Sunday, February 17, 2008

Financial Crisis May Bankrupt Cities

The US financial crisis, driven by the sub-prime loan feeding frenzy, is now threatening to bankrupt US cities as mounting losses pressure the three largest bond insurers. Here’s how it works. Greedy banks and investment houses, for the first time in history, bundled vast numbers of sub-prime residential mortgages into investment instruments called mortgage-backed securities or collatoralized debt obglitions (CDOs). These instruments were then marketed to banks and funds worldwide. Thus, the traditional roles and responsibilities of lenders and borrowers changed - as the rush to cash-in on the profit side trumped good judgement. This formula for disaster produced massive mortgage defaults and major insurers got way nervous.

Trouble is, these same insurers also back municipal bonds across the country. Those are the financial instruments used by cities to fund basic infrastructure repair and buildout. So the crisis threatens a long list of projects including schools, bridges, municipal water services, sewer services, ariports and museums. New York governor, Elliot Spitzer, outlined the scope of the potential problem before congress last week. Check out this report on his testimony.

Insuring debt, especially “safe” municipal debt, has always been a major piece of the insurance industry’s profits. Now, with the worst-case scenario actually playing out, trillions of US dollars in debt losses are threatening the very survival of the insurance industry. After all, they are bound to make good on their policies and cover the losses. So according to reports, they’re considering breaking themselves up. Read what an analysis in the London Times had to say about that here. The implication of this action is clear: without some kind of radical solution, the entire bond market including munis is facing risky times. And that does not bode well for our cities.

Last Friday, one of the big three insurers announced (under some pressure) that they were considering breaking up their operations into two business units; one for municipal bonds, the other for mortgage-backed securities. Uh-huh. I’m hearing some desperation in these announcements. Like we needed this.

Pop Impulse called this recession, and identified its causes and culprits, weeks before the story hit the mainstream media. The Author has been reluctant to use the "D-word," it's just so negative and sensational. But not all have shown this kind of reluctance. Take financial giant AIG's senior analyst, Bernard Connelly, for example. He's already talking about a worldwide depression. Read about his comments here. If you want even more detailed background, check-out Doug Noland's lengthy commentary on the issue in the Asia Times. As they say, read it and weep.

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