So bottom line, the downgrade of creditworthiness means that Entities will have to pay higher interest rates then they had budgeted for, so taxes will increase to cover the unexpected expense?
For me the question then becomes, why are municipalities paying for insurance for basically an enterprise that can always raise revenues?
Correct on your first question.
Your second question:
First reason: So they can issue debt at lower interest levels, which means that they’re able to issue more debt for less taxation. Taxpayers are not an infinite well of funds - at some point, they revolt and the pace of public construction slows to a crawl. That will happen faster should the issuers be forced into the general market rate structure.
Second reason: not all muni bonds are “G-O” bonds — ie, bonds that are obligations on the political entity’s general fund. Some bonds are issued by school districts, or power districts, or are special project bonds. There’s all sorts of muni bonds out there, and some of them would require detailed investigation by investors before they’d bother buying the bonds.
In today’s market, with so much competition for investor money, anything that requires detailed, local investigation is likely to be very hard to sell the first time, and very close to illiquid in the secondary markets.
So to address these two points, bond insurance was born.
The "standard" for this type of debt issuance is based upon certain assumptions that embody "the way things work". In this case, the issuing entity is a university; and while they can raise tuition fees etc; there are limits to what they can do. I have no idea what GU is attempting to do with this debt, and indeed, it may be a rollover of existing debt. (this would be really bad!) Maybe they want to build or refurb a couple of buildings or acquire some land and build some new bldgs. Don't know. Per Google, the student population at Georgetown U. is 14148. At the point where they would have to raise tuition to double that of Harvard to service the debt as a result of having to pay higher rates on the coupon...that ain't gonna fly.
In the case of the Nevada utility, often their rates are capped by state regulators or some other restrictions may apply. Again, I don't know the particulars other than the amount, $115 million.
As you suggest, in the case of cities or counties, perhaps increased borrowing costs can be met by raising taxes or fees. Wonderful.
Both of these examples are nothing but macro versions of a would-be homeowner having to pay a higher rate of interest on a home loan because their credit isn't so great.
These things are happening against a backdrop where Treasuries currently pay a coupon in the high 2's, IOW, 2.x%. And, of course, the higher borrowing costs cut into the availability of funds for whatever the projects were. And, the company/university had to pay Lehman their multi-million dollar cut in exchange for accomplishing essentially nothing. Oh yes, do not think that Lehman will go unpaid.
So you start following the concentric circles of effects beyond these particular examples: The entities get less money for their projects; the stock of the utility will probably fall, reflecting a decrease in shareholder equity; Maybe the util has to reduce its dividend, so folks dependent upon that divvy get less money. And, their stock falls in value.
Then, realize that these were issues that just "didn't fly". We're not talking about any actual defaults.....yet.
Also, this bond insurance is not like an annual premium; it's paid all upfront. So, it's not like you had a fire ins policy with State Farm and they went belly up but your house didn't burn down. Well, you were going to pay out that premium anyway, so next year you just pay it to Allstate. Big deal. Nope, ALL bonds insured with those cos suddenly lose market value because the insurers lost their AAA rating. Now, ALL of them will have to pay higher rates OR go buy default insurance anew, and, it surely will not be as cheap as it was, AND the money they all spent, all 114,500 of them is GONE.
And WE STILL HAVEN'T HAD ANY DEFAULTS YET.
Oh yeah, now we get to loads of bond mutual funds or some pension funds. Well, many of those funds cannot hold uninsured bonds BY THEIR CHARTERS, or perhaps they cannot hold non-AAA bonds per their charters. So, guess what? The funds now have to SELL those degraded bonds BUT THERE IS NO MARKET now! They will HAVE to sell into an entirely illiquid market. Well, OK. But now, whatever price (actually discount) is established by those forced sales means that EVERY BOND, everywhere, gets discounted by that amount, or more, in the moment of reckoning this entire universe has been dreading, the dreaded "mark to market (M2M)".
Well, OK, when E-trade was forced to sell off their mort portfolio, that was one of the few M2M episodes to date. Know what their port sold for? Months ago when this situation wasn't anything near this bad? You really want to know? Eleven cents on the dollar! And E-Trade's portfolio was NOT subprime dirt, it was at worst Alt-A as I understand it, and had good amounts of "A" paper in it. I've seen CDO tranches where the contents were total puke material, I'm talking 98% LTV neg-am loans on homes that have already fallen 15%. Need I say more?
Oh, and did I mention that WE STILL HAVEN'T HAD ANY DEFAULTS YET? So what do you think starts to happen when we start seeing a few defaults?
The point of all this is, the effects of this, touching virtually every town, every sewer district, every fire district, every county, in this, just round one, are literally unimaginable. It is a cascading contraction in credit availability that is really jaw dropping once you ponder the ripple effects.