It would cost the federal government zero – GSA insurance for municipal bonds

Well, that’s what Barney Frank (D-Ma.), House Financial Services chairman, says about a new program he is pushing.  Although, I doubt you have forgotten, this is the same Barney Frank who said, a few years ago, that Fannie Mae and Freddie Mac were in excellent shape and would never cost the taxpayers anything.

He was wrong then, but undaunted, he is putting his financial acumen on the line again.  Actually, his financial acumen is irrelevant.  He is putting your tax dollars on the line again.  He wants Congress to create an agency (yup, yet another government agency) to act as the insurer of municipal bond issues much like the FDIC is to banks.

Let me tell you how this nifty new program would work.

Let’s say you are the city of Podunk, in the state of Nuzono and you are convinced that if you could just build a new sports arena you could lure a major sports team to Podunk, thus creating “thousands” of jobs, and, more to the point, a huge tax base. But, your city doesn’t have the $100 million needed to build a new sports arena. So, you decide to issue $100 million in municipal tax free bonds to investors to raise the funds. After all, once the arena is built, certainly one major league team will relocate, thus creating the income to pay off the bonds.

However, to sell your bonds you need insurance. Currently there are several companies who, for a premium, will insure these new bond issues. In other words, the insurance companies say to the investors, if Podunk defaults on these bonds, we will repay you. Thus investors who have never heard of Podunk, Nuzono will feel safe investing in the city’s bonds.

Here’s what Warren Buffet has to say about insurance for municipal bond issues.

Insuring tax-exempts, therefore, has the look today of a dangerous business — one with similarities, in fact, to the insuring of natural catastrophes. In both cases, a string of loss-free years can be followed by a devastating experience that more than wipes out all earlier profits.

Enter Barney Frank. He believes this private insurance is too expensive and, that many cities won’t even try to issue bonds because the project is so risky that no private company would ever insure the bonds. Thus, he proposes that the government create an insurance company that will not only insure Podunk’s bond issue, but any municipality’s bond issue, whether risky or not. And, the premiums for this insurance will be less than those charged by the private companies.

Back to Podunk. The sports arena is built, but, after paying interest on the bonds for several years, no major league team wants to relocate to Podunk. And, economic times are not good. The city council can’t pay off the bonds without cutting the salaries of police, firemen, teachers, and the thousands of city retirees with guaranteed pensions. And,

What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?

Guess who that “far-away bond insurer” is?  Well, under Barney’s plan it’s you. And, much like dominoes,when one city defaults (successfully), others will follow.

Zero loss to the federal government, aka, you, the taxpayer, I think not.