The fear of lending that has gripped Wall Street is making it more expensive — or impossible — for state and local governments to borrow money needed for schools, road improvements and other projects.
Municipal bond analysts and local finance officials say the multibillion-dollar banking industry bailout plans being negotiated in Washington would likely ease the credit crunch they now face. But if no agreement is reached soon, municipalities could be forced to scale back or postpone spending plans.
Lending to consumers and businesses has fallen to a dangerously slow pace amid the credit crisis that is now more than a year old. Borrowing by state and local governments with good credit usually is easy, thanks to rules that make lenders' profits tax-exempt.
Because of this tightness in the market for tax-free municipal bonds, Kent County, Mich., where Grand Rapids is located, will pay some $750,000 more than it expected in interest on a $15 million, 10-year refinancing bond it sent to market earlier this week, according to county treasurer Kenneth D. Parrish.
He said if the bond had been for a longer period, it would have been impossible to sell.
Parrish, who is president of the National Association of County Collectors, Treasurers and Finance Officers, said that if interest rates continue to rise, officials like him may have to consider scaling back or canceling plans to build new schools, roads or museums.
Tennessee is paying twice the interest it used to on a short-term school bond, an official said Thursday. Mary-Margaret Collier, director of the state Comptroller of the Treasury's office of bond finance said the $27 billion state budget likely wouldn't be affected because it does little short-term borrowing, but worried that higher borrowing costs could linger at a time when state agencies are cutting budgets and payrolls.
In Connecticut, an official blamed borrowing costs in part for the state's projected $1.3 billion shortfall by fiscal year 2012.
Borrowing rates were at their highest point since May 2002, according to three key indexes published by the Bond Buyer Thursday.
Matt Fabian, managing director of the research firm Municipal Market Advisors, said the problems extend throughout the municipal bond market, where the borrowing rate for seven-day debt spiked from 1.8 percent to 5.15 percent last week. He said traders were returning to dealers billions of dollars' worth of short-term bonds they were unable to sell, leading the dealers to raise rates dramatically or step back from trading entirely.
Municipal Market Advisors has cut its annual forecast for new bond issues from $450 billion to $425 billion, and Fabian said "that might go lower" before the year is up.
Fabian said a key source of uncertainty for those who finance municipal projects is the possibility that the restructuring of American International Group Inc., which received an $85 billion federal bailout last week, may involve unloading some of that firm's $50 billion to $60 billion in municipal bonds.
"There's definitely a reduction in the number of issues that are being brought to market — significant reductions," agreed Harold Johnson, deputy general counsel with the Municipal Securities Rulemaking Board, a self-regulatory body overseen by the Securities and Exchange Commission.
But, Johnson said, "it seems to me that this is a temporary situation and not something that's fundamental about the municipal securities market." He said it would be hard to know at what point the temporary lockup could become a real problem, but that for now, most issuers have decided "that it would be better to wait."
"This is just an unusual time," he said.
Municipal borrowing had become more difficult even before the turmoil of the last two weeks.
Louisiana added $14.3 billion to its budget for fiscal 2007 to account for higher borrowing costs and Vermont set aside $200,000 for similar purposes, according to a June report from the National Governors Association and the National Association of State Budget Officers.
Scott Pattison, executive director of the National Association of State Budget Officers, echoed the concerns about state and municipal finances and suggested that state and local governments are being hit as hard by declining tax revenues as they are by a tighter credit market.
"You're going to see re-evaluations based both on the markets and on budgets being tight and difficult," he said.