Comments on: Clearing up an economic mea culpa http://secondavenuesagas.com/2008/11/06/clearing-up-an-economic-mea-culpa/ A New York City Subway Blog Fri, 25 May 2012 11:40:42 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Angus Grieve-Smith http://secondavenuesagas.com/2008/11/06/clearing-up-an-economic-mea-culpa/#comment-56962 Angus Grieve-Smith Fri, 07 Nov 2008 04:31:09 +0000 http://secondavenuesagas.com/?p=1599#comment-56962 Ben, you may have overstated your criticism of the MTA, but I think your general point is still valid. There's no such thing as risk-free financing, but there's a range of risk. For consumers, for example, it runs from Freddie the Shark to fixed-rate mortgages, passing through payday loans, option ARMs and bait-and-switch credit cards on the way. The MTA issued those variable-rate bonds knowing that there was a significant chance that they'd have to pay higher interest rates than with fixed-rate bonds. They took a bet that it wouldn't happen. For a while they won the bet, but then they started losing. Which means we started losing, because interest rates cut into operating costs. In essence, they crossed a line and took on too much risk. They were gambling with our future fares. Just because they won the first few hands doesn't make it right. They're a public institution, and they have an obligation to be prudent with public funds, and limit our exposure to high interest rates. Ben, you may have overstated your criticism of the MTA, but I think your general point is still valid. There’s no such thing as risk-free financing, but there’s a range of risk. For consumers, for example, it runs from Freddie the Shark to fixed-rate mortgages, passing through payday loans, option ARMs and bait-and-switch credit cards on the way.

The MTA issued those variable-rate bonds knowing that there was a significant chance that they’d have to pay higher interest rates than with fixed-rate bonds. They took a bet that it wouldn’t happen. For a while they won the bet, but then they started losing. Which means we started losing, because interest rates cut into operating costs.

In essence, they crossed a line and took on too much risk. They were gambling with our future fares. Just because they won the first few hands doesn’t make it right. They’re a public institution, and they have an obligation to be prudent with public funds, and limit our exposure to high interest rates.

]]> By: Matt Singleton http://secondavenuesagas.com/2008/11/06/clearing-up-an-economic-mea-culpa/#comment-56960 Matt Singleton Thu, 06 Nov 2008 14:35:04 +0000 http://secondavenuesagas.com/?p=1599#comment-56960 I think it's important to realize that the MTA wasn't investing in variable rate bonds, but it used them to finance its growth. To understand how a variable rate bond works, you have to understand that the interest rate is set in an auction process, and the interest rate that is the lowest prevails as the rate the MTA would pay its investors. However, if the auction fails and there are no bidders (what happened in the credit crunch), the interest rate goes up to a very high 'default rate' and MTA gets stuck paying that out. The variable rate market was a very efficient way to finance long term debt with short term interest rates (which are usually lower). Bankers typically offered an implicit guarantee that even if nobody else wanted to buy an agency’s bonds, they would step in and purchase the bonds for them, guaranteeing that the MTA would never have to pay these higher rates. However, even though the banks wanted to help their clients when the auctions began to fail, banks had their own problems and couldn’t commit capital to these investments. The MTA and almost every other municipal issuer in the country got stuck with ballooning debt payments. Nobody is ‘at fault’ here, but I think both sides learned their lessons about issuing and trusting implicit guarantees. The variable rate bond market is pretty much destroyed, and I think we’ll be lucky if it ever comes back in the form we knew it. Unfortunately, this means that financing public projects will be much more expensive. I think it’s important to realize that the MTA wasn’t investing in variable rate bonds, but it used them to finance its growth. To understand how a variable rate bond works, you have to understand that the interest rate is set in an auction process, and the interest rate that is the lowest prevails as the rate the MTA would pay its investors. However, if the auction fails and there are no bidders (what happened in the credit crunch), the interest rate goes up to a very high ‘default rate’ and MTA gets stuck paying that out. The variable rate market was a very efficient way to finance long term debt with short term interest rates (which are usually lower). Bankers typically offered an implicit guarantee that even if nobody else wanted to buy an agency’s bonds, they would step in and purchase the bonds for them, guaranteeing that the MTA would never have to pay these higher rates. However, even though the banks wanted to help their clients when the auctions began to fail, banks had their own problems and couldn’t commit capital to these investments. The MTA and almost every other municipal issuer in the country got stuck with ballooning debt payments. Nobody is ‘at fault’ here, but I think both sides learned their lessons about issuing and trusting implicit guarantees. The variable rate bond market is pretty much destroyed, and I think we’ll be lucky if it ever comes back in the form we knew it. Unfortunately, this means that financing public projects will be much more expensive.

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