Wednesday, May 7, 2008

Pushing On A String

MBIA, the bond insurer, had its rating dropped from AAA to AA by Fitch Ratings, a credit rating agency. MBIA has asked Fitch to stop rating it. I wish I could ask the Highway Patrol to stop monitoring my driving. MBIA’s request illustrates the arrogance of Wall Street.

The free market doesn’t care.

Reverend Wright could say it better, but MBIA’s chickens are coming home to roost. The arrogance that led to their request is the same arrogance that led them to insure bad municipal debt. Lots of it in retrospect.

Bond issue due diligence included entering assumptions like continued revenue from building permits and appreciating home values. Building permits, and their associated impact fees, have dried up. Housing values are down 25% and continuing to drop by 2.7% per month.

The City of Vallejo is going bankrupt. Vallejo’s bondholders will be paid by whichever company insured their bonds. So will probably the bondholders of the next dozen or so municipalities who claim bankruptcy. Then the insurance money runs out and the insurers go away. Subsequent bond holders will get creamed.

I can envision bondholders pushing their municipalities into bankruptcy in a race to get their insurance money. Expect a cascade of municipal bankruptcies and the dissolution of the insurers. Warren Buffett is not smart getting into the industry.

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