Credit market freeze may claim local governments as victims
States, cities and other entities that issued variable-rate municipal bonds are facing interest-rate shocks akin to those that hammered homeowners with adjustable-rate loans.
The worldwide credit market freeze may be claiming a new set of victims: states, cities and other government entities that issued variable-rate bonds and are now facing interest-rate shocks akin to those that hammered homeowners with adjustable-rate loans.
The government agencies at risk issued a hybrid municipal bond known as a variable-rate demand note. The payouts on many of these issues have been driven sky-high by the credit crisis.
The situation prompted California Treasurer Bill Lockyer and 19 municipal treasurers to ask Friday for an emergency Federal Reserve program to restore liquidity to the malfunctioning market and force rates back down.
Without government intervention, there will be higher costs for taxpayers, more budget woes for localities and higher obstacles for crucial infrastructure projects, they said in a letter to California's Democratic Sens. Dianne Feinstein and Barbara Boxer, House Speaker Nancy Pelosi (D-San Francisco) and House Banking Committee Chairman Barney Frank (D-Mass.).
The variable-rate notes were sold mostly to money market funds. The bonds carry maturities of up to 30 years but pay short-term interest rates that can be reset as frequently as once a day.
Until recently, the resets were not a problem for issuers. The dysfunctional credit markets, however, have exposed them to rate increases no one ever anticipated.
The Los Angeles Metropolitan Transportation Authority, for example, says the rate it is paying on $132 million in variable-rate notes has soared to as much as 12%, from as little as 1%. That's a difference of as much as $1.2 million in interest a month. The MTA says it may also have to pay $50 million to retire interest-rate swaps it purchased to hedge against interest-rate changes on the original notes.
When variable-rate notes were first developed in the 1980s, they looked like a good deal for issuers as short-term interest rates in the municipal market consistently undercut long-term rates by as much as 3 percentage points. On a $5-billion bond issue, that difference would mean savings for taxpayers of $150 million a year.
Between 1999 and 2007, states and municipalities across the country issued $420 billion in variable-rate notes, Lockyer's office said. California municipalities and the state itself have more than $60 billion of such bonds outstanding.
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