AAA, Insured Municipals at Extreme Risk

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.