28 February 2008

Another Day, Another Alphabet Soup Collapse

A few days ago, I was wondering what a VIE (variable interest entity) was, and why they were collapsing.

Well, the Wall Street Journal now has the answer. VIEs are basically bonds where the interest rate is periodically refigured at auction.

Municipalities like them, because the interest rates are lower, both because they are more liquid, and because if interest rates rise, then they will follow.

They are basically the same as adjustable rate mortgages, only for bonds.

The problem is that no one is buying at auctions, and the banks have to cover the unpurchased bonds.

The difference between these and auction rate securities is that the banks have to purchase these from whoever wants to sell.

The interest spike is not as bad, these typically go up to prime, so it's a jump from around 2% to around 6%, but the maturity date gets kicked up too, with 30 year bonds becoming 5 year bonds.

Expect to see more municipal bankruptcies as a result.


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