If you are not familiar with the municipal bond market, you may think that muniland is nothing more than states, municipalities and school districts offering plain bonds that mature on a set date and offer a fixed interest rate. That is the textbook description.
Actually the municipal bond market is a murky tangle of odd bond structures, variable-rate debt, multiple layers of issuers and bank guarantors. The lack of standardization of bond structures and relationships is one of the main reasons that the asset class has never migrated to the internet for retail investors.
Often the odd bond structures can create much more exposure to the tides of global affairs than plain vanilla bonds. The biggest example now is the Belgian-French bank Dexia, which is a big guarantor of U.S. muni bonds.The WSJ reported in an excellent article that investors are selling off muni bonds that Dexia insures:
From a skating rink in Everett, Wash., to New York City’s schools to Chicago’s O’Hare International Airport, interest rates on some bonds have soared since late May and could rise even further because money-market investors are less willing to buy some of the $17 billion in municipal bond deals backed by Dexia SA, a Belgian-French bank shaken by its exposure to government debts in Greece.
The problem with Dexia’s role here is that many U.S. municipalities issued debt for long-term capital projects (think school buildings, sports arenas, bridges) and agreed to borrowing terms that are reset on a weekly or daily basis. Imagine a super-charged ”adjustable rate” mortgage that is constantly moving around depending on interest rates. The adjustable daily/weekly rates are short-term rates. So the issuer has the benefit of funding long-term projects with very low short-term rates. It works really well — until it doesn’t.