By MARY WILLIAMS WALSH and RANDAL C. ARCHIBOLD - The New York Times - October 7, 2008
California and other states scrambled on Tuesday to cope with bills coming due as they pressed Washington for assistance because the municipal bond markets remain largely closed to them.
In Washington, White House officials said they were talking with state officials and reviewing the issue of aid. But despite the urgency of the problem, thorny legal issues have emerged.
Though the federal government has taken extraordinary steps to lend money to corporations in the short-term markets, and to provide more money to banks, officials have been stymied over how to assist local governments because of their status as issuers of tax-exempt bonds.
A longstanding provision of the Internal Revenue Code bars the federal government from guaranteeing tax-exempt bonds. Officials are concerned that if the federal government helps states and others without Congressional action it could put their tax exemption at risk.
While officials seek a way around this obstacle, many local governments are running into severe cash squeezes.
California has the largest and most pressing problem. The state has told the Treasury Department it might need an emergency loan of up to $7 billion to pay its day-to-day bills in coming weeks, including those to school districts and municipal governments due on Oct. 29. Massachusetts has also reached out for help.
“It’s critical,” said Jeffrey L. Esser, executive director of the Government Finance Officers Association. “There are no buyers out there for the governments, to meet their short-term financing needs.”
Among the ideas being discussed is finding a way for the federal government to provide some guarantee of municipal bonds without violating the tax code, and in that way building investor confidence in the bonds.
“I think there are partial guarantees or other federal programs that would fall short of the full guarantee that might not violate this code section,” said Richard Chirls, a partner at Orrick Herrington & Sutcliffe, the bond counsel to California.
Another approach may be to include some short-term municipal issues under the Federal Reserve’s newest program to buy commercial paper.
California has an immediate problem because, like many other places, it receives tax revenue in batches during the year. The state is accustomed to borrowing in short-term markets in the fall, to tide itself over through the lean months before the next batch of tax revenue comes in. The credit markets froze just when California would have issued its revenue anticipation notes.
Other governments have run into a cash squeeze because they have issued a type of short-term debt with an interest rate that resets every week. That worked until the credit markets froze, but now the interest rates that governments pay on such debt are tripling or quadrupling.
The trouble in the credit markets has compounded the deteriorating finances of many states and cities, which are finding the revenues they had projected months ago are now falling short, sometimes drastically.
Andrew A. Davis, executive director of the Illinois Student Assistance Commission, said that if the federal government stepped in to help California, other states might expect similar relief instead of tackling tough budget issues themselves. “There’s going to be very little incentive to levy taxes,” Mr. Davis said.
Even if states get short-term access to credit, many will need to take further steps to balance their budgets. Unlike the federal government, they are generally required to balance their budgets each year.
In California, the most populous state and one of those suffering the most from the housing slump, Gov. Arnold Schwarzenegger said he would meet with legislators on Wednesday to propose possible routes out of the state’s crisis.
The California treasurer, Bill Lockyer, said he would discuss the possibility of tapping into the state’s big public pension funds with their managers. Mr. Lockyer said he would see if they could buy some of the state’s short-term notes, or issue a line of credit, if the markets do not improve and the federal government cannot help.
Before the problem became critical this month, California was relying on optimistic revenue forecasts to balance its budget. Now it is coming up short again, possibly by as much as $1 billion.
Massachusetts, which has also told the federal government it might need assistance, withdrew a planned $750 million offer of short-term notes on Tuesday, for the second time in two weeks, saying that the market seemed inhospitable and that it could dip into a state fund for emergencies.
North Carolina said it was fielding calls from other states about how to duplicate an innovative deal it struck to borrow $1.1 billion from the state employees’ credit union. It is using the money to provide student loans. Illinois recently completed a similar deal for about $100 million with a group of eight credit unions, also for student lending.
The New York State Insurance Department put together a $1 billion package to assist Jefferson County, Ala., on Tuesday, to help keep the county from declaring bankruptcy. It has been teetering for several months, after having issued a large number of variable-rate bonds for major improvements in its sewer system.
These unusual measures show just how much pressure some local governments face as their tax revenues dry up and the credit squeeze prevents them from issuing the kind of debt that they have long relied on to handle their operations.
“Talking to our members in the last week or so, it is so bleak,” said Scott Pattison, executive director of the National Association of State Budget Officers, adding that just two weeks ago he never would have dreamed the situation would become so dire.
A handful of well-rated debt offerings did come to market on Tuesday, but for the most part the markets were quiet.
The Long Island Power Authority sold the largest municipal bond issue since the credit squeeze began, aided in part by bond insurance provided by Berkshire Hathaway, the company headed by Warren E. Buffett. Berkshire stepped in to fill a gap in the bond insurance business earlier this year, but has received more attention in recent days by investing in Goldman Sachs, the lead underwriter for the utility’s bond issue, and in General Electric.
The Cold Spring Harbor school district on Long Island also sold a relatively small $7 million issue of tax anticipation notes on Tuesday, but its success seemed to stem from not urgently needing the money. “We’re one of two school districts in the whole state that has a triple-A uninsured bond rating,” said the district’s assistant superintendent for business, William Bernhard.
Absent extraordinary measures by the Federal Reserve, investors were not buying anything except Treasury securities, said Mark V. McCray, managing director and portfolio manager for Pimco.
“There is absolute panic in the markets,” Mr. McCray said. “People are hoarding cash.”
Edmund L. Andrews and Katie Zezima contributed reporting.
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