naked capitalism

The pain and the costs of the dislocation in the auction rate securities market only continues to rise.

In case no one has yet said this clearly enough, this product was a disaster waiting to happen. The idea that one is going to fund long term obligations in a short term funding market is nuts, unless you have a skilled, market savvy treasurer who is prepared to move to longer maturities when you see the short end of the yield curve move against you. And even then, very few respectable pros who were funding long-term operations (as opposed to trading positions) would take the risk of relying heavily on the fickle short-term markets. You’d stagger maturities, extending and shortening maturities if you had the time and patience from time to time. However, in the vast majority of cases, the tried and true, low risk approach is best. Simply match exposures as best you can to the lives of the cash-generating assets (note there is a robust debate as to whether corporate treasuries should be a profit center or not, and if so, how much risk they ought to be permitted to take).

But no one with an operating brain cell should fund a long-lived project or entity on an ongoing basis with short-term debt, particularly one-month-ish debt. You expose yourself to too much uncertainty in your funding costs, as many are learning the hard way now.

From Bloomberg:

New York state taxpayers’ weekly borrowing costs increased $2.3 million after banks failed to attract bidders to auction-rate bonds and stopped buying unwanted securities.

Interest rates on Dormitory Authority bonds sold for the City University of New York rose to as high as 6.26 percent last week from 3.42 percent on Feb. 6, according to data compiled by Bloomberg. Buffalo’s rate on water system revenue bonds soared to 11 percent from 3.30 percent. Bonds issued by the Museum of Modern Art climbed to 4.47 percent on Feb. 13 from 3 percent at the end of January….

“It hurts,” said Anthony Farina, executive assistant in the Buffalo comptroller’s office. Interest costs on the $63 million of auction-rate bonds rose $93,000 for the week, he said. “Nobody expected this kind of jump.”

The Wall Street Journal reports that organizations facing big funding cost increases are quickly trying to raise money at the longer maturities they should have borrowed at in the first place:
Turmoil in an obscure corner of the credit markets is expected to lead to a wave of refinancing by institutions that are in danger of finding themselves paying abnormally high interest rates on their bonds.

One of the first to queue up is the University of Pittsburgh Medical Center, which yesterday announced plans to refinance as much as $430 million of bonds. The medical center offered to buy back $92 million of bonds after market rates on some of its existing auction-rate debt topped 17% last week — threatening the center with extra weekly interest costs of as much as $605,000.