Tuesday, December 23, 2008 1 comments ++[ CLICK TO COMMENT ]++

Bad news for bond insurers: Analyst sees up to 10 municipal bankruptcies

They have been given up for dead but the bond insurers are still limping along. However, there is some bad news on the horizon, although I'm not sure if any of the bond insurers are impacted. Bloomberg reports that an analyst predicts as many as 10 municipal bankruptcies in the upcoming year with more the following year:

The accountant who predicted the nation’s largest municipal bankruptcy says as many as 10 insolvencies will roil the $2.7 trillion U.S. market for state, county and city debt next year as public finances worsen amid calls for federal aid to state and local governments.

John Moorlach said in 1994 that Orange County, California’s leveraged investing strategy could wreck its finances. The county went bankrupt about six months later after losing $1.6 billion.

As many as four cities in the Golden State and six others nationwide may seek court protection from creditors next year under Chapter 9 of the bankruptcy code, the section devoted to municipal governments, Moorlach said in an interview.

Some of the ones cited seem to be tiny so their impact will be minimal. Even if defaults were fairly high, insurers will likely get higher recoveries or ownership of assets (such as sewage systems, roads, streetcars, and the like.) In contrast, losses on residential real estate, especially the CDO-squareds, can result in losses close to 100%.

Similar to how the stock market swooned after the bond insurer problems with real estate bonds surfaced, I suspect further problems with municipal bonds will likely cause another big sell-off in the stock and bond markets. If American municipalities and states start defaulting in a high number, the US economy will be in far worse state than I have ever contemplated.


1 Response to Bad news for bond insurers: Analyst sees up to 10 municipal bankruptcies

December 24, 2008 at 4:15 PM

Short term this is not ideal for the monolines. However typically they do not experience an ultimate cash loss when a wrapped muni defaults -- they are able to recover all payments via their rights to the collaterol. (See claims paid for municipalities damaged by Katrina.)

Ultimatley this may be a good thing for the monolines. Investors in wrapped bonds will not miss receiving a payment of interest or principal while the municipality restructures. This may help highlight the service offered by the bond insurers and lead to new underwriting...

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