Bond Crisis Already Crimping States

 

Michigan just suspended a state loan program for 8,500 students, and the Port Authority of New York and New Jersey is facing a four-fold jump in interest rates on one of its loans. Both are signs of a new bond-market crisis that is threatening to hurt other cities and states if left unchecked.

Hopes are riding high that famed investor Warren Buffett, the administration of New York Gov. Eliot Spitzer (D), Congress or federal agencies will avert even bigger troubles.

If not, cities and states that issue tax-exempt bonds to raise money for such projects as road and bridge work or rely on investors to raise student-loan money could confront a series of new problems stemming from the subprime mortgage meltdown.

Spitzer and the Empire State's top insurance regulator, Eric Dinallo, came to Capitol Hill Thursday (Feb. 14) to sound the alarm bell about repercussions for governments, investors and capital markets if a solution is not found soon. Already, states as geographically disparate as Mississippi and Montana have encountered problems in recent days in finding investors in the bond market to raise money for student loans, though neither were forced like Michigan to suspend any loan programs.

The problem isn't with cities or states issuing the securities but with the insurance carriers that promise to pay interest and principal on municipal bonds in the unlikely event that states or local governments default. In recent years, the insurance carriers also began guaranteeing securities based on car loans, commercial real-estate deals, credit card debt and mortgages, including subprime loans that are now defaulting.

The bad loans are threatening to cause securities ratings firms such as Moody's Investors Service, Fitch Ratings Ltd. and Standard & Poor's to drop the credit rating of the insurers, which in turn would drop the credit rating of bonds they insure.

A ratings drop would drive up costs for state and local governments, forcing them to pay higher interest rates to borrow, or could keep investors away in a time of tight credit.

Michigan's MI-LOAN, one of several student-loan programs run by the state, is among the first victims of the credit crunch. Authorities suspended the $68 million program, which made credit available for students whose federal loans aren't enough to cover their college tuition.

Michigan couldn't find takers of bonds needed to raise money for next fall's student loans, said Tom Saxton, a Michigan deputy state treasurer, in a telephone interview. He said student loans are already tough to finance. In normal times, the state could persuade investors to buy the bonds by offering insurance. But now, Saxton said, nobody wants bonds with insurance

Similarly, Montana was unable to sell $300 million of bonds for student loans this week. The Wall Street Journal reported that Mississippi also had a failed auction.

The Port Authority of New York and New Jersey, which operates the region's airports and runs the World Trade Center, got a rude shock this week when it tried to get buyers for a special type of bond whose rate is set at frequent auctions. They found no takers.

That means the agency will pay close to 20 percent in interest, at least in the short term, instead of 4.3 percent interest it paid just last week.

Spitzer and many members of the U.S. House's subcommittee on capital markets held out hope that insurers will be able to allay concerns of the rating agencies - and stave off a credit crisis - by raising outside dollars.

But if nothing happens quickly, Dinallo, New York's insurance superintendent, indicated his agency could pressure the insurance carriers to sell off their municipal bond business in order to insulate local and state governments from the shock of a ratings cut.

Buffett, the Omaha investor, has indicated he's interested in insuring municipal bonds, a move that rallied stock markets when he announced it on Tuesday (Feb. 12).

Spitzer, who clashed regularly with Wall Street executives as New York attorney general, said he would be open to some federal regulation of the bond insurers as long as federal oversight didn't curb states' own powers to oversee insurance.

U.S. Rep. Paul Kanjorski, a Pennsylvania Democrat who chairs the subcommittee, also suggested the federal government could guarantee municipal bonds instead of private carriers, similar to the way the Federal Deposit Insurance Corporation backs bank deposits. Spitzer said the idea could have prevented the current crisis if it had been enacted months ago, but said it probably couldn't pass Congress in time to halt the problems now.

 
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