The global spiderweb of debt

June 27, 2011

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.

Dexia’s fate looks increasing imperiled and muni issuers who use the bank to guarantee their bonds are approaching the problem from different directions. of Everett, Washington, reported that their town is taking the wait-and-see approach:

The Everett Public Facilities District, which owns Comcast Arena, issued $27.4 million in revenue bonds now affected by the crisis.

The publicly owned district’s variable interest payments have more than doubled since May — from $14,646 to $39,432 a month.

While the city of Everett doesn’t own the arena, it does guarantee the bonds that paid for its construction. That means if the district couldn’t pay on its debt for some reason, the city would have to pick up the bill.

[Karen Clements, the chief financial officer] deals with bonds as part of her job with the Port. In her experience at the Port, it takes about 60 days to refinance bonds into a fixed rate, she said.

The public facilities district is having no problem making interest payments right now, said Debra Bryant, Everett’s chief financial officer.

Some other issuers are taking advantage of low current interest rates to refinance short-term, variable debt into long-term, fixed rate debt. The state of Georgia issued refunding bonds at 5% interest rate last week to “retire” their Dexia-guaranteed bonds.

This is a very sound move because this not the first time Dexia has encountered problems. Bloomberg’s Bob Ivry wrote an excellent explanation of how Dexia borrowed more from the Federal Reserve in the financial crisis than any other institution. They were borrowing an average of $12.3 billion in daily loans during the 18 months after Lehman Brothers collapsed in September 2008.

The Federal Reserve has never said that they wanted to support muniland through the back door by propping up Dexia. In fact, the Federal Reserve loaned funds to all foreign banks who came to the discount window.

What is not understood by many outside of the bond markets is that most financial institutions are deeply interconnected; they lend directly to other financial institutions, serve as counterparties on credit-default swaps and occasionally guarantee each others’ debts.

What happens to muniland if Dexia collapses from it’s exposure to Greek debt? It’s hard to know exactly, but interest rates for borrowers guaranteed by them will shoot up and finding new sources of liquidity will be hard. The Fed has said that it will not buy muni bonds or lend directly to states or municipal issuers. But be sure if yields rise high enough Merrill Lynch, Goldman Sachs and JP Morgan will be standing ready to “save” these issuers. There is no “lender of last resort” for muniland.


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Ironically published at this evening… and would demonstrate fiscal incompetence if necessary.

“In a move highlighting the severe fiscal stress facing many states, New Jersey officials have been negotiating a temporary bank loan of as much as $2.25 billion to plug a cash shortfall, according to people familiar with the matter.

The loan would cover bills the state will need to pay as its new fiscal year begins July 1. Normally, states have some cash available as they finish one fiscal year and begin the next, while gearing up for a bond offering based on the new budget.

State officials are negotiating with J.P. Morgan Chase & Co. over terms for the bridge loan, following a spirited competition for the state’s business, several people familiar with the selection process said.” 052702303627104576412172854764168.html

Posted by Cate_Long | Report as abusive

Is New Jersey the canary in Meredith Whitney’s coalmine? According to the WSJ, New Jersey may be the first state to use the highly unconventional approach of using a commercial bank funded bridge loan as large as $2.25 billion to “plug a cash shortfall.” The loan raised by Chris Christie’s state, “would cover bills the state will need to pay as its new fiscal year begins July 1. Normally, states have some cash available as they finish one fiscal year and begin the next, while gearing up for a bond offering based on the new budget…Terms of the loan, also known as a credit line, haven’t been finalized and negotiations could fall apart, according to the people familiar with the matter.” And since this will likely be a benchmark loan whose term sheet will be promptly circulated to other cash-strapped states, it will be all the more important in defining such key term components as subordination, collateralization, and general interest rates. ew-jersey-seeking-225-billion-bridge-loa n-9-jpmorgan-emergency-funding

Posted by Cate_Long | Report as abusive

Being a fan of Whitneys analysis and watching US governments at every level act like profligate spendthrifts I am not surprised to see the constant restructuring of debt. It is the government equivalent of credit card skating.

The guarantor model of government as the backstop to business is the entire problem. Projects getting promoted with blue sky finance projections convince the political class to pass on the risk to the taxpayer. Every business mans dream, keep the profit potential in your pocket and give someone else the risk.

Modern governments have been conned by the banks – plain and simple.

Posted by NotBob | Report as abusive

[…] Jitters Ricochet Across U.S. – WSJ Dexia’s Troubles Reverberate to West – WSJ The global spiderweb of debt – Muniland Dexia Distress Lingers – The Bond […]

Posted by FT Alphaville » Dexia still bringing stress to a town near you | Report as abusive

[…] to get out of the market. This is the same firm, after all, that had the ignoble distinction of borrowing the most from the Fed’s crisis lending facilities during the panic of 2008 and 2009. Let’s hope […]

Posted by Dexia from the bottom up | MuniLand | Report as abusive