The Washington Metropolitan Airports Authority has already begun construction of a bigger international arrivals building at Dulles, a new parking deck at Reagan National and other major projects, and said it intended to forge ahead using cash and commercial paper.
New York City decided to brave the markets on Monday and ended up having the whole place to itself. It managed to issue $300 million of bonds for public schools, the only issue of the day. The New York Transitional Finance Authority will pay 5.75 percent on those 30-year bonds, the equivalent of a 10.5 percent interest rate to New York City residents, who will not have to pay city, state and federal tax on the income.
Yet even with that rate, the issue was not completely sold, said Mr. Miller of Nuveen.
“This is for a very well-liked name, a very well-known name,” said Mr. Miller, explaining that New York City’s bonds usually sell out quickly.
Mr. Lenna said Maine’s advisers had warned that it might end up paying interest as high as 10 percent if it brought its highway bonds to market now. “We’re not going to go out and incur these costs,” he said.
The municipal bond markets had already hiccupped before the latest turmoil. But analysts say the gridlock began in mid-September, when Lehman Brothers declared bankruptcy.
Lehman Brothers was one of several Wall Street firms that had created structured-finance products for municipalities for the past few years. These products could be hybrids, allowing a local government to issue what seemed like a fixed-rate bond that could in turn be bought by an investor who received a variable rate of interest.
Governments generally prefer fixed-rate bonds because the cost is predictable — but variable-rate bonds were attractive because of their generally lower rates. Securities firms tried to merge the best of both worlds by linking derivatives contracts to municipal bonds. One structured product was a variable-rate demand note, which gave the investor the option of putting the note back to the securities firm if the investor decided the rate was too low.
The notes were often bought by mutual funds for their tax-exempt bond funds. The booming demand for those funds, in turn, held down the price of borrowing for states and cities, at least for a while. But when Lehman collapsed, the mutual funds suddenly perceived a risk: the securities firms that had created the products might go out of business. So, owners of the notes put them back to the securities firms that had sold them.
The prices investors were willing to pay for the notes plunged, driving up short-term rates for municipal bonds. Securities firms, under pressure, unwound the notes and reconstituted them as old-fashioned fixed-rate bonds.
None of this had anything to do with the behavior of local governments or their ability to repay their debts, but it brought the municipal bond market to a halt.
Thomas G. Doe, president of Municipal Market Advisors, said his firm was fielding calls this week from government contractors asking how much credit might be available next year. For insight, he pointed to municipal bond data from the 1930s.
“During the first few years after the ’29 crash, municipal issuance dropped 24 percent,” he said. “It wouldn’t be unreasonable to think that we could see municipal issuance go from a total of $430 billion last year, to something like $350 billion next year, which would be a drop of 25 or 30 percent.”
This would not mean widespread bond defaults, he said, just greatly narrowed local budgets.
“It’s no different from a family budget,” he said. “We’re not going to go out to dinner any more. We’re not going to buy a new car. That’s the similarity.”