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Investing Advice Inspired by Jack Bogle
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Ariel
Joined: 10 Mar 2007
Posts: 1361
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 Posted: Mon Mar 03, 2008 9:26 am Post subject: New York Times on Muni Bonds, Ratings |
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| Quote: | States and Cities Start Rebelling on Bond Ratings
By JULIE CRESWELL and VIKAS BAJAJ
Published: March 3, 2008
Does Wall Street underrate Main Street?
A growing number of states and cities say yes. If they are right, billions of taxpayers’ dollars — money that could be used to build schools, pave roads and repair bridges — are being siphoned off in the financial markets, where the recent tumult has driven up borrowing costs for many communities. |
It's hard not to read this artcle and think that the rating agencies and bond insurers are much the same as the mob (organized crime), engaged in a high-profit shakedown of taxpayers and investors.
The soul of capitalism? We need a lot more leaders like John Bogle ... and a lot fewer of the garden-variety parasites that dominate the system.
http://www.nytimes.com/2008/03....ref=slogin
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Do what you will, the capital is at hazard ... - Justice Samuel Putnam (1830), as quoted by John Bogle (1994) |
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larryswedroe
Joined: 22 Feb 2007
Posts: 5419
Location: St Louis MO
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| Posted: Mon Mar 03, 2008 9:29 am Post subject: |
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IMO
This is silly once you think about it.
There are academic papers that show that Single A munis are 90% less likely to default than Single A corporates. Does that mean the market prices them the same? Of course not. The market knows that the munis are safer and prices them accordingly. |
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Ariel
Joined: 10 Mar 2007
Posts: 1361
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| Posted: Mon Mar 03, 2008 10:03 am Post subject: |
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| larryswedroe wrote: | IMO
This is silly once you think about it.
There are academic papers that show that Single A munis are 90% less likely to default than Single A corporates. Does that mean the market prices them the same? Of course not. The market knows that the munis are safer and prices them accordingly. |
I agree that the market can re-price according to risk. But in the mean time, the parasitic rating and insurance agencies have extracted their bogus fees from the taxpayers and investors. And the only services they provide are to make themselves seemingly indispensible, and thus create turmoil when they make boneheaded mistakes like rating and insuring munis and CDOs on equivalent scales. It's corruption, pure and simple, in my opinion.
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Do what you will, the capital is at hazard ... - Justice Samuel Putnam (1830), as quoted by John Bogle (1994) |
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baw703916
Joined: 01 Apr 2007
Posts: 2409
Location: Northern Virginia
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| Posted: Mon Mar 03, 2008 10:22 am Post subject: |
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| Quote: | | There are academic papers that show that Single A munis are 90% less likely to default than Single A corporates. Does that mean the market prices them the same? Of course not. The market knows that the munis are safer and prices them accordingly. |
True, and PIMCO gave some data on default rates recently that AA muni's are less risky than AAA corporates. And, thanks for pointing out to us in previous conversations that a natural AAA muni is very different than a muni with a AAA due to insurance.
The problem though as many articles have pointed out is that many fiduciaries are legally obligated to hold only AAA bonds. So a AA rated issuer of municipal bonds, by buying insurance, obtains a greater number of potential purchasers of its bonds, who would not otherwise (due to the legal restriction) be able to buy them. That's why it's usually worth issuers' while to buy the insurance. Never mind that according to the market price for default swaps AMBAC has a 45% chance of defaulting over the next 5 years--for *some reason* it has a AAA rating.
So the combination of a mandate for many purchasers to only buy AAA bonds, together with a very strict rating standard for municipal bond issuers, and a very lenient one for insurers---serves to guarantee business for insurers.
So yes, if purchasers are allowed to make their own assessment of risk, the market is smart enough to figure this out. But because of these "own only AAA" clauses, the market isn't allowed to operate freely in many cases.
Best wishes,
Brad
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I don't foresee any Black Swans appearing in the future |
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astroturf
Joined: 26 Aug 2007
Posts: 548
Location: Greater NYC Area
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| Posted: Mon Mar 03, 2008 11:02 am Post subject: |
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| Ariel wrote: |
I agree that the market can re-price according to risk. But in the mean time, the parasitic rating and insurance agencies have extracted their bogus fees from the taxpayers and investors. |
Agree, the systematic underrating of munis costs money to the tax payer, that's the main point. The money goes out in fees to the rating agencies and the insurers or in the form of higher interest rates for uninsured bonds. Professional investors know this has been going on for a long time.
Whether the muni market is as efficient as some people think is another matter, and I really don't think much about it. The fact is that when other markets are created around munis, like auction-rate preferred securities and tender option bonds, bad things can happen after Wall Street collects their fees. For example, bid rigging and not providing expected back stop liquidity. Lets see how long the lessons learned will last.
Last edited by astroturf on Mon Mar 03, 2008 4:19 pm; edited 1 time in total |
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jh
Joined: 14 May 2007
Posts: 1319
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| Posted: Mon Mar 03, 2008 11:02 am Post subject: |
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...
