Industry professionals who lived through a real muniland disaster when the auction-rate security (ARS) market exploded in 2008 have cocked a jaundiced eye at the news that the giant Belgian/French bank Dexia — a big guarantor of American municipal bonds — is on the verge of collapse.
The difference in magnitude of the two events is exponential; Dexia only backstops about $10 billion of U.S. muni bonds — many times smaller than the $400 billion ARS market that froze in February 2008 and helped precipitate the financial crisis.
Nevertheless, both shocks involved the problem of long-term municipal bonds called “variable rate demand notes” (VRDOs) which reset their interest rates every week. Even the rates on the most super-charged adjustable-rate mortgages don’t reset that frequently. Moreover, VRDOs are distinct in that if the buyer doesn’t like the reset rate they have the right to return the VRDO back to a liquidity provider, Dexia in this case, which stands ready to buy the bonds if the buyer doesn’t want them anymore. The possibility that Dexia doesn’t have the capital to buy the $9.6 billion in VRDOs is a big issue.
Reuters is reporting that Dexia has been voluntarily withdrawing from the U.S. market:
“Our exposure (to the U.S. muni market) has been diminished significantly, and that was a deliberate choice on our part,” Guy Cools, general manager of Dexia Credit Local’s New York branch, told Reuters on Tuesday.