A story on Bloomberg highlights the seize up in the muni bond auction market, which is forcing issuers to pay as much as 20% in interest to roll short-term debt.
The bonds are auctioned every seven, 28 or 35 days. If the auctions don’t attract enough bidders, the municipalities must pay rates specified in their offering agreement, which can be punitive.
The failures result because neither investors nor dealers want to wind up holding paper that is downgraded due to bond insurer downgrades. Weirdly, if the rating agencies re-rated the monolines rather than holding the sword of Damocles of a rate reduction over them, this uncertainly would be eliminated.
From Bloomberg:
Rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, with bidding run by Goldman, soared to 20 percent yesterday from 4.3 percent a week ago, according to data compiled by Bloomberg. Presbyterian Healthcare in Albuquerque and New York state’s Metropolitan Transportation Authority also experienced failures, officials said….
“It’s the beginning of the end for the auction-rate market,” said Matt Fabian, a senior analyst with Concord, Massachusetts-based Municipal Market Advisors. “Banks have stopped supporting the market.”…
Local governments are obliged to pay the high rates until either the auctions start attracting more buyers or they arrange to convert the bonds to some other form of debt. Bankers and borrowers have been working on conversion plans for several weeks.
The 20 percent rate for the $100 million of Port Authority auction bonds will cost it $388,889 until the next weekly auction, up from $83,611 last week. Interest on the bonds is subject to federal income tax….
A Citibank-run auction for the New York state’s Dormitory Authority failed yesterday, resulting in an interest rate of 6.26 percent, up from 3.12 percent a week earlier, according to Bloomberg data. Following the auction miss, the interest rate was set at twice one-month Libor, the London interbank offered rate for wholesale bank deposits, according to the official statement for the bonds….
Bidding by dealers is essential to the smooth functioning of auction securities and banks are now wary of loading their balance sheets with the bonds, said Alex Roever, a JPMorgan Chase & Co. fixed income analyst.“This market has been under a tremendous amount of stress,” Roever said. “Without the dealers providing an active secondary bid, it’s very hard for these transactions to clear.”
The soured auctions in recent weeks are the first since September, when about $6 billion of auction debt failed on investor concerns that bond insurers may lose their AAA ratings, Roever said in a Feb. 8 report. The latest wave began as recently as Jan. 22, when auctions run by Lehman Brothers Holdings Inc. for Georgetown University and Nevada Power failed
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“Weirdly, if the rating agencies re-rated the monolines rather than holding the sword of Damocles of a rate reduction over them, this uncertainly would be eliminated.”
Aaaah! Telling the truth shall set you free huh? That’s assuming society has its priorities straight.
But not here! Those who’d be set free are the hordes of lawyers ready to Stalingrad the rating agencies under a tsunami of lawsuits.
Mind you, if the rating agencies had kept their common sense instead of shooting for the biggest buck possible under a quasi-absence of regulation (a very difficult thing to do when money is on the line) they would have asked the tough questions BEFORE providing a rating and would have kept not only their credibility but also a lot of people out of trouble.
It goes without saying the same commentary applies to the monolines.
Can you put this in perspective for a new economy-watcher? Are bond auction failures somewhat common in recessions? Or in other bank (S&L) crises?
A few times a decade, practically never … ???
Sorry for a newbie question, but I’m unclear who is getting paid the 20%. So if the auction fails, does that mean the current bondholders who aren’t being repaid since their bonds can’t be rolled over are now owed 20% until their principal is repaid?
In either case, I fail to see why the munis didn’t just raise the yield on their debt until they sold enough to meet their rollover requirements. I’m sure they would have sold enough at 5 or 6 or even 10% and avoid the 20% penalty rate. Or are there floor/ceiling reserves set at the auction that would prevent such yields?
At any rate, it seems stupid to pay a 20% penalty rate when you could have just paid a higher yield and attracted enough bidders. Heck, even junk bonds still pay significantly lower than 20%, even in the current market.
The fundamental problem with auction-rate securities, as Accrued Interest pointed out, is that there’s little upside for bargain hunters. Sure, 20% is a great yield, but it might only last 7 days (or 28 days, or whatever).
For fixed-rate securities, if you buy them during turmoil at a discount and conditions later improve, you make a nice profit. For auction-rate securities, if you buy them during turmoil and conditions later improve, all you get is a much lower yield.
So you have an illiquid security with little upside. Compare more traditional bonds, for which there’s always a market: even North Korean bonds that defaulted 32 years ago still sell for 30 cents on the dollar (!)