By Michael McDonald
May 21 (Bloomberg) -- The Federal Reserve told 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., lost top ratings, limiting the value of that coverage.
The Fed is “quite concerned” about guaranteeing municipal bonds, David Wilcox, the deputy director of the Fed’s research and statistics division told lawmakers this morning. The Fed could suffer losses if it ended up holding long-term municipal securities that it had to sell to shrink its balance sheet after it provided short-term guarantees, he said.
“The Federal Reserve has important misgivings about assuming such a role in light of the potential for decisions about the provision of credit to states and municipalities to assume a political dimension,” Wilcox said. He urged Congress to “narrowly” tailor any program if it does proceed, ensuring a quick exit for the government.
Muni Backing
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 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.
‘Real Money’
“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 terminations in California, where the state plans to fire 5,000 of its 200,000 workforce.
Municipal borrowers selling short-term notes or variable- rate demand bonds 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.
No Treasury Testimony
No one from the Treasury is scheduled to appear today. William Apgar, a senior adviser in the U.S. Housing and Urban Development Department, said in his prepared remarks that his agency along with the Treasury and the White House is “finalizing” a program to help state housing finance agencies sell tax-exempt securities.
Congress approved $11 billion in new tax-exempt bonding authority for state housing finance agencies last year to spur home lending, which the agencies haven’t been able to sell because they can’t access the municipal market, Apgar said.
Other witnesses include Martha Haines, the head of municipal finance at the U.S. Securities and Exchange Commission, and the mayors of Dallas and Oakland, California.
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