Credit crisis turmoil claims new victims

Losses resulting from the credit market turmoil – until now largely limited to the world's biggest investment banks – are starting to be felt much more widely, by wealthy individuals, local government and even sports teams, presaging a new and potentially litigious phase in the crisis.

Regulators in at least two US states are investigating whether there were any abuses in the auction-rate securities market, it emerged yesterday, while rumours of a wave of selling in complex credit derivatives sent the cost of protection against bond defaults soaring to a record level.

The auction-rate securities market has been the latest domino to fall as fears have spread about the creditworthiness of all kinds of complicated fixed-income investments. Such securities are long-term debt whose interest rates are reset at a weekly or monthly auction, typically earning them a higher value and a lower interest rate.

Local governments and other issuers use these securities to get long-term debt at short-term interest rates, and brokers have steered wealthy clients into these investments as a higher-yielding alternative to cash, but which is almost as safe.

Since last week, Wall Street banks have refused to prop up demand at the regular auctions, and interest rates have soared. The Port Authority of New York and New Jersey, for example, was yesterday paying an 8 per cent interest rate on $100m of its bonds, down from a 20 per cent rate when the previous auction failed last week, but double the rate at the start of the month. The New England Patriots, runners up in the Superbowl, were paying a 20 per cent-plus interest rate at the height of the turmoil, it was revealed yesterday.

Meanwhile, the lack of liquidity in the auctions means that many wealthy individuals and supposedly safe-as-houses bond funds are unable to sell and could be sitting on losses.

The Massachusetts secretary of state, William Galvin, said: "The failures in these auctions cause many and diverse problems but the impact on closed-end municipal bond funds can be daunting for the investor who has sought a safe and dependable harbour for life savings."

Mr Galvin wrote to nine fund managers yesterday demanding information, and Ohio's attorney general, Marc Dann, said he was considering bringing lawsuits on behalf of state funds that invested in the auction-rate securities market. "There are potential disclosure issues," Mr Dann said. "They've been kind of treated as a cash equivalent."

Kevin Logan, the senior US economist at Dresdner Kleinwort, said we are witnessing a chain reaction that began with rising mortgage defaults by low-income Americans 18 months ago. Mortgage-related derivatives have collapsed in value, endangering the creditworthiness of insurance companies that guarantee all sorts of bonds, including the auction-rate bonds issued by municipalities. "It is a contagion, and though you would like to think we are getting to the end of it, things just seem to keep popping up."

The latest obscure corner of the credit market to hit trouble is the credit default swaps market, which investors use to buy protection from the risk of a default by corporate bonds. The cost of this protection soared to a record yesterday, amid rumours that packages of credit default swaps, called CPDOs, are being dumped by investors following warnings they may themselves default on their payouts.

In other signs that the credit crisis is far from over, Standard Chartered yesterday abandoned a plan to bail out its $7.15bn (£3.68bn) structured investment vehicle after market fears caused a plunge in the value of the fund's assets. The SIV, called Whistlejacket, was put into receivership last week. SIVs are funds that use short-term borrowing to buy longer, higher-yielding assets. The assets are used to back the debt that SIVs issue to investors. Deloitte, the receiver, is understood to have frozen all payments to Whistlejacket's senior debt holders. That debt will probably go into default today.

Meanwhile, a similar publicly quoted investment vehicle set up by KKR, called KKR Financial, said it was delaying paying its debt-holders and had begun restructuring talks with creditors.