Betting on Muni Failures and why Congress should ban a Fed Bailout
This is the story of another government guaranteed, debt-bomb waiting to explode with investor buying bonds from cities teetering on bankruptcy, because they believe the Fed will bail them out.
Another Fed bailout — as in the Federal Reserve — will simply be another money printing exercise to bailout incompetent, corrupt city governments who are borrowing to fuel super-salaries of union workers in cities that issue debt as if they had the power to print money, but in this case, it’s bonds.
Now some of those investors, like the few lonely mortgage-industry short sellers in 2005–06, have started betting against the borrowers. Time reports that some of them “are jumping into the credit default swap market to bet against cities, towns and states.” A CDS is an insurance contract that protects a bond holder against default. But there’s a difference: You don’t necessarily have to be exposed to the underlying bond to buy a CDS. They can be bought or sold, and are priced depending on the market’s perception of bond default probability. If the risk increases, it is likely that the demand for CDSs will too, leading to an increase in their price. Brian Fraser, a partner at the law firm Richards Kibbe & Orbe LLP, told Time, “The spreads on CDSs have been growing, and the dollar amount of CDSs on municipals has grown in the last year. That’s a clear warning sign that people are effectively starting to short the muni market.”
There must be a law passed to prevent the Fed from bailing out these cities with freshly printed money. Why? Because, as Veronique de Rugy writes:
“The state and municipal debt crisis could culminate in a request for the third near-trillion-dollar bailout of the last two years. That much federal borrowing on top of the current debt could very quickly have an impact on interest rates and on the dollar. And at that point, we can just forget about the recovery.”