Think Twice Finance

The Auction Rate Municipal Securities Bare Washington’s Greatest Fear

It is not the intent of this article to explain exactly what banks are doing to mislead investors with regard to the sale of auction-rate municipal securities. That is the trap into which most articles on the subject fall, and since confusing the public is the purpose of every significant security that has played a role in the credit crisis, let’s just avoid that trap.

What the public needs to understand about these securities, it does understand. Let me provide the obvious fact about auction rate securities. They are a way of hiding an enormous risk being passed to the Money Market Funds of US investors. This is what Washington calls “an inconvenient fact.”

First of all, auction rate securities were designed to deceive investors about their risks. Municipals, like homeowners, prefer long term debt to short. Long term debt is not acceptable to conservative investors, so the maturity had to be manipulated to get it sold. Auction rate securities were designed to permit banks to profit from securities trading without risk to themselves. This was to be accomplished by devising a way of taking all the day-to-day risk out of the business, replacing it with a risk that the method would fail, resulting in a cataclysm. (Tom Friedman’s description of how the Chinese are ruled provides an apt metaphor. As the Olympics display, it’s a great show until it all falls apart.) I hasten, along with all the bankers involved, to add that nobody claimed these securities were riskless. The approach, as usual, is to say it’s like a riskless security. The banks are being sued because some prominent brokers forgot to use the l— word. The outcome of the suit will hinge on how often the word was forgotten and whether it was in writing. (Or, if the chief executive and some other cretin had a good giggle about it over the email.)

So it did fall apart.

When bank scams fall apart, the Federal Reserve who (make no mistake) condoned the scam in the first place, makes the banks “eat their sins.” That is, the banks must repurchase all the bum securities. Since these institutions are now all wholly owned by Persian Gulf Governments (Allah be praised!) and the US government, the transaction should actually be viewed as follows.

The risky debt of municipal governments is now being assumed by the Federal Government and Governments in the Persian Gulf. This, of course, has been a plank of the Republican Platform since God was born. But there must be an easier way.