2008 Municipal Bond Collapse : part 2

We have already discussed the forced selling of bonds by hedge funds and pension funds in 2008. Many funds were forced to sell their bonds just because they needed the money for margin calls from other collapsing investments.

Another reason for the decimation of municipal bonds during 2008 was that all of the ‘municipal bond insurers’ went caput.  Mutual Bonds Insurers were found do be wearing no clothes. They didn’t have enough assets to cover the companies they were insuring. When that happened, hedge funds got very nervous and sold their bonds. 

Allow me to elaborate.

In the old days (a few months ago), municipal bonds used to be ‘insured’ against default.  Having insurance made municipal bond holders feel good. Why? Well with bond insurance, shit could happen and if it did and the bond defaulted or the city blew up  it didn’t matter cause there was a municipal bond insurance company who issued  ”insurance” to cover your bond.

 Just to clarify–the role of the municipal bond insurer was to pay the bondholders IF the bond defaulted. The analogy is that if your house burns down and you have insurance, the insurance company pays you.  With insurance, you feel pretty dern good.

Well, bond insurance was a nice ponzi scheme idea in theory, until the bond insurers discovered that they really had no money inadequate balance sheets.  It was also a nice cash cow for Insurers because municipal bonds rarely default. 

In 2008 , bond insurers got busted on the playground . Report cards were issued for these insurance companies and it was not pretty.   Nearly all of the bond insurers were downgraded to non-investment grade , or worse yet, JUNK BOND status. Wall Street freaked out.  On top of the deleveraging that was already taking place, they now had no insurance for protection. Whoops.

So, when the financial world discovered that the companies who sold insurance to protect the bonds were turning into JUNK, everybody went into even more shock and sold.  So, this was yet another reason why municipal bonds were decimated in 2008. 

And so it came to be that at the beginning of  2009, there was not really a reliable company to insure municipal bonds. With questionalble or  no insurance coverage, everybody became really afraid to buy municipal bonds.

The really big $64 question remains: With the municipal bond INSURANCE market now in ashes, do we really need insurance anyways?  Just yesterday, one of the old insurance companies, MBIA,  rose from the ashes in an attempt to go back to insuring municipal bonds. However, they _still_ have a terrible credit rating . Can we trust them? But does it really matter? 

xoxo

BB