Mike the Mad Biologist

A couple of weeks ago, I described how the collapse of bond insurers meant that it will be harder and more expensive for state and local governments to float bonds, which means you'll get fewer government services and have to pay higher taxes, mostly property taxes, for them. Well, Bit Shitpile just keeps rollin' on (italics mine):

The credit crisis paining Wall Street is reaching out across the nation, afflicting municipalities, hospitals and cultural touchstones like the Metropolitan Museum of Art.

In recent days another large but obscure corner of the financial world has come under acute stress. Alarmed by the running turmoil in the debt markets, investors have refused to buy certain securities that not long ago many regarded as equivalent to cash.

Even though the securities are long term, banks hold auctions periodically to set the interest rates. During the last three days, almost 1,000 of these auctions failed because there were not enough buyers. The banks that marketed the instruments, known as auction-rate securities, also declined to buy.

The Port Authority of New York and New Jersey now finds itself paying a rate of 20 percent on $100 million of its debt, almost quadruple its costs a week ago. The Metropolitan Museum of Art is now paying 15 percent on auction securities. It is unclear how long such high rates will persist, or when the market for these instruments will revive, if at all.

"What is going on here is a credit crunch," said G. David MacEwen, chief investment officer for fixed income at American Century Investment, the big mutual fund company. "And the cost of the credit and the availability of credit even for good borrowers has clearly taken a big hit."

The failed auctions are tied to and exacerbating the larger problems in the financial markets. On Thursday, financial stocks led the market down and bond investors drove up mortgage rates.

At the top of investors' list of worries are the bond insurers MBIA and the Ambac Financial Group, longtime linchpins of the capital markets. Many fear the insurers, which guarantee interest and principal payments on nearly half of all municipal bonds, will lose their triple-A credit ratings. On Thursday, Moody's Investors Service downgraded the triple-A rating of a smaller insurer, the Financial Guaranty Insurance Company.

At a daylong hearing on Thursday in Washington, members of the House Financial Services Committee discussed the possibility of a federal bailout for the largest bond insurers, a move the insurers said was not needed.

The auction-rate securities market, which totals about $330 billion, accounts for a small fraction of the debt sold by municipalities. But this source of financing has suddenly become astronomically expensive, even though the Federal Reserve has cut short-term interest rates to stimulate the economy. The turmoil has heightened worries about how states and towns, particularly poorer ones, will pay their bills as a weakening housing market and potential recession squeeze tax revenues.

We can only hope that this is a liquidity crisis because so few buyers are present. Hopefully, other buyers will remain calm and realize that these are still decent investments. If not, states and municipalities just took another hit right as we're stumbling into a recession.