This Crisis Has Many Faces

As foreclosures have mounted and bank lending has become extremely scarce, consumers have begun pulling in their horns, bringing the U.S. economy to the brink of recession.
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Decades ago, there was a very famous actor, Paul Muni, who played a variety of different historical figures in the movies. From "Scarface" to Louis Pasteur to Toulouse Lautrec to Emile Zola, Muni was a character actor known for his many faces.

This financial market crisis that we have been battling over the last year has also had many faces. Delinquencies, defaults and foreclosures in sub-prime mortgages have caused many different types of investment based on sub-prime securities to plummet in value. Banks and brokers have written off, to date, over $130 billion in losses based on these bad investments. Financial stocks have plummeted, homebuilders have had the roof cave in on them, and the global stock market has lost $7.7 trillion in value since the crisis began and the U.S. dollar has plunged in value.

As foreclosures have mounted and bank lending has become extremely scarce, consumers have begun pulling in their horns, bringing the U.S. economy to the brink of recession. A friend of mine in the home interior furnishings business told me that his multi-national firm has seen orders from his two biggest U.S. distributors, plunge 20% in January alone, suggesting that the housing recession is having a huge impact on consumer spending and may continue to do so for months ahead. The U.S. is now, by far, the weakest market in which he operates.

Those are just some of the faces of this growing and deeply complex financial problem.

The many faces of Paul Muni may also have some relevance to the financial market crisis we are experiencing today ... since the next crisis that may rock Wall Street is a "Muni" crisis that will shake the municipal bond market to its core.

Municipal Bonds are facing a series of difficulties thanks to a variety of unexpected circumstances. Municipal Bond insurance companies have unexpectedly found themselves with too little capital to back the bonds that municipalities use to raise money for public works projects ... from roads to schools to parks.

Municipal Bond insurers, are called "Monolines" by Wall Street, because everyone thought they were only in one business ... the business of insuring municipal bonds. Instead, they have insured all forms of exotic investments, unbeknownst to the general public and most regulators and policymakers.

The "monolines" are suffering huge losses because they insured, not just muni-bonds, but also credit instruments tied to money-losing sub-prime mortgages. So, now that they are losing money, having insured these soured investments, they arguably have scant capital left to insure the trillions of dollars of muni-bonds that have been sold over the last many years. The monolines deny they are capital impaired, but regulators are scrambling to find billions of dollars in new capital to make sure that monolines have adequate capital to make good on their promises to insure everyone's favorite investment ... tax-free municipal bonds.

If the municipal bond insurers can't back those bonds, many institutions that were counting on the insurance to protect their muni-bond investments, may dump them in huge amounts, putting downward pressure on muni-bond prices and upward prices on yields ... hurting "mom and pop" investors who thought their "insured," tax-free muni-bonds were the safest investment around.

There are other dislocations going on in the muni-market that could also cause trouble. Some are quite complex and difficult to explain. But suffice to say, that if the situation in municipal bonds continues to deteriorate, it will affect not only the markets, but individual investors as well.

This is a perfect time to check the credit quality of your muni-bond holdings, their insurance and their prices and yields.

And like Paul Muni, the actor, many seemingly safe investments masquerade as bulletproof investments. We know from history that some investments can act like very safe securities, until a crisis rips off their protective masks and exposes their underlying weaknesses.

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