Bill Coming This Week To Guarantee Entire Muni Market

One of the most insane ideas we've heard of may soon become reality.

Fox Biz is reporting that the House Financial Services Committee is set to take up legislation this week that would establish a federal backstop for all Municipal bonds and muni insurance.

This would, of course, represent another massive expansion of the government's guarantees and turn all states into Fannie and Freddy.

Here are the details, again per Fox Business:

• Create a liquidity facility through the Federal Reserve to purchase municipal bonds, much like what the Federal Reserve does with mortgage-backed and federal government bonds.
• Form a temporary federal government program to reinsure municipal bond insurers.  Almost all municipalities buy bond insurance because it boosts their credit ratings.  The cost of the insurance is usually lower than the higher interest payments that come with a lower credit rating.  If the insurer runs into financial trouble, then the credit ratings on the municipal bonds drop because there is doubt about the insurance.  Government backing would eliminate that concern. 
• Provide additional regulation for financial advisors to municipalities.  Many, including former Securities and Exchange Commission Chairman Arthur Levitt, have been calling for stronger oversight of the municipal bond market in the wake of pay-to-play bond scandals, in which banks and advisers have made gifts or political contributions, and received financing jobs along with the fees for those jobs. 

Representative Frank has in the past criticizes muni bond raters for downgrading muni debt during a time of recession, not because such downgrades aren't warranted, but because a higher cost of capital is counter-stimulative. Of course, California is on the verge of bankruptcy, and investors should be extremely cautious lending to the state.

We almost wonder whether the entire purpose of this program is to bail out California, which, if it went bankrupt, could cause a cascade of problems, as the debt market shuts off completely for other states, while muni insurers -- who have modeled extremely low default rates -- potentially go belly up.

Politically, it's probably easier to just backstop the whole damn market than to target aid at the worst states.

Of course, all these guarantees are predicated on the idea that this is a temporary blip and that revenues will return to normal as the economy grows again. We don't think it will, and we don't think there's any way California (or any other state) can return to revenues that only seemed normal during a bubble.