May 9 (Bloomberg) -- For anyone who remembered the last time the industry fell apart, the news was stunning: UBS AG is getting out of the municipal bond business.

The move, part of a massacre slashing 5,500 jobs, was framed in other terms when it was announced on May 6. The bank was going to sell the municipal department. UBS was getting out of the business ``on the institutional side,'' as Jerker Johansson, chief executive officer of the investment-banking unit, put it in a conference call. UBS would move some traders over to the wealth-management division.

Most of the people in the department knew something bad was about to happen. The day before the announcement, the headhunters started reporting that they were getting calls from people at UBS's municipal bond department.

And so another round of cutbacks in the municipal bond industry begins. It has been a while.

UBS, which was the third-ranked underwriter of municipals in 2007, may be the first firm in this cycle to announce its exit, like Salomon Brothers did so spectacularly back in 1987. There will be blood.

Why would a securities firm all of a sudden decide to cut an entire line of business that is devilishly difficult to enter in the first place?

UBS officials echoed the words of so many bankers before them: They don't make enough selling municipal bonds.

Business Broken

I believe that, up to a point.

Which is another way of saying, I guess, that I don't believe it at all. Yes, underwriters make less money on municipal bonds than they do with some other products and by providing some other services. This is an old wheeze.

But the model of a firm underwriting only a whole big bunch of bond deals for states and localities has been discredited for years, hasn't it? Don't securities firms underwrite bonds and then look to provide a whole array of other products and services to their customers?

This was hardly a secret strategy. Bankers have been saying that this was the key to success in the municipal market, where you have thousands of potential clients, for at least a decade.

The real reason that UBS and more firms will depart the municipal market isn't because the underwriting spread on the bonds is lousy, but because the business has been broken and they don't want to stick around and wait while it is fixed. Short-term thinking isn't new in the securities business.

I keep thinking about a book on Morgan Stanley that I read last September, which contained the immortal observation, ``On Wall Street, if you're making the money, you get to decide.''

Insurer Collapse

I guess the municipal bond department didn't make ``the money'' in 2007. Sure, it was a bumper year for new bond sales, with states and municipalities selling a record $430 billion.

But the second half of 2007 wasn't very good, with hedge funds and tender-option bond programs dumping billions of dollars in municipal bonds because of the subprime crisis. That was just the beginning.

Then there was the collapse of the municipal bond insurers, which at one point covered half the market. That began late last year. And then this year, the dealers all decided to stop supporting the auction bond market, alienating issuers and investors alike, and provoking a spate of lawsuits and state inquiries.

The dealers still collect money to run the nonexistent auctions where no bidders show up, but that business is going away fast as issuers redeem their auction-rate securities.

Limitless Downside

What's ahead this year? The potential to make money seems limited, while the downside is limitless.

The auction market, once amounting to more than $330 billion, is broken, and it is doubtful it can be fixed. The insurance business was broken, but it may be fixed.

After a year where interest-rate swaps backfired and often cost issuers more than they figured, I don't think we'll be seeing lots of new customers for those, although some issuers will still use them.

The federal government's inquiry into price-fixing and bid- rigging in the reinvestment-of-proceeds business is going to be the icing on the cake. It looks like that is broken, too. I can't see how some firms will survive the damage to their reputations.

There's a flip side to this bad news, of course. Someone will still have to work out how to help thousands of issuers sell $300 billion to $400 billion in bonds every year.

But that's a long-term thought. I'm not sure how helpful it will be to the thousands of bankers who will be out of work, on trial or behind bars.

(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net

Last Updated: May 9, 2008 00:01 EDT