States, cities, hospitals and major public agencies battered by wild interest rate swings in one sector of the municipal bond market are scrambling to refinance the debt as they add up the damages to their budgets and nurse some hard feelings.
The highest-profile fallout so far is the tightening of the student-loan market, including the suspension of new student loans by agencies in Pennsylvania, Iowa and Michigan.
Budgetmakers who had planned on paying around 4 percent on borrowed funds as recently as December are searching for ways to fit rates of 5 percent to 10 percent into their budgets. So far, most affected institutions appear to be withstanding the tens of millions of dollars in additional costs without laying off workers or shutting down crucial services.
Still, it's a lousy time to refinance, as many in the stampede out of the broken "auction-rate securities" bond market can attest.
A shrunken pool of banks willing to lend in the midst of the mortgage-related credit mess are being more selective about the bonds they choose to underwrite. There are also fewer bond insurers whose backing is worth the money, after most were downgraded because of growing losses in mortgage-backed securities.
As a result, refinancing is more expensive, complicated and time-consuming than in the past.
"A year ago, we could have issued debt without a problem in a number of different markets," said Tim Guenther, the chief financial officer of Pennsylvania's student-loan agency, the second-biggest issuer of auction-rate debt this decade. "But at this point, it seems to be almost impossible to issue debt anywhere."
For more than 20 years, investment banks promised government and nonprofit agencies they could save money by selling auction-rate bonds. Those securities had terms of up to 30 years, but since the interest paid on them was reset at auctions every seven, 28 or 35 days, investors treated them like short-term debt and the rates paid by issuers were lower than if they sold plain-vanilla long-term bonds.
Buyers also benefited because their yields were slightly higher than money market funds, and they were lulled into the expectation that they could easily cash out within days when the next auction was held.
All of that was based on the assumption there would always be eager buyers in what grew to be a $300 billion-plus market. But investors began fleeing late last year as write-downs of mortgage-backed securities grew and the backing of some bond insurers became worthless after their downgrades by credit-rating agencies.
As the crunch intensified, investment banks also starting backing away from their promise to buy at auctions the bonds that no one else wanted. That caused many auctions to technically fail, triggering requirements that called for higher interest rates for a day or longer — the Pennsylvania Housing Finance Agency paid 25 percent at one point — and prompting a rush to refinance into fixed-rate bonds or bank-backed variable-rate bonds.
While officials from states, cities, public authorities and nonprofit hospitals say they intend to get out of the auction-rate market even if it takes all year, the demand for safer securities has left at least one analyst concerned that lenders are in too short supply.
"It's really not a good situation and it's getting worse," said Matt Fabian, a managing director at the independent research firm Municipal Market Advisors in Westport, Conn.
To help, Fabian suggested that temporary credit relief be allowed from home-loan banks — a system of 12 quasi-public regional banks created during the Depression to ensure a stable source of funds for residential mortgages.
Legislation to that effect is being pressed in Congress by hospitals, cities and counties. It would change federal law to allow thousands of banks to guarantee tax-exempt municipal bonds. Supporters say that would free up financing for local projects like roads and sewers that otherwise may be bogged down in tight lending markets.
Some authorities, such as the state of California and the authority that runs New York City's airports and bridges, have been able to stop some of the bleeding by swapping out for long-term fixed-rate debt. The Children's Hospital of Philadelphia took out a short-term $170 million bridge loan to escape the auction-rate market more quickly.
Others, such as the E-470 Public Highway Authority in suburban Denver, are looking at a matrix of options provided by financial consultants, including short-term deals.
In some cases, refinancing costs may be higher than the extra interest rate payments.
Increasingly, a bigger syndicate of banks is necessary to back a new bond issue. And financial officers say they are being told by consultants not to bother sending requests for bids — the banks are too busy to go through them all — and instead pick up the telephone and milk personal relationships.
Houston is trying to get out of $1.9 billion in auction-rate bonds and expects to be tied up in the process for months to come.
"The market stinks right now no matter what you do," said Jim Moncur, the deputy controller for the city of Houston. "Every other issuer with auction-rate securities is doing what we are."
Assuming the increased costs subside soon, many agencies say they have the reserves or flexibility to absorb a hit that, for some, has piled up by millions of dollars a week. Some smaller agencies say they hope to save enough money elsewhere in the budget.
The Houston city controller's office cited $15 million in increased costs. Guenther's agency, the Pennsylvania Higher Education Assistance Agency, is unlikely to realize $115 million in earnings this fiscal year that otherwise would have supported its operations and student tuition grants, he said.
Amid the scramble, officials have stressed the larger savings their agencies and institutions realized over the years, but also raised questions about how transparent the auction-rate market was, or how well-regulated the insurers were.
Some are unhappy that investment banks continued to collect fees to operate the auctions even after dropping out of the bidding, despite what state and other public officials described as the banks' unwritten obligation to act as the bidder of last resort.
"We will keep in mind the investment banks that stood with us," said Tom Dresslar, a spokesman for California Treasurer Bill Lockyer, "and those that didn't."