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Friday, November 30, 2007


why the monoline defaults are even more serious than they seem

i've mentioned the monoline bond insurers (ambac, MBIA) and to a lesser extent whole loan insurers (MGIC, radian, pmi group) a couple times (most recently here) and the knock-on effect their troubles are having in the vast municipal bond market. this short video from indicates the consensus of the value investing community -- while some think freddie mac may be a value play in spite of how the whole loan insurers may let them down, there is no price level low enough to bring them into monoline equity.

but what i may not have said is why those troubles are coming at the worst possible time for muni bond investors: the financial surity of municipalities and local governments is being overthrown by the collapse in housing.

Treasurer's offices all over the country are bracing for the day when lenders stop paying the taxes on many properties in the worst hit neighborhoods.

Many houses in Cleveland's central city neighborhoods have been so damaged by looting, fires and weather that they are almost total losses. The lenders will eventually walk away from them.

"The lenders will come to us and say, 'We just can't hold the properties any longer. We don't want to pay the demolition costs. Here's the property,' " said Jim Rokakis, Treasurer of Cuyahoga County, which includes Cleveland, one of the cities hardest hit by foreclosures

The trend will not be confined to Midwestern cities like Cleveland, where the local economies have been clobbered by manufacturing job losses.

Many Sun-Belt cities now rank high on the list of foreclosures, especially in California. In a report released this week, the United States Conference of Mayors forecast a reduction in property tax collections in California of nearly $3 billion for 2008.

"Across the country, there has been a boom in property tax volume growth. That's going to stop," said Jim Diffley, the Global Insight economist who put together the analysis for the Mayor's Conference.

it will not only stop; it will reverse hard.

a lot of the borrowings conducted by local government in the recent years of supremely easy credit were predicated on very low intermediate-term interest rates and revenue projections which will now not be met. therefore, the probability of default in these local bond issues has jumped exponentially as terms of credit tighten and houses both fail to sell (and generate transfer tax revenue) and fall into foreclosure (cutting off property tax revenue) at unprecedented rates. at the same time, sales tax revenues are falling sharply -- particularly in states most heavily affected with housing problems, as the credit contraction now starts to compress consumer spending. worse still, many municipalities have or will soon run into the problem now being manifested in florida, where a not-insignificant amount of cash is part of the $900bn locked in frozen asset-backed commercial paper and cannot be redeemed.

as a result, one should expect municipal bonds to become a much more tumultuous field of play in the coming year. and, as previously noted, munis -- alongside the instruments of fannie mae and freddie mac -- underlie a lot of cash-proxy money market funds, pension funds, insurers and commercial bank holdings.

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