14 months ago, I learned about the $330 billion market for Auction Rate Securities (ARS) -- bonds sold as cash-like whose yields reset in periodic auctions. But in February 2008, the banks that created ARS stopped propping up the market and people who held these cash-like securities found that their ARS were frozen. Since I first posted about this, 7,988 comments have appeared on the post from people trying to get their money back.
Today, I learned that there is an even bigger market that has been suffering the same fate since October 2008 -- Variable Rate Demand Notes (VRDNs) -- which until then were supposedly low-cost bonds that cities issued and whose rates reset in daily or weekly auctions. Houston issued $1.8 billion worth of VRDNs in May 2008, but when the auctions froze up, it found itself paying 15% interest rates instead of the much lower money market rates it had anticipated.
VRDNs are a $479 billion market and when the auctions failed, the banks that issued them had to guarantee them. Some did so at much higher rates than had been promised to the local governments that issued the VRDNs. And since banks which guarantee them have taken $1.3 trillion in losses in the last 18 months, they are charging 10 times higher rates to support those guarantees. So what?
If you live in a city that's used VRDNs, that city is likely to be cutting back on services and firing employees. That's because the city must pay far more than it had budgeted to cover interest expense. And with tax revenues plunging, the only way to operate with a balanced budget is to cut cut cut.
Unless cities can find ways to lock in lower long-term interest rates, they will be raising their fees and taxes while cutting back on services. And that is going to hurt a large number of people.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.
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Reader Comments (Page 1 of 1)
4-16-2009 @ 1:17PM
BBBAAAHHH!!! said...
Well , it looks like congress screwed the pooch on that one , Wall street got huge bail out and the rest of us got the shaft, the only solution is to pressure congress to disolve the Federal Reserver which is not even a goverment agency , believe it or not it a private company mostly owned by the UBER elitist bankers the rothchilds amonst others , the time to take the country is rapidly slipping away from us.
4-17-2009 @ 12:09PM
Kathy said...
Is there any conclusion to draw other than Wall Street enriching itself by driving cities to the brink? I'm all for healthy capitalism, but this is unacceptable.
Clearly, Wall Street has no moral center.