Subprime Woes To Boost Muni Funding Costs, Slow Spending
The side-effects of the subprime mortgage crisis are seeping into the municipal bond market, raising the cost of capital and likely slowing state and local government spending next year, according to CreditSights.
As if the market did not have enough to worry about between CDOs, ABCP, SIVs, and all the rest, another two ingredients in the structured finance alphabet soup have been making waves in recent weeks, CreditSights writes in The Muni Meltdown - Are TOBs the Next SIVs?
“The often-overlooked muni market has managed to join the mix with its TOBs (tender option bonds) and VRDOs (variable rate demand obligations), the municipal cousins of ABCP conduits and SIVs which together represent more than $400 billion of muni debt outstanding.
The same issues that have plagued ABCP and SIVs this year - including short-term indebtedness that was always supposed to roll at maturity, bank and broker liquidity facilities that were never supposed to be drawn upon, and monoline guarantees that were never supposed to be exercised - are all present in one form or another in the TOB and VRDO mess.
Suspicions about the quality of monoline guarantees and liquidity facilities have pushed muni yields into record territory relative to US Treasury securities, with tax-free muni yields in some tenors even trading north of taxable UST yields in recent weeks, CridtSights writes. “The aggressive provision of liquidity from the major central banks appears to have helped stage a modest recovery in the muni market over the last week or so, and the TOBs and VRDOs do not appear set to roil the markets to anywhere near the same degree as SIVs upset the markets in recent months.”
Still, the potential financial and economic impact of a worst-case muni market scenario of widespread exercises of the embedded puts in the TOBs and VRDOs is one more financial danger zone of which investors should at least be aware going into 2008.
CreditSights writes that munis should be able to fund themselves in the term debt market, although at a higher cost of capital. “This higher cost will have a negative economic impact, however, and we expect the reduced availability of municipal finance to reduce public sector investment to some degree.”
The ultimate impact on the US economy should not be too extreme - perhaps knocking 0.2% to 0.3% off of US GDP growth next year - but a slowdown in state and local investment spending would be just one more example of the recessionary contagion from the global credit crunch.
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December 21st, 2007 at 12:37 pm
[...] top post of the week was Subprime Woes To Boost Muni Funding Costs, Slow Spending, in which CreditSights outlined how tighter credit conditions and higher risk premiums are pushing [...]