Displaying items by tag: Capital Markets

Friday, 16 May 2008 05:00

Government Flip Flop

You know how I feel on this topic - Reggie Middleton says don't believe 'em ...

"In my judgment, we are closer to the end of the market turmoil than the beginning," Henry Paulson said in the text of a speech he plans to deliver in Washington. "Looking forward, I expect that financial markets will be driven less by the recent turmoil and more by broader economic conditions and, specifically, by the recovery of the housing sector."


“Frankly, things may get worse before they get better. As regulators, we continue to see a lot of distress out there,” Sheila Bair, chairman of the Federal Deposit Insurance Corp., said in the text of a speech to the Brookings Institution...“Too many unaffordable mortgages are causing a never-ending cycle — a whirlpool of falling house prices and limited refinancing options that contribute to more defaults, foreclosures and the ballooning of the housing stock,” Bair said.

Hmmm... Who do you believe???

Published in BoomBustBlog

Note: for some arcane reason, the graphs refuse to show up on this post so here is a pdf version for the blogs registered users: icon Municipal Bond Market and the Securitization Crisis (242.88 kB 2008-05-14 18:09:27)

his is a DRAFT of part 5 of Reggie Middleton on the Asset Securitization Crisis – Why using other people’s money has wrecked the banking system: a comparison to the S&L crisis of 80s and 90s. As was stated in the earlier parts, I periodically have third parties fact check my investment thesis to make sure I am on the right track. This prevents the "hubris" scenario that is prone to cause me to lose my hard earned money. I have decided to release these "fact checks" as periodic reports. This installment covers consumer finance, an aspect at risk in the banking system that is both overlooked and underestimated, in my opinion.

I urge discourse, conversation and debate on this post and the entire series. To me, it is necessary to make sure the world is as I percieve it.

The Current US Credit Crisis: What went wrong?

  1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. You are here => Municipal bond market and the securitization crisis – where do we stand
  6. To be Published: An overview of my personal Regional Bank short prospects

The following municipal bond portion of the asset securitization crisis is also a tie-in to the prospects of the monoline insurance industry. The latest of my monoline analyses is the Assured Guaranty Report. You can also peruse the work I did on MBIA and Ambac starting from the inception of my short position in these companies last year.

  1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton
  2. Tie-in to the Halloween Story
  3. Welcome to the World of Dr. FrankenFinance!
  4. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion
  5. Follow up to the Ambac Analysis
  6. Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibili
  7. More tidbits on the monolines
  8. What does Brittany Spears, Snow White and MBIA have in Common?
  9. Moody's Affirms Ratings of Ambac and MBIA & Loses any Credibility They May Have Had Left
  10. My Analyst's Comments on MBIA/Ambac/Moody's Post
  11. As was warned in this blog, the S&P downgrade of a monoline insurer reverberated losses through c

And now, on to the Muni report...

Municipal bond market and the securitization crisis – where do we stand

As defined by the Securities Industry And Financial Markets Association (SIFMA), municipal bonds (often called munis) are debt obligations issued by states, cities, counties and other governmental entities to raise money to build schools, highways, hospitals and sewer systems, as well as many other projects for the public good. The interest income generated from these bonds is free from federal taxes, state taxes, local taxes or all the above. However, not all munis are tax-free.

Municipal bonds generally are classified as general obligations and revenue bonds. General obligation bonds (or GO bonds) are mostly backed by the credit and the ‘taxing power’ (inflow of tax revenues) of the issuing municipality. They are generally considered one of the safest investments as they have governmental support.

Revenue bonds, on the other hand, depend upon the revenue generation capability of the project in which the bond proceeds are to be invested. Hence, they are generally perceived to be riskier than the GO bonds.

Out of a total market worth US$2.62 trillion municipal bonds outstanding, mutual funds hold the maximum (35.8%), while individuals hold the second highest amount (35.0%) of the municipal bonds in the US.

Municipal bonds breakdown - outstanding and issued in 2007


Source: SIFMA

From the issuance perspective, revenue bonds have almost always attracted more investors due to their higher paying nature. Consequently, revenue bond issuance has grown at a CAGR of 8.4% in the last 12 years as compared to 6.6% for GO bonds. In 2007, the total municipal bonds issued were worth US$424.3 million, of which revenue bonds issued constituted 69.1%.

Most municipal bonds are insured by bond insurance companies. According to the S&P National Municipal Bond Index (which comprises 3,102 bonds) at the end of 2007, 48.8% of the municipal bonds were insured.

The impact of the Asset Securitization crisis on municipal bonds

The municipal bond market was severely impacted during the second half of 2007 as compared to the first half.

