July 25 (Bloomberg) -- The announcement by Moody's Investors Service this week that, hey, maybe the last two major bond insurers really aren't AAA after all, means there are new rules for those who want to buy municipal bonds.
First: Disregard the insurance.
Second: Disregard the rating companies.
The first one you always knew, didn't you? The market's wise guys always told you to look beyond the insurance to the security beneath. Sometimes they said to look at the underlying rating, that is, the security's real rating without the insurance.
Something tells me you haven't always done that. Many investors, instead, relied upon their broker's claim that the bond was insured and rated AAA, so don't worry.
Just last week someone e-mailed me saying he owned ``AAA bonds,'' and wondered what would happen to them if the insurers went away. Did that mean the bonds stopped paying?
Oh, dear. Well, I suppose the current crisis in the credit markets has taught us all a lot. AAA bonds? What are those?
Maybe there's a third rule here. And that is, never listen to what your broker tells you. Instead, take a good look at what you're buying. All the investors who are stuck with ``cash equivalent'' auction-rate securities and fund shares now wish they looked through the offering documents.
Last Man Standing
That's what all investors will have to do in the new municipal bond market, after the enigmatic pronouncements made by Moody's late in the afternoon of July 21.
Financial Security Assurance Holdings Ltd.'s credit profile ``may no longer be consistent with the Aaa rating, given the materiality of the stress faced by the firm in its insurance and asset management operations, uncertainty about the firm's portfolio risk profile, material shifts in the demand function for financial guarantees, and -- as observed recently among FSA's competitors -- potential sensitivity of its franchise and financial flexibility if losses continue to rise,'' is how the rating company put it.
Moody's used substantially the same language to describe the only other major bond insurer with a AAA rating: Assured Guaranty Corp. I am not counting Warren Buffett's new insurer as a major entity, yet, although it may be the last man standing.
In essence, Moody's says both Financial Security Assurance Holdings and Assured Guaranty Ltd. insured some stuff that may blow up and result in losses that are hard to calculate right now, and that the financial-guarantee business sure isn't what it used to be.
Paper Chase
And what a nice product it was! Bond insurance, which dates only from 1971, took an entire market that is idiosyncratic and specific to an advanced degree and wrapped it all (or at least 50 percent of it) in a tidy AAA package. Insurance took municipal bonds and turned them, almost, into a commodity.
Insurance rendered municipals palatable for individual investors and saved money for issuers. But that's all in the past, and this is no time for nostalgia. Maybe the market will revive in six months, or a year, or three years. For now, though, I know no reason why anyone should give up any yield in exchange for what used to be known as ``sleep assurance.''
If you're interested in buying individual muni bonds, I advise you to get acquainted with the world of official statements, indentures and comprehensive annual financial reports. Get to know your muni bonds in the raw.
As for the rating companies, can you trust them? Didn't they help the insurers get into this mess? These assessors were the ones charged with regularly grading the insurers and making sure that everything was consistent with AAA status.
All for Naught
They had big staffs, sophisticated analytical models and access. All of that was for naught. In the end, the insurers were brought low by one dedicated short-seller who suspected that they were all getting in way over their heads. This smashup ought to disabuse everyone of the notion that the rating companies were in any way the champions of sound finance.
The rating companies are now even questioning the way they have been grading the municipal market. They are filled with self-doubt, and perhaps a measure of self-loathing. Why should you take their word when it comes to municipal credits?
I repeat: If you are still interested in buying municipal bonds, get ready to do your own analytical work.
Or maybe come back in five years.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Joe Mysak in New York atjmysakjr@bloomberg.net
