The auction rate market is getting worse as the media is giving it more and more play. Today I heard Citigroup had at least two issues within my home state of Maryland where the auction rate was 10%. Three interesting notes on these two particular issues...
- Both are insured, but one was FSA and the other was CIFG.
- In both cases the underlying issuer has an "A" rating. One is a hospital system and the other is a water and sewer utility.
- The auctions didn't fail, the 10% level was the rate garnered at auction.
I reiterate what I said the other day. There aren't any particular problems with municipal credit quality. Part of the problem is that ARS holders assumed that the auction facility assured they could get out. But there was never any such assurance. Now people are hearing that they own something that might have zero liquidity, literally, and they are panicking.
An interesting wrinkle to this story. There are lots of people who would be willing to take a chance on the credits which are involved in failed auctions. Problem is that the upside isn't that great. I mean, let's say you are looking the A-rated hospital. Sure the 10% auction coupon looks great. But that 10% may only be there for the next 28 days. It isn't like you can buy the bonds at a steep discount on the hopes that the problem resolves itself in a few months. In fact, if the problem resolves itself, then the auction will reset much lower, making the bond less attractive.
To see what I mean, contrast what's going on with ARS vs. long-term fixed-rate munis. We know fixed-rate munis are trading weaker than they would be without the insurance problems. But nothing is trading at 10%. In other words, the two issues Citi currently has would probably yield somewhere in the 4.25-4.75% range if they were fixed-rate issues.
I want to say more on the Buffett proposal, which I'll do when I have more time. I'm surprised the stock market reacted as favorably as it did, but I disagree with those who have been saying "it only helps munis so who cares." The fact is that Citigroup has pledged capital to holding these two ARS I mentioned, and probably dozens more. Its an area of contagion that just doesn't have to be. There's absolutely nothing wrong with these ARS.
So if someone comes in and basically makes the whole muni insurance problem go away, then that's one element of the contagion that's contained. I mean, we know the subprime problem is with us, and will be with us for a while. The market can price that problem. We can price declining home values. We can price damn near anything, but we can't price unknown and ever widening contagion. So in order to get to a bottom in risky assets, we need to get to a place where the contagion stops widening.
Of course, the old saying holds: no one is going to ring a bell when this has happened. But I think getting a solution to the municipal problem is a step in the right direction.