Wednesday, May 20, 2009

Fed Reluctant to Guarantee Muni Borrowings as Hearings Begin

(Bloomberg) -- The Federal Reserve will tell a congressional committee today that it is reluctant to extend guarantees to California and other municipal market borrowers struggling to sell bonds.

The House Financial Services Committee, chaired by Massachusetts Democrat Barney Frank, is conducting hearings on four municipal finance bills, including one that would give the Fed authority to guarantee the repayment of variable-rate bonds and short-term notes. Another measure would create a public finance office in the Treasury Department to reinsure $50 billion of municipal bonds through 2015. Insurers, including MBIA Inc. and Ambac Financial Group Inc., have lost top ratings, limiting the value of that coverage.

The Fed has “important misgivings” about guaranteeing municipal bonds, David Wilcox, the deputy director of the Fed’s research and statistics division, said in prepared remarks for the hearing that the committee released late yesterday. He urged Congress to “narrowly” tailor any program if it does proceed, ensuring a quick exit for the government.

“The Federal Reserve believes that such a role is better suited to elected officials and the administration than to the central bank,” Wilcox said in his remarks regarding the proposed legislation.

State and federal lawmakers have pressed the Fed and Treasury to extend support to municipal securities since the Troubled Asset Relief Program, or TARP, was introduced last year. Municipal bond sales tumbled after the bankruptcy of Lehman Brothers Holdings Inc. in September, according to data compiled by Bloomberg.

California Plea

California Treasurer Bill Lockyer wrote to Treasury Secretary Timothy Geithner on May 13 asking him to extend the TARP to states and local governments facing “a severe cash flow crunch in the near term due to eroding tax revenues resulting from the current economic downturn.”

California, which is rated A by Standard & Poor’s, the lowest for a U.S. state, may need as much as $23 billion in short-term borrowing, according to state’s Legislative Analyst’s Office. Voters rejected a package of budget-balancing measures this week, increasing the need for such financing.

A federal backstop may lower the cost of issuing the securities by about $1 billion, said James Reynolds, chief executive officer at Loop Capital Markets LLC. California sold two short-term note issues totaling $5.8 billion last year, according to Thomson Reuters.

“That’s real money,” said Reynolds, whose Chicago-based company led the sale of $2.5 billion of municipal bonds last year, according to Thomson Reuters. “That’s real jobs,” he said, referring to the threat of more state worker terminations in California, where the state plans to fire 5,000 of its 200,000 workforce.

Variable-Rate Notes

Municipal borrowers selling short-term notes or variable- rate demand notes, or VRDNs, often seek a bank guarantee to buy the securities if there is no demand from investors when rates periodically reset. Variable-rate bonds mature in as many as 30 years with rates resetting weekly or monthly. The notes mature within 13 months.

Illinois sold two series of 4 percent notes totaling $1 billion on May 14, the largest deal this year -- a $500 million series maturing on April 26, 2010, and the other maturing May 20, 2010.

“Things have improved a lot, but this California situation is highlighting the vulnerability of the market right now,” said Chris Mier, a municipal market strategist at Loop Capital.

Bernanke Letter

Fed Chairman Ben S. Bernanke said in a March 31 letter to members of the House that a $1 trillion program under the TARP for reviving the asset-backed securities market wasn’t appropriate for variable-rate demand notes. Bernanke also said that much of the municipal market had improved this year, permitting states to resume conventional fixed-rate sales.

Frank, the chairman of the House committee, has pressed for changes in the municipal market since last year when demand for state and local government securities plummeted amid the global credit crisis. One of the four bills being heard today is the revival of his legislation prohibiting credit rating companies from evaluating municipal debt with standards differing from those used for corporate bonds.

The committee will also consider legislation requiring state and local government financial advisers to register with the U.S. Securities and Exchange Commission. The measure would aim to curb so-called pay for play in which advisers sell services to public agencies by currying favor among public officials.

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