"Betting Against State Bonds"

by Larry Levin

I have mentioned in this space the troubles of several States' profligate spending and mismanagement on several occasions. Several are near bankruptcy. Perhaps taxpayers in those states should actually buy the CDSs that are recommended in the Bloomberg article below, as a hedge against the sure-to-come tax hikes that will be levied - rather than spending cuts. Yes, you can now bet against the solvency of your state if you like, which sounds like a no-brainer for some!

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.

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.

A New Reality

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 spread on 10-year California swaps widened to 289 basis points yesterday from 93 basis points in mid-September, according to data compiled by Bloomberg. Investors who sold their contracts could have pocketed $196,000. A basis point is equivalent to 0.01 percentage point.

New York-based Morgan Stanley has also recommended using swaps to bet against state credit. While Merrill Lynch recommends the derivatives to institutions who want a vehicle to express relative value views, Phil Fischer, a vice president of municipal strategy at the firm, said many are thinly traded.

As part of a September presentation to institutional investors on Best Long and Short Risk Strategies, Goldman recommended buying credit-default swaps on a basket of liquid State General Obligation credits with current and worsening fiscal outlooks, including California, Florida, Nevada, Ohio, Wisconsin and Michigan.

The firm also recommended the derivatives on states with significant unfunded pension and other retiree obligations, including Illinois, Connecticut, Hawaii, New Jersey, Massachusetts and Nevada.

The practice of betting against such states is distasteful, said Frank Hoadley, Wisconsin's director of capital finance in Madison.

Previous Day's Trading Room Results:

Trade Date: 12/10/08

E-Mini S&P Trades*
(before fees and commissions):

1) Globex sell @ 11:10am at 907.25 = b/e (1 lot)

2) Algorithm positions (2)...combined daily total...+3.75

ZB (30 Year Bond) Trades*
(before fees and commissions):


1) No trades today.



Sign up as an AvidTrader Member to receive "The Technician" Value Area's each day. The market then has an 80% chance of filling the Value Area. Many traders familiar with the Value Area and the techniques that go along with it use it to help them decide what trades to do each day. Join and see how this technique can help you trade more successfully!