The markets could have went down a lot more on Friday in our opinion.  Something unheard-of in recent history, the municipal bond auction rate market failed.  Many state and local governments were forced into short term high interest rate funding, some as high as 20%.  20% tax free investment?  Where do I sign up?  What does this mean?

Some institutions and individuals buy municipals and hold to maturity.   There is nothing out there that says the municipal bond market is unstable for this use.  However, for those that buy municipals in the short term as a cash vehicle, without a stable bond insurance market, this liquidity dried up.  Obviously the bulk of the liquidity.  These corporations do not see that the governments are going to default on the debt, but rather a lack of liquidity which will stick them with the bonds.

We are going to be analyzing this one for quite a while.  But if state and local governments have to continue to pay higher interest rates with a declining housing market bringing in lower revenue that is a recipe for chaos.  Can you say state and local tax increases?  Get ready for that if banks don't get over being paranoid.  Fix the bond insurers, get over another hurdle.

Fix the bond insurers, and hurry.

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