This article highlights that hedge funds and financial institutions are going short the municipal and state bond markets. They will be deliberately attacking these market with short positions.
http://www.theglobeandmail.com/...
Below the fold, I explain why I see this as a huge scandal.
Key points from the article:
These are the funds who stalk the $80-trillion global fixed income market, forcing unpleasant decisions on governments who don't have the stomach for real budget cuts. They had their way with Canada in the early 1990s and now are toying with Greece.
But they are already eyeing new targets. They are watching California, as they are Michigan, New Jersey, New York and other states that have been piling up debt. Positions in credit default swaps on state bonds are building as bondholders and speculators place their bets.
In some respects, it's easy pickings.
The cause of the states' predicament is easy to spot: plunging tax revenue from a recession and burst housing bubble has left income far short of spending. States have been working to cut outlays, with California even slashing funding to its treasured state university system, but it's not happening fast enough. There are few options, given that some states have limited powers to increase taxes.
There hasn't been much sympathy at all for Greece among DailyKos posters, and heck even the administration with David Plouffe's comment about Greek fiscal responsibility, wasn't that generous. Well, the hedge funds might things uncomfortable for our social programs in the USA. And quite soon.
Here's how I see it working. Gridlocked gov't in many states prevents them from making policies quickly enough to address state finances. The stimulus bill benefits will soon end. Hedge funds will pounce with short contracts. Interest rates in the bond market will drive up costs for state governments. Investors see the rise in CDS indexes, and they panic. They start buying the CDS contracts at a premium from the speculative hacks at the hedge funds who initiated the CDS contracts at a pittance. After the initial rush in the CDS market, the momentum vigilantes then move out of the CDS contracts and make a huge killing, they start buying state bonds with their exorbitant interest rates, betting that the states will never default. So, in short, they start a panic, make huge profits from the panic, flip to the long side, and suck the taxpayers dry like leeches. Soon, a huge amount of taxes are diverted to pay off exorbitant interest rates on bonds. State gov'ts slash education, social programs, fire workers, and the state budget looks even worse as a new recessionary wave is kicked off.
From our investor-backed media class, you'll hear that this is how the capital markets should work: to keep states honest and to tamp down the social welfare state, we need to make sure that states don't overextend themselves with debt. But the fact is, the whole crisis was created by this investor-class that colludes with one another to gamble but to tilt the table toward their end like a casino. They move faster than state govt's, which are helpless prey when a bad recession moves in. The bond vigilantes move in, attack, reap huge profits, and decimate workers and social systems.
Here's the big part of the scandal. The investment banks that used TARP are not lending. They have entered the CDS market hugely, using the same instruments that caused the problem in the first place. In other words, they are using OUR MONEY TO ATTACK US.
You'll hear a lot of defenders of the hedge funds argue that the CDS market is too small to move the market (i.e. panic investors) but the truth is, the market is mostly private and unregulated. Note the journalist of this article refers to an index which shows the action in CDS purchases by those who actually own bonds. No mention at all of naked short positions (i.e. contracts by people who have not loaned money to states). AND, most importantly, when there is talk of regulating the CDS market and making it more transparent so that we can see how badly the country is exposed, that's when you get the investment banks to suddenly cry foul.
One wonders, if the market is so small, if indeed the CDS index is accurate, then what do they have to lose? I'll tell you what they lose: the private market dwarfs the action that's shown in the index, and the index is hardly believable. It's run by the banks themselves. We might as well put Moody's in charge of the US gov't.
You would think that after TARP the banks would not attack the people who saved them. I was for TARP (i.e. trading away a good portion of my children's future) because I didn't want billions to starve now. But if the attacks on us are to continue with my children's money, then we should have chosen the Roubini way out of this: we should have set up national banks to keep the economy going.