Property tax revenues of local and state governments severely impacted

Most local and state governments rely on taxes as their major sources of income; hence it is obvious for them to raise money through bonds based on their taxing powers. Moreover, each of the 50 states has different definitions of “property”.

There were two taxes that were primarily affected as a result of the housing market downfall – property tax as well as use tax on rents. Property tax is a primary source of income for most state and local governments in the US, states the US Treasury Department. There was a rapid decline in demand for real estate which was augmented by increasing supply of homes on account of rising foreclosures. As a result, property valuations went significantly down which affected the tax inflows of many states in the US. Moreover, with people not able to service the rents, even the income through use taxes suffered. An evidence of such a state is California. California was home to almost half of the 25 biggest US subprime lenders. According to the California Association of Realtors, the number of houses and condominiums sold in California declined approximately 30% y-o-y in January 2008 to 313,580, while the median price for an existing home slumped 22% y-o-y to US$430,370. Moreover, California had 481,392 foreclosure filings on properties last year, the most of any state, according to RealtyTrac.

As a result, the state’s Director of Finance expects the growth rate in property tax revenue to be as low as 2% y-o-y in 2008-2009 with an expectation of a 6% y-o-y fall in 2009-10. According to the California Legislative Analyst Office, a 1% y-o-y decline amounts to US$450 million of lost tax revenue (for those who don’t want to do the math, that’s approximately $2,700,000,000).

Lower income tax revenues due to economic slowdown

For the US Federal Government, income tax charges contribute most to its revenue, with personal income tax producing almost five times the revenue produced from corporate income taxes. In 2007, of the total Federal revenue collection, income taxes from individuals constituted 78.5%.

Importance of income tax revenues to the US Government

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Source: Financial statements, US Federal Reserve

With the economic hard landing in the US, income tax collections are likely to get hit, going forward. According to advance estimates from the Bureau of Economic Analysis, the US economy grew by only 0.6% y-o-y in 1Q 08 with unemployment rate having jumped from 4.5% in April 2007 to 5.0% in April 2008. With high food prices across the globe, higher fuel costs, increasing debt component pressurizing the household income and the decline in the values of houses of US citizens, there is an unavoidable pressure on personal disposable income. With rising unemployment across the country, a declining or even a marginally negative growth rate of revenues generated through income tax would severely pinch the Government’s earnings. With homeowners expecting at least as much assistance as was provided to the financial industry, tough times await the US Government.

An impact in tax revenues directly affects the credibility and capability of the government to issue any bonds based on its taxing powers – whether they be municipal or federal. This is also a major reason why the overall outlook for municipal bonds market appears grim in the near to medium term.

Bloated budgeting in the boom times

Most US state and local governments had prepared budgets based on the revenue from the (then) extant real estate boom. Hence, they continued to issue munis to fund their expansion plans; even the interest rate scenario was conducive and they could pay the investors due to a consistent inflow of taxes. However, after the housing market collapsed, property values went down and an increasing number of homeowners went for the property revaluation to cut down the property tax figures from the list of their financial obligations.

Consequently, tax inflow for these state and local governments slowed down. Due to this, payments on the long term municipal bonds became riskier than at the time of their issue. The government of California has already reduced the budgets of its police and fire departments for the coming year by approximately 20% following these developments. This, combined with private sector workforce reductions, serve to act as a reflexive mechanism that causes a feedback loop, wherein cost reductions reduce income tax revenue which exacerbated the need for further cost reductions.

Published in BoomBustBlog
Tuesday, 04 March 2008 05:00

Banks, Brokers and Bull Dookey, continued...

In Banks, Brokers, & Bullsh1+ part 2 I forecasted Morgan Stanley having beef with their hedge fund clients and counterparties. Well, actually I claimed that they had excessive counterparty risk from these clients, which was bound to come back to bite them. In today's WSJ.com:

Some other hedge-fund managers say they've been bullied by securities firms when they've tried to cash out on profits from such positions. When one hedge-fund manager considered selling out of a credit-default swap -- in which his fund bought protection on $10 million of bonds of Countrywide Financial Corp. -- he says there was a condition attached by two securities firms. He says the firms -- Bear Stearns Cos., which sold him the swap, and Morgan Stanley -- told him they would cash him out of his profitable position, only if he would simultaneously enter into another swap-selling insurance protection on the bonds equal to his fund's $3 million profit. Eventually, he says, his fund sold the position through Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc., allowing him to book the $3 million profit. Representatives for Bear Stearns, Morgan Stanley, Goldman and Lehman declined to comment.

Published in BoomBustBlog
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