The Knock-on Effect of the Subprime Mess

By Steve Poftak
December 27th, 2007

I attended the Finance Advisory Board meeting last week and one of the new appointees to the Board, Robert McConnaughey, (who replaced the previous incompetent), raised an interesting and insightful point — how will downgrades to bond insurers impact public sector debt?

To unpack his question a bit — much public sector (i.e. municipalities, authorities, states, etc.) debt is enhanced with bond insurance, which provides a higher bond rating and reduces borrowing costs. If these bond insurers themselves get downgraded (largely as a result of exposure to bad subprime debt that they insured), it flows through the market and affects the bonds that they insured.

Mr. McConnaughey’s question is already looking even more timely. S&P just downgraded a major bond insurer from “A” to “CCC”, cut outlooks to negative for two other insurers, and issued negative outlooks for two other insurers. The initial result:

S&P cut ratings on nearly 3,000 municipal bonds, affecting city and county programs around the country.

Keep an eye on this issue. It appears that public sector borrowing is going to get more expensive. Soon.

UPDATE — Enter the Warren!!  A sharp-eyed reader points to today’s news that Warren Buffett is bringing the vast balance sheet of Berkshire Hathaway to the bond insurance business.   Seeing a vulnerable field of competitors, this probably makes sense but, as the linked article suggests, this is not a charity effort.