Obviously, NY's governor Spitzer like his fellow governors Schwerzenegger, Corzine etc. is supressing panic mode after seeing the isolated instances of Muni Bond Auction failures turn widespread this past week. All of these states are running huge budget deficits, which they can only paper over by A) cutting social welfare benefits and public sector employment by 5-10%, B). raising state tax revenues by 5-10% (= raising tax rates by 10-20% since only 1/2 of state residents actually pay taxes), or C) sell new muni bonds to get fresh cash and let state taxpayers pay the bond interest for the next 20 years.
However, as auctions fail, the interest rates that must be paid on new muni bonds have been ASTRONOMICAL ( most recent failure was NY Port Authority which wound up paying a 20% yes that's right 20% interest rate on their failed auction bonds). Those sort of interest rates takes the bond option off the table as a means of allowing states and state agencies to temporarily 'balance' their budgets.
So what Spitzer is proposing is new law / regulation that would split the bond insurance business into Muni bond insurance and private sector bond insurance, which would then theoretically remove the insurance 'fear factor' that is now stopping would-be buyers from snapping up new Muni bonds at low interest rates. Doing so would solve Spitzer's problem ... but
... doing so would also create a NEW problem, by shifting all of the bad risk onto the private sector bond insurers. This could cause many billions of dollars of additional losses for the investment banks, hedge funds etc.



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