Thursday 30 August 2012

Untold Story of Municipal Bond Defaults

Untold Story of Municipal Bond Defaults

You might recall an earlier post of mine on "LIBOR Fixing - The Mother of all Scams". I had alluded to the fact that the volumes involved run to Trillions of Dollars - Every Day!

You'll also be painfully aware of the sub-prime crisis that was caused due to "Collateral Debt Obligations", popularly known in the financial circles as CDOs. 

You'll further recall Warren Buffett's remarks about derivatives being "Weapons of Mass Destruction".

I don't intend to repeat what I've already stated about the LIBOR scam - If required, you can refer to the link provided above.

However, if the Sub-prime crisis can be compared to a simple knife in the hands of a warrior, imagine what would be an aircraft loaded with the latest nuclear bombs. Ideally, you should wish that you'll never have to know. I certainly wish that the Financial Armageddon does not occur during my lifetime. 

Unfortunately, I can't be certain that it won't happen. 

In this blog post and in a few future posts, I intend to highlight a few possibilities which can create a worldwide depression on a scale never seen since the Great Depression (1929-1933).

First, take a look at the story of a market which runs into trillions of dollars - The Municipal Bond market of US cities and states:

Till the sub-prime crisis erupted, virtually nobody in the outside world knew about the CDOs which had been created based on sub-prime mortgages (which somehow got a AAA credit rating).

In a similar vein, thus far, I've not got any meaningful clue about the quantum of derivatives which have been created based on these US Municipal Bonds. Considering the perceived (though wrongly perceived, if I may say so) notion that US Municipal Bonds are safe, I'm sure that there would be tons and tons of derivatives that must have been created and sold to institutions around the world.

When the Municipal Bond defaults escalate and reach a tipping point, all these derivatives will blow in the faces of ALL Financial Institutions and HNIs who happen to be holding derivatives based on these bonds. And the resultant crash in the
  • Municipal Bond markets, followed by
  • The run on a wide range of banks, followed by
  • A major crash in the stock markets around the world, followed by
  • Margin calls leading to unheard of bankruptcies around the world
.... .... .... .... is way to scary for me to contemplate.

Thus far, I've not ventured to figure out if there is any economy in the world or any asset class that would remain safe from such a crash. I'm still looking.

Good luck!



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