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Interest Rates: A new crisis

Posted February 22, 2008

"Even more troubling than the mortgage crisis is the havoc it is creating in the bond market. Borrowers and lenders that depend on the usually highly liquid and safe municipal bond market are suffering from a market that seemingly dried up overnight. " – Andrew Snyder 

By Andrew Snyder 

Baltimore (TFN) — Every major economic downturn in this nation's short history is related to bank or credit failures.  The latest one is no different. 

We have all heard of the surmounting losses taken by some of the nation's largest banks.  Combined, Wall Street lenders have lost over $146 billion to bad debt.  The number will continue to grow.  And of course, it will trickle down to the little guy.  It already has.

Even more troubling than the mortgage crisis is the havoc it is creating in the bond market.  Borrowers and lenders that depend on the usually highly liquid and safe municipal bond market are suffering from a market that seemingly dried up overnight.

In case you are not well versed in the "muni" market, nearly every day local municipalities and organizations hold debt auctions.  It is how they finance construction and improvement projects, even pension funds.

Rates are through the roof

The average interest rate for these short-term bonds was somewhere in the 4% range just thirty days ago.  Last week, some borrowers were forced to pay rates as high as 20%.  The soaring rates have them scrambling to find other financing options.  But until they do, you and I will be footing the bill.  Somebody has got to pay for those improvements and pension funds. 

The reason rates are soaring is due to a lack of bond investors.  Throughout the market's history, a buyer shortfall was not an issue. The major banks hosting the bond options would simply snatch up any remaining bonds.  It was a good way for them to lock in secure income with a decent interest rate.

But now that firms like UBS, Merrill Lynch, Goldman Sachs, and Citigroup are licking their wounds from the mortgage industry collapse, they are unwilling to shell out the necessary capital to continue funding this $342-billion market.  And without their support, the industry collapsed.

Worst market in history

In the 22 years prior to this mortgage industry fallout, only 13 municipal bond auctions failed.  Most of them failed because of credit issues, not a lack of buyers.  Now that the major banks are in trouble, 31 auctions failed in the second half of 2007.  So far this year?  Over 500 auctions have failed.  It is wreaking havoc in bond markets across the globe.

Governments, schools, and pension funds that are used to borrowing money for three and four percent now pay twelve, sixteen, or even twenty percent.  For example, the Port Authority of New York and New Jersey, which normally pays just over $80,000 each week in interest, was paid to shell out over $390,000 this week. I bet that was not in the annual budget. 

Who is going to pay for the increase?  You and I, my friend.  Anybody that has taken Econ 101 knows what rising interest rates do to inflation.  It is not going to be pretty.

Stay tuned.  I am working on an interesting way of profiting from this pain. 


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Posted by Andrew Snyder · Filed Under US Stocks and Markets 

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