Bonds issued by local governments, known as "munis," have rarely if ever defaulted. They have probably never needed to be backed by Bond Insurance. As many readers of past posts in this space have read here, Bond Insurance made its appearance in a market that was 'created' for it, a market that never previously existed -- and was never needed.
With the demise of Bond Insurance Companies, however, suddenly the Bond Insurance market was open for business with no competition. Goldman Sachs and other issuers of Credit-Default Swaps swiftly made their appearance. They filled the "void" with Credit-Default Swaps, an unregulated form of Insurance. The CDS's, as they are known, were sold by issuers like Goldman Sachs for the supposed security of investors buying munis, just as local governments once paid Premiums on Bond Insurance.
There was a problem in California (and perhaps elsewhere), however. In California, Goldman Sachs also marketed the State's munis at the same time that it was hawking its own Credit-Default Swaps to back those munis on the ground that California might default on the munis. (Ironically, California has reportedly NEVER defaulted.)
This has struck some as a possible conflict of interest, although apparently the current Securities and Exchange Commission apparently has decreed that it is not a conflict of interest for one division of a large business entity to market munis, while a different division of the same entity disparages them in order to market its Credit-Default Swaps guaranteeing the face amount of the munis should they default. See Sharona Coutts, Marc Lifsher and Michael A. Hiltzik, "Goldman Sachs Urged Bets Against California Bonds it Helped Sell" (Los Angeles Times Online, Tuesday, November 11, 2008). It appears from the linked article that Goldman Sachs has discontinued the practice. See id.
"Indeed, what some traders found perplexing about the push for a market in municipal credit default swaps was that muni defaults almost never happen." Id.
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