By Tim Husson, PhD
The New York times has an article about the MAT and ASTA products sold by Citigroup that were the subject of a $54.1 million award in Denver last April. SLCG provided expert testimony and analysis for the claimants in this case, including assessing the MAT/ASTA products at issue, and we are excited that the Times has drawn attention to these highly risky investments.
The MAT and ASTA products were hedge funds that implemented a leveraged municipal bond arbitrage strategy. Essentially, these funds tried to capture the small difference in yields between municipal and Treasury notes. Since this spread was small, they leveraged their exposure to generate substantial returns. Their fundamental assumption was that muni bonds yield more than Treasury notes because of market inefficiencies, and that the difference was an arbitrage strategy. They were wrong.
As our previous research has shown, the higher price of municipal bonds is not an arbitrage opportunity, but is a result of the call features that exist in municipal but not Treasury bonds, as well as liquidity and credit risk. In fact, when these funds failed, it was not even due to extraordinary market events, but normal market fluctuations combined with their high degree of leverage.
The MAT and ASTA products were not the only implementation of ‘muni arb’ strategies in the mid-2000s, but were often marketed in misleading ways, as detailed in the Times article. We have encountered several breeds of muni arb products, almost all of which failed around the same time and for the same reasons. We believe it is critical for investors to know that these strategies were extremely risky and were based on a false assumption that flew in the face of decades of financial theory and research.
Kudos to the NY Times for calling attention to this important issue!
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