Shorting state finances after being bailed…good for profits, but….???

rdan

Hat tip ataxingmatter for the link to this matter in Bloomberg:

Dec. 10 (Bloomberg) — Goldman Sachs Group Inc., one of the top five U.S. municipal bond underwriters, is angering politicians and public-finance officials in New Jersey, Wisconsin, California and Florida by recommending that investors purchase credit-default swaps to bet against 11 states’ debt.

In the three months since the New York-based securities firm recommended “shorting municipal credit,” the value of the Markit MCDX index of the derivatives’ price more than tripled, to as high as 278.33 basis points from 87.75. A basis point on a credit-default swap protecting $10 million of debt for five years is equivalent to $1,000 annually.

Bets against public debt, once unheard of on bonds considered safe enough for retirees, have soared as the National Conference of State Legislatures projects recession-fueled budget crises will cause $97 billion of shortfalls nationwide over the next 18 to 24 months.

It’s “disturbing” to advise investors to bet against the financial health of a state whose bonds Goldman helps sell, Assemblyman Gary S. Schaer, a Democrat who chairs the Financial Institutions and Insurance Committee, said last week in a letter to Chief Executive Officer Lloyd C. Blankfein.

“New Jersey needs to maximize its presence in the credit markets, not to see its presence undermined.” Schaer wrote.

Goldman responded on Dec. 5, said Andrew Schwab, a spokesman for Schaer. The assemblyman was discussing the firm’s letter with state Treasurer David Rousseau, he said. Michael DuVally, a Goldman spokesman, declined to comment.

‘A New Reality’

Short sellers borrow securities to sell, betting their value will decrease. Credit-default swaps, conceived to protect bondholders against default, pay a buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to debt agreements. They increase in value as perceptions of credit quality deteriorate.

“Shorting municipal bonds — the world is a new place,” said Patrick Born, chief financial officer for the city of Minneapolis. “There’s a new reality, at least for a while.”

The appreciation in municipal credit default swaps came as borrowing costs rose, with tax-exempt yields as measured by the Bond Buyer 20-bond index reaching 6.01 percent on Oct. 16, the highest since January, 2000. The index is now 5.58%.