Last edited by jh on Sat Mar 29, 2008 3:22 pm; edited 1 time in total |
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joppy
Joined: 22 Feb 2007
Posts: 231
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| Posted: Mon Mar 03, 2008 11:38 am Post subject: transfer of AAA rating |
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| The New York Times wrote: | | The insurers are themselves rated triple A — on the corporate scale — by Moody’s and S.& P., and essentially transfer those gilt-edged ratings to municipal issuers through the policies they sell. Municipal issuers with lower ratings paid $2.5 billion in premiums for bond insurance last year alone. |
The problem is not that there are different scales between munis and corporates. As Larry points out it would be silly not to be able to differentiate between different classes of muni bonds, by labelling them all AAA on the corporate scale. The problem is that there is no "official translation" between the muni and corporate scales, even though people "know" the translation. Referring to Brad's comment, such an official translation may allow fiduciaries to buy anything better than AAA corporate which would include a lot of lower rated munis. Alternately, fiduciaries may decide that they really need to purchase AAA munis and AAA corporates don't satisfy their requirements.
It makes no sense that a muni bond rated "A" which is equivalent or better than a corporate "AAA" should have to buy insurance from a corporate "AAA". If there really is insurance to be bought, it should have to be bought from an organization rated "AAA" on the muni scale -- yes this would be *more* expensive, but this insurance may actually be worth buying. The problem here is that muni's are "allowed" and "encouraged" to jump over from the muni scale to the more lax corporate scale by paying insurance money.
- Joppy |
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larryswedroe
Joined: 22 Feb 2007
Posts: 5419
Location: St Louis MO
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| Posted: Mon Mar 03, 2008 3:55 pm Post subject: |
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Brad
The market knows all this and it is why AAA munis without insurance trade higher than those with it. |
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baw703916
Joined: 01 Apr 2007
Posts: 2409
Location: Northern Virginia
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| Posted: Mon Mar 03, 2008 9:35 pm Post subject: |
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Larry,
But the point is that the way the current system is set up, bond insurance in msot cases doesn't benefit anyone but the ratings agencies and the insurance companies.
The issuer of the bonds has to pay costs of insurance (your tax dollars at work!). The investor doesn't really gain any safety by having bonds insured by a company which is less financially secure than the issuer. And in fact, investors whose fiduciary has the "only own AAA" obligation may end up with a less secure portfolio, if they end up with insured bonds whose underlying rating is less than A, rather than uninsured AA bonds.
So if it doesn't benefit either the buyer or the seller, it's a market inefficiency.
Brad
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I don't foresee any Black Swans appearing in the future |
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Fantumzone
Joined: 24 Feb 2008
Posts: 120
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peter71
Joined: 24 Jul 2007
Posts: 3247
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| Posted: Tue Mar 04, 2008 12:24 am Post subject: |
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Hi All,
definitely agree that the irony of municipalities paying an insurer that's 10 times more likely to default than they are for default insurance is incredible, but do people think there's any truth to the S&P Exec's below statement about the "benign" 20-year time period for muni defaults?
Executives at S.& P., however, say they use a single global rating scale to measure all kinds of debt. Colleen Woodell, chief quality officer for public finance, acknowledged that municipal debt had defaulted at lower rates than corporate issues, but she noted that the data covered a relatively benign 20-year period.
Ms. Woodell said the disparity was “within a tolerable band” and would diminish over time. She said the firm upgraded a number of municipalities after it finished its first default study in 2000. (Data on S.& P.-rated municipal and corporate debt from the early 1980s to 2006 show similar differences in default rates as those rated by Moody’s.)
My first thought is that it has to be a /relatively/ benign period for muni defaults in comparison to corporate defaults for Woodell's point to be valid, and if it hasn't been I'm all the more willing to believe the rating agencies are evil/incompetent, but is there perhaps evidence that with defaults during the dot-com bubble and such that this is in fact the case?
Put much more simply, has there ever been an era (say the 70's?) when muni defaults exceeded corporate defaults?
All best,
Pete |
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baw703916
Joined: 01 Apr 2007
Posts: 2409
Location: Northern Virginia
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| Posted: Tue Mar 04, 2008 12:49 am Post subject: |
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| peter71 wrote: | Hi All,
definitely agree that the irony of municipalities paying an insurer that's 10 times more likely to default than they are for default insurance is incredible, but do people think there's any truth to the S&P Exec's below statement about the "benign" 20-year time period for muni defaults?
Executives at S.& P., however, say they use a single global rating scale to measure all kinds of debt. Colleen Woodell, chief quality officer for public finance, acknowledged that municipal debt had defaulted at lower rates than corporate issues, but she noted that the data covered a relatively benign 20-year period.
Ms. Woodell said the disparity was “within a tolerable band” and would diminish over time. She said the firm upgraded a number of municipalities after it finished its first default study in 2000. (Data on S.& P.-rated municipal and corporate debt from the early 1980s to 2006 show similar differences in default rates as those rated by Moody’s.)
My first thought is that it has to be a /relatively/ benign period for muni defaults in comparison to corporate defaults for Woodell's point to be valid, and if it hasn't been I'm all the more willing to believe the rating agencies are evil/incompetent, but is there perhaps evidence that with defaults during the dot-com bubble and such that this is in fact the case?
Put much more simply, has there ever been an era (say the 70's?) when muni defaults exceeded corporate defaults?
All best,
Pete |
Hi Pete,
Certainly I would be making those points if I were working for S&P and presenting their side of the story. And, to be fair to them, it's worth asking whether the historical record you're basing your conclusions is truly representative and repeatable going forward.
But one reason I'm suspicious is that they just reaffirmed the insurers' AAA rating (or Moody's did, don't remember which). And, they completely missed the boat on SIVs, I think those were downgraded from AAA to junk in one fell swoop.
I don't really have the data for historical muni default rates. I think it was PIMCO that came out with the analysis that I'd seen reported.
Best wishes,
Brad
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