Monday, June 16, 2008

Does Not Compute

Something about Felix's argument doesn't compute, but my brain is a bit too cloudy to take this on right now. I need some sleep.

Yes, credit enhancement has generally been the name of the game with muni issuers and monolines. The issuers were trying to get their issuance costs down (e.g. their yields), knowing full well that the primary buyers of their product were likely not going to spend a lot of time doing credit analysis. Even doing 1 issue would be problematic for a small investor, never mind the universe of muni credits in the marketplace. Guys like Tom make a lot of money (and spend a lot of time) doing that research. People like me, however? Not so much.

So what am I missing here? Yes, credit enhancement in an era of diminished trust in the ratings agencies is probably absurd. However, you have to play to your audience. The rating agency problem will, hopefully, start getting sorted out with new entrants to the market. I don't see this world changing drastically.

Of course its nuts that munis, with their historical default rates, were not being compared evenly with corporate credits. However, I think your state treasurer probably was working with a small budget, and any way to shave a few hundred thousand in coupon payments annually was (and is) significant. All of those costs (and savings) flow directly to the bottom line.

In the longer run, the market will likely morph. Higher quality credits will probably go without insurance. Lower quality issues will probably still seek it out. I doubt the market will disappear, but shrinkage seems highly likely to me. For these issuers, making those costs evaporate is probably the key reason for the demand for insurance. Now, I may be missing something from my limited vantage point. Please, someone, clue me in if I have missed something. Basically, I think Felix is being a bit too cynical on this one. Ratings arbitrage occurs, sure, but I think the primary motivator for many of these treasurers is keeping their costs low. For a relatively small outlay (especially for larger issuers), they could get that, with the higher rating being gravy (an effect rather than a cause).

Does that make sense to anyone other than me? I hope it does. Maybe I'll expound on this after I get some rest.

Until then, dear - don't leave home without it!

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