CENTRAL FALLS FALLS (LOOK OUT ABOVE)

An article by Romy Varghese in the WSJ today has raised the specter of an imminent flood of municipal bond defaults which many of the more astute financial commentators have long expected to inundate the nation with a vengeance, crippling the ability of municipalities to fund basic service and public safety issues, and in general wreaking an unprecedented economic and social havoc across the nation. The muni-bond canary in the coal mine was found dead in the tiny one square mile municipality of Central Falls, Rhode Island, whose mayor and city council petitioned the State for receivership on May 19, 2010 citing a $3 million deficit in its $18 million budget, a deficit which is expected to grow to $5 million in 2011. The municipality also must pay interest on $17 million in general obligation debt. Even more serious was the revelation of only $4 million in assets in the municipal pension fund with an outstanding $35 million dollars in liabilities. It is estimated that more than one out of every three residents of Central Falls, a city of 19,000 with an Hispanic population of 40%, lives in poverty. Central Falls acheived some national notoriety last March 1 when President Obama publicly endorsed the firing of 93 teachers and administrators from the senior high school by the Board of Trustees as only 7% of 11th graders tested proficient in math. Some of the teachers were renistated after a labor agreement allowed them an increased work load and longer hours.

Almost in tandem with this seemingly innocuous news item was the larger news of the impending bankruptcy of the AMBAC Financial Group bond insurance agency whose toxic assets of over $64 billion were recently seized by Wisconsin state regulators. Ambac has floated a decision not to make interest rate payments as early as the 2nd quarter of 2010. As a consequence, a bond holder committee is attempting to enter into bankruptcy to restructure $1.24 billion in senior debt. Similar actions might be pending for MBIA Inc., AMBAC's main competitor also suffering massive losses from mortgage backed securities investments. Both organizations also have significant exposure to collateralized debt obligations, some $16.4 billion in AMBAC's case. Here follows a concise summary of the situation by Dave over at the Golden Truth:

While Banana Ben Fiddles, More Doo Doo Hits The Fan

"Looks like Ambac - the bond insurer that has been savaged by it's very poor investment decisions, incompetent management and credit default swaps - is getting ready to go tits up, while Bernanke cheerleads the lemmings off the cliff in front of Congress. ABK's stock is currently down 37% on volumn that will end up today well over 3x the average daily volumn for the past 10 trading days.

Here's the article link courtesy of a commentor: ABK = R.I.P. The collateral effect of this situation could be quite staggering - the financial equivalent of the BP oil catastrophe - as this will potentially trigger $100's of billions in related credit default swaps and other toxic derivative transactions. Muni paper, the largest beneficiary of ABK credit protection, could face staggering losses.

Ambac was one of the major beneficiaries from the $800 billion TARP and $1.25 trillion in toxic bond purchases by the Fed, as that monetization prevented the triggering of ABK's absurdly large portfolio of credit default swaps related to the Company's horrific investment decisions over the past 10 years. I guess Banana Ben is too busy working out the details of his next helicopter drop to be bothered with specific details about why he looked like an utter idiot in front of the public today. Got gold?"

In Central Falls, a name which might come to be remembered as the first domino to fall in the long list of municipailties enmired in similar dire economic straights in a $2.8 trillion national muni-bond market, City Solicitor John Gannon said "We made significant budget cuts. We laid off people from all departments. At this point, we are down to the bone as far as public safety is concerned". As early as 1991, as an alternative to outright bankruptcy, and according to state law, Rhode Island had appointed a panel to review the city's finances. Such an alternative in the most recent crisis was no longer deemed possible. The state legislature recently closed a $427 million deficit by cutting $165 to municipal government and school districts. According to Don Beardsley, executive director of the Rhode Island League of Cities and Towns, such budget cuts "will put several municipalities over the precipice". Rhode Island is one of 22 States which have no provision for Chapter 9 bankruptcy. Under the temporary receivership of attornery John Savage, $4 million in tax anticipation notes will be mailed.

ps.It is being reported that a massive network of big banks and financial institutions have been involved in blatant bid-rigging fraud that cost taxpayers across the U.S. billions of dollars. The U.S. Justice Department is charging that financial advisers to municipalities colluded with Bank of America, Citigroup, JPMorgan Chase, Lehman Brothers, Wachovia and 11 other banks in a conspiracy to rig bids on municipal financial instruments.