Sunday, January 20, 2008

The shire magnitude of CDO meltdown is Mass-ive

As reported last month, Australian shire councils have been placed in dire circumstances by the losses handed them by CD-selling brokerage houses. And now we're seeing the security of those investments is being yanked out beneath US cities, too.

The WSJ tells the story of how Springfield, Mass lost about 90% of one of its main investments to the subprime credit crunch. It turns out
This fund was stuffed with risky securities backed by subprime mortgages.

Springfield's losses, because of the collapse in subprime-related debt, follow other hits taken by government-run funds around the country, from Florida to Montana. They underscore how cities and states are emerging as the most recent -- and some of the hardest-hit -- victims of the subprime-mortgage crisis.

Unlike many of the hedge funds, banks and brokerage firms burned by their purchases of shaky mortgage-backed securities, local governments usually lack the staff and resources to make informed decisions on complex investments.

Instead, they lean heavily on ratings firms and their advisers for guidance. Florida officials were forced to close down temporarily the state's short-term-cash fund late last year after local governments withdrew billions of dollars because the fund had invested in subprime-related securities it couldn't sell.

The Montana state fund also said it had suffered more than $300 million in withdrawals. The consequences of a government fund losing money can have a direct impact on schools, police and safety, and other public services. Over time, a municipality might have to raise taxes or cut spending if it loses access to some of its cash.

Like the Australian shires, the US municipalities are blaming the brokers who sold them the CDOs.

Fortunately for the brokers, they have friends in high courts, as The Economist has pointed out.
SIGHS of relief were audible in boardrooms across America this week at the Supreme Court's long-awaited decision in StoneRidge Investment Partners v Scientific Atlanta. At issue were the circumstances in which a company can be sued for “scheme liability”.

One immediate casualty of the StoneRidge ruling is likely to be a $40 billion class-action suit against the financial-services firms that advised Enron.
It is also likely to make it harder to bring successful suits against Wall Street advisers and ratings agencies over the subprime-mortgage meltdown.
See also the Bloomberg Commentary by Susan Antilla: "Is this the highest court in the U.S. or the Chamber of Commerce?"

Guambat joins with Bloomberg in adding, "The opinions expressed are her own."

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