Candidate wars got you down? If you are interested, join me for a somewhat chilling economic development.
Who are monoline insurers?
Companies that insure bonds against default, the most prominent ones being MBIA and AMBAC. Plainly put by financial blogger Graeme Pietersz:
The default risk is transferred from bold holders to the insurer. Bondholders are left only with the residual risk that the monoline insurer will also default.
Basically this is a good way to ensure you will get your money. However, this is a huge risk for the monoline insurers, as they are covering the interest and principal of billions of dollars in bonds. If something goes wrong, they have to pay, which is one of the reason why they can only insure bonds(hence the mono).
It appears very likely that many of the bonds insured by monolines will default. Monoline insurers mainly insure municipal and state bonds, ones with very low risk of default. But, just like every other financial player, monolines entered the business of insuring securities backed by mortgages--which will most certainly default. Of course I am not the only who thinks this, AMBAC's credit rating was cut from AAA to AA. Warren Buffet also offered "generously" to buyout all the Monoline's municipal bond insurance, and let them keep the mortgaged-backed securities. An offer that is not likely to be taken up.
And now the ripple effect.
Monolines are very important to the municipal and state bond market because they help keep interest rates low. By removing default risk, monolines make it much cheaper for government entities to lend. Now that they are on the verge of failure, investors are beginning to lose confidence in their ability to actually pay up in the case of a default. Therefore, municipal and state bonds have a much higher risk of default, as there is no longer a safety net like the monolines, thus interest rates for municipal and state bonds have skyrocketed. As financial reporter Bloomberg notes:
California, Florida schools and the operator of John F. Kennedy International Airport joined a growing list of municipal borrowers exiting the U.S. auction- rate market as record failures push taxpayer costs higher.
Thousands of auctions run by banks to set rates on the debt failed this month as investors shunned the securities and dealers refused to submit bids for their own accounts, sending interest costs to more than 10 percent on some bonds. Since Feb. 13, auctions covering as much as $26 billion of bonds a day failed to attract enough buyers, according to Bank of America Corp.
Florida's Palm Beach County Schools converted $116 million of auction securities into fixed-rate debt this week, while the Seattle area's Valley Medical Center refinanced $170 million. The Port Authority of New York and New Jersey said it would redeem $200 million of the bonds next month, after its weekly interest rate rose as high as 20 percent.
So, now school disctricts, municipal governments, and other government entities can't raise debt, gee that sucks. Where do you think they will get their money? Most likely, they won't get any for a while, which could obviously have a huge strain on our infrastructure and economy.
First British Bank Northern Rock failed, as as a side note they are now going to be nationalized, then the FBI began to investigated mortgage lenders, and now this. And of course it won't end here. How many different segments of the economy will be affected by the sub-prime housing crisis?
I am guessing this is just the start, what do you think?