Thursday, January 31, 2008
Tender Option Bond Yields Widened
--At the center of these Muni problems is a little-known but widely held investment known as a "tender option bond." These securities, like some of the other instruments that have struggled, rely on the kind of financial engineering of Wall Street banks and hedge funds that investors are second-guessing. --Tender option bonds are an estimated $175 billion to $200 billion market, and had become a common holding in tax-exempt money-market funds in recent years. With a tender option bond, hedge funds, banks and others raise money through short-term borrowings to fund the purchase of long-term municipal bonds. --Fearful of losses, money-market investors aren't buying, leaving billions of dollars of these bonds piling up at banks and brokerage firms like Citigroup Inc. and Merrill Lynch & Co. --Some hedge funds have been suffering double-digit losses as investors bailed out of tender option bonds and other kinds of insured muni debt. --Lack of buyers has caused prices on some of these short-term bonds to fall, sending their yields as high as 8%. Normally these bonds yield less than short-term Treasury notes, which yield 2.5% --It has caused dislocations in the wider municipal-bond market. Yields on 30-year municipal bonds, at 4.30% as of Tuesday, were a bit higher than the yield on a 30-year Treasury. Muni yields are usually much lower than Treasurys because of the favorable tax status of munis. --Tender option bonds are similar in some ways to investments known as structured investment vehicles, or SIVs, issued by banks in recent years. The critical difference is that tender option bonds invest in relatively safe municipal debt, while SIVs, which have caused banks huge losses, invested in risky mortgage debt. In addition, a tender option bond holder can give the debt back to the dealer at full value, an option investors have been making ample use of lately, much to the dismay of the brokerage firms.