles that they parked their money in was safe.

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