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The Collection Agency - Weekly Report

Welcome to the weekly report. As another bond market fails due to a dearth of buyers and a lack of support from Market Makers, I want to have a look at the inner workings to see who is displaying signs of distress. Is the Municipal Bond market the right place for investment and have PIMCO and SIFMA unintentionally pointed out the pitfalls?

First up though is Bear Stearns whose shares and call options leapt up on Friday (15th).

An unconfirmed buyout rumour circulated the markets during Friday causing a 5.5% jump in Bears shares to $82.79 with 20 million shares traded, the highest volume since August last year. Call option volume was high too with more than 80,000 contracts traded. Someone made a killing on this rumour. The rumoured buyout price is around $98, with the offer supposedly in cash. However by digging a little deeper the possible real reason for the unconfirmed rumour becomes clearer.

According to Reuters via Bloomberg: "China's government-controlled Citic Securities Co., which agreed in October to pay $1 billion for a 6 percent stake in Bear, is renegotiating to get a 9.9 percent stake because of the decline in the company's shares since then, Reuters reported yesterday, citing two people with knowledge of the talks whom it didn't identify. Bear shares lost 33 percent of their value since the original Citic agreement through yesterday. Citic is still seeking to invest $1 billion in the company, Reuters reported."

Without alluding to a conspiracy theory, the rumour does seem rather well timed. Let us say, just for arguments sake, someone is intent on ensuring that only 6% of Bear is up for sale. To achieve that target the share price would need to recover to the October level.

A look at the Bear chart for the past 6 months (Bloomberg) reveals some interesting points:

It has some nice support with volume in January and late September last year. For those that like gaps in price action we have gaps at approximately $90, $100, $112 and - yes you guessed it - at the high in October '07. We may not fill all the gaps but I wouldn't be surprised if 3 out of 4 did. As usual, I have no position in Bear and I am not recommending one be taken.

For those that read my Occasional Letters, the contagion in the credit markets comes as no surprise, indeed I have been writing about it for long enough that some may think its "old hat". I hope so, it means I did my job well. This week saw a continuation of the breakdown in the Auction-Bond system, where Municipal Bonds are auctioned off by banks acting as market makers. The problem is simple buyers are not showing up, driving muni bond prices down and yields up. This is not a new event, it has happened before but previously the banks stepped in and provided support by buying using their own money.

Not anymore. The capital resources of major banks are no longer available to ensure the smooth running of the Municipal bond auctions. The money it seems is needed elsewhere. Don't forget, these Muni bonds are not junk, they are highly rated with yields that reflected their status. We are not talking about banks being risk adverse (unless.....) this is about banks no longer having capital to support a safe market. Be warned.

If the Banks blame the auction failures on the downgrades of the Monoline Insurers, which is threatening the rating and safety of the muni bonds, think of the excuse as more of a propaganda tool.

Even in the failed auctions the yields on most bonds didn't hit the headlined 20%. Most rose to the 5-6% area. You would have thought that should make easy profits for the market making banks if they picked up the muni's at the lows. It would seem that the banks can't even afford to bottom pick.

The fallout in the economy if this continues will be of great importance. Local Governments, Authorities, Hospitals, Schools etc will either have to pay greatly increased yields to bond buyers or buy the debt back. Either measure will cost those who have to pay taxes or fees. Yes, that you. Of course, the bond sellers could always default if the payment of the high yield becomes too much to bear. I suspect the calls for a full-scale bailout maybe louder and earlier than those made for the sub-prime crash.

As an aside, so far since the "credit crunch" arrived, the Commercial Paper, Asset Backed Commercial Paper, MBS, CDO, CDS, Covered Bonds (Europe) and LBO markets have all suffered dislocation or an actual closure or failure. Do not forget which Federal Reserve, Government, Treasury, Brokerage, CEOs or Analyst spokespersons told you this was a contained problem that would not spillover into the economy. Remember not to trust them again.

Let us spend a few minutes looking at which banks act as market makers in the Muni bond auctions. Of course, I am not saying that they maybe in trouble but it does worry me that they have no capacity left to help credit markets, or at least, they are no longer willing to make markets. Hands up those who think such a problem will remain contained to the Muni auctions? No hands.....You are all very bright...

Listed in no particular order are the banks associated with failed Muni bond auctions, with charts from Bloomberg:


Goldman Sachs:

Lehman Brothers:

So far I have only seen reference to the above broker/bankers in relation to Auction failures and the lack of support. I suspect there are more.

You may well ask if there is a way that the troubles in the Muni bond market could be speculated upon? There is an instrument...

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