Investors Shun Muni Bonds As Credit Crisis Worsens with Wires

The credit crisis is spreading from Wall Street to Main Street.

Investors are starting to shun municipal bonds, the debt securities that states and cities issue to fund everything from sewer projects to new schools. Though muni bonds have long been considered among the safest investments, few are buying them because of worries about the safety of bond insurers that back the bonds.


On Tuesday, two muni auctions failed to find buyers, and experts said that was the first time this had ever happened. Conditions have only worsened since then, they explained.

As a result, states, counties, cities and towns around the nation now are being forced to pay sharply higher short-term interest rates, in some cases as much as 15 percent.

Investors, meanwhile, are flocking to U.S. Treasurys, which are backed by the U.S. government.

"In the financial system ... we are just getting hit from all sides here," said T.J. Marta, fixed income strategist with Royal Bank of Canada Capital Markets in New York. "That is adding to the positive tone for Treasurys."

The regulator for U.S. municipal bonds may soon intervene to force greater transparency in a more than $300 billion corner of the market that investors have shied away from in recent weeks.

The Municipal Securities Rulemaking Board is considering asking banks that package so-called auction-rate securities to share more information about that troubled part of the market, Lynnette Hotchkiss, executive director of the Alexandria, Va.-based group, said Friday.

Hotchkiss said the board could make the request sometime within the next month, with the goal being "to increase transparency in that market."

  • Video: Learn More About Auction-Rate Securities

Credit market turmoil that started last summer with rising defaults among risky mortgage loans has spread to auction-rate securities, in part because the bond insurers that back them face downgrades by credit rating agencies. The bonds underlying the securities -- a popular way for companies, municipalities and pension plans to store cash -- are generally speaking not considered to be at risk of default.

Fixing Bond Insurers

However, periodic auctions held by large banks and other financial institutions to determine the interest rate for these securities recently have found few -- if any -- buyers. As a result, interest rates on some of these securities have shot up, raising concerns among lawmakers and regulators about the potential impact on the cost of financing public works projects and student loans.

Banc of America Securities estimates that 80 percent of auctions held Wednesday failed.

Auditors are taking a close look at the issue, and experts expect them to pressure companies to write-down the value of their investments if they cannot be sold. Accounting and consulting firm Deloitte & Touche last month issued an alert saying that the auction-rate securities "warrant scrutiny" due to credit market turmoil.

Rates for auction-rate paper are reset periodically, and an auction fails when no buyer can be found and the dealer does not take it back.

Tax-free issuers have sold a total of $250 billion of muni auction-rate debt and many are now reviewing whether to switch to a different kind of floating rate debt, such as variable
rate demand obligations, which can be more liquid. They also are considering fixing their interest rates instead of using floating rate paper.

One muni issuer whose Tuesday auction failed was the Maryland State and Health and Higher Educational Facilities Authority, the conduit for Anne Arundal Health debt due in 2029, added one source, who provided the CUSIPs for the debt.

The other was California Statewide Communities Development Authority auction-rate for Children's Hospital Series B that matures in 2032, said the source.

--The Associated Press and Reuters contributed to this report.