When Market Risk Becomes a Credit Factor: Short-Term Markets and Government’s Response

Low borrowing rates and juiced-up investment returns have long been the Holy Grail of financial market professionals. As credit market inventors have come up with new products, state and local governments have been counted among the willing customers. With lots of available cash to invest and a good supply of paper, structured products have been the answer to state and local governments’ prayers. Recent history has shown that excessive leverage, insufficient collateral, betting on interest rate movements, and inventive structures combining short-term borrowing with long-term investing repeatedly tripped up state and local government in the 1970s, 1980s, and 1990s. Some of the same features are with us again today. While causes of today’s crisis will be the subject of authoritative books for years to come, this paper focuses specifically on the short-term markets and touches on the history of these repeated perfect storms and, more specifically, on the consequences for state and local governments.