Right now, there are too many people trying to sell bonds and not enough investors buying. Some of VSAC's bonds have already failed in the Variable Rate market. What's worse, people who buy bonds in the Variable Rate market can force a sale back to VSAC with as little as 24 hours notice.
But the issues in bond markets only get worse. Many investment offerings require underwriting, or insurance, just in case something goes wrong. The global insurer AIG fell to its knees last year as an insurer of very risky credit swaps. Ambac Assurance Corporation was involved in the same line of investment insurance.
Ambac was the underwriter for 31 classes of bonds VSAC issued. In September, the ratings firm, Moody's Financial Services, placed these bonds as "under review for possible downgrade." In early February, the bond ratings tanked from Prime 1 Aa3 to Prime 2 Baa1.
More significantly, market risk has been rising substantially since the beginning of the year. There are three particular areas of heightened concern. First, there's more supply than demand. Second, frozen liquidity. Third, insurance companies are unable to underwrite the bonds. Ambac's request to the Treasury for $1.5 billion was recently denied.
The problems are so significant, the Securities Industry and Financial Markets Association (SIFMA) has written letters to House Banking, Senate Financial Services, the Fed and Treasury Secretary appealing for help.
Through all of this, VSAC has failed to inform legislators of the dire straits they are facing. Instead, they are presenting their request as if it wasn't a big deal at all. They refer to VSAC's repayment history as well as the success of Vermont's outstanding moral bonds already authorized to VHFA, VEDA, UVM, VTA and our state colleges.
Instead of referring to history, VSAC should be offering full disclosure to legislators. In fact, historical success shouldn't be mentioned at all. This is why brokers are required to tell investors, "Past performance does not guarantee future results."
As a public institution, VSAC needs to be held accountable for not disclosing material facts to legislature while seeking authorization for a $50 million moral obligation. Because they have not informed legislators appropriately, the bill, H.166, is racing through the approval process. The first reading of H.166 was held on Friday, February 5th. It passed the House only two session days later.
The metaphor of family financing is apt and should be expanded to show exactly why a moral obligation with VSAC is a really, really bad idea.
Let's imagine the father in-law vouches on behalf of the son in-law in his $97,000 loan request. It happens that the father in law has other children he's already vouched for: daughter VHFA, son VEDA, daugher in-law UVM, etc. As matter of fact, the father in-law is already stretched a bit thin with the amount of trust he should really offer.
Along comes son in-law VSAC, a high flying financial wizard that unfortunately hit hard times no one could have ever predicted. The conversation goes like this:
"Um, dad in-law, I need a little help with a loan. It's not a lot of money, really."
"Well, can you explain it to me? You've never needed help before."
"Um, it's complicated, but there's nothing to worry about, really. I just need you to tell the bank you'll back me. But it's just a piece of paper. You don't have to pay if anything goes wrong."
True, the father in-law, Vermont, isn't legally obliged to come up with $50 million for VSAC if things go bad. But if you think about it, how seriously can ratings agencies take any Vermont moral obligation from that point forward? The first immediate impact would likely be a ratings downgrade for every Vermont entity backed by a moral obligation. That means it would cost more to raise capital for roads, schools, bridges, etc. Then there's the question of impact to Vermont's triple A rating. In the early 1970s one of the reasons listed as factors in Vermont's downgrade from triple A was excessive outstanding moral obligations. A triple A rating is easy to lose and much harder to win back. So why not take a step back and consider how much risk is associated with a VSAC moral obligation?
For those who know bond markets, things don't good look for VSAC. If things go bad, a $50 million State moral obligation will force legislature to make one of two very painful choices: let VSAC die, and with it Vermont's financial credibility; or come up with $50 million cash.
So what can you do about it? Call your Senators and ask one simple question: "Do we know for a fact that VSAC is financially sound?"
Nate Freeman has held various licenses in finance including General Securities and the Uniform Combined State Law.
