Just When You Thought It Was Safe to Buy State Bonds...

Goldman Sachs Bets Against State Bonds It Sold
Source: Subprimelosses.com

After raking in millions of dollars in underwriting fees for municipal bonds, Goldman Sachs turned around and told another group of investors that they could make big profits by buying insurance from the investment bank because those bonds could be headed for default. Goldman’s strategy is known as “shorting municipal credit,” and while technically not illegal, the actions reek of conflict of interest and questionable business conduct.

For years, traders have been able to make money short-selling stock, but shorting municipal bonds via credit default swaps is a relatively new phenomenon. Goldman Sachs is both a leading dealer of municipal credit default swaps, as well as a major underwriter of municipal securities.

This summer, Goldman collected $1 million in fees for helping the state of New Jersey sell $345 million in highway improvement bonds to investors. The fees are among some $15 million that the investment firm has earned since 2002 for selling hundreds of millions of dollars in New Jersey debt to investors, according to a Nov. 23 article in the Newark Star-Ledger.

In California, Goldman reportedly has earned about $25 million over the past five years in underwriting fees from bond issues.

In September, several news reports say Goldman began ramping up its strategy of shorting municipal credit, outlining plans in a 58-page report obtained by ProPublica, a New York-based not-for-profit group. According to the report, Goldman advised certain investors that states like New Jersey and five others might not be able to make their bond payments as planned because of pending budget shortfalls. As a result, investors buying default insurance stood to make big profits from their demise.

As for Goldman Sachs, it bit the hand of at least one client that fed it and profited all around. The investment firm not only collected millions of dollars in fees from the states where it sold bonds and found buyers, but also made money when it sold credit default swaps to investors and thereby bet those same states would be unable to make their scheduled payments....

NOTE: The anxiety level for the states that dealt with Goldman Sachs is going through the roof, as they don't want the value of their bonds to decline and the cost of borrowing money to increase at the same time.