States, cities, and public agencies begin liquidating auction rate securitiy bonds

Although holder of auction rate securities have been suffering from a virtually complete freeze of liquidity in recent weeks, a thaw may be coming soon. Some of the details can be found in an article from Bloomberg by William Selway entitled "California Dumps Auction Debt; States Push on Ratings" which points out that since failed auctions cause the borrowers (states, cities, and public agencies) to pay high penalty rates, and the borrowers cannot accept that burden for long, the result is that the borrowers are selling new non-auction-rate bonds to pay off the auction-rate bonds. Granted, the amounts are still a small fraction of the total auction rate market, but it is finally a good, solid, positive sign of progress. No idea how long it could take to completely replace the total auction-rate market, but the progress we are starting to see could quickly snowball, and possibly complete within a few months.

Another part of the article is about how most municipal bonds never really needed insurance to begin with. If the debt were rated with the same criteria as corporations, virtually all of it would be rated AAA. A significant portion of the auction-rate securities selloff was due to concerns about municipal debt if the insurers of that debt were to be unable to cover the debt if it defaulted. Of course, we can now see that this concern was always a complete red herring since the vast bulk of the municipal debt should have been rated AAA and not needed insurance since day one.

-- Jack Krupansky