Yet Another Way States and Municipalities Are Getting Hammered on Bonds

By way of ScienceBlogling Joseph, we learn of yet another way the collapse of the housing market will increase your state and local taxes (or require cuts in services). When investors stopped buying certain municipal bonds, the interest rates on the bonds skyrocketed--that is, it will cost cities and states more money (i.e., tax dollars) to pay back these loans. Not because the loan holders did anything wrong, but simply because investors just didn't want to play. Now, to add insult to injury, Wall Street investors are charging additional fees to purchase these loans:

The collapse of the auction-rate bond market may cost borrowers from New York to California at least $1 billion in fees, enriching JPMorgan Chase & Co., Goldman Sachs Group Inc. and the rest of Wall Street that let the market fall apart.

The firms that pulled their support of the market where states, counties, hospitals and universities raised $166 billion are offering to convert the securities for a price. Banks may be paid as much as $525,000 for every $100 million of securities, based on the average price for arranging municipal bond sales in 2007. The fees are on top of interest rates as high as 20 percent that borrowers are paying on the debt after auctions failed for lack of buyers.

Banks and brokers built the market for auction-rate bonds by marketing the debt to investors as safe, cash-like securities and to municipal borrowers as a low-cost source of financing. Until mid-February, banks supported prices by bidding for bonds that went unsold, preventing auctions they ran from failing.

"There's always a shiny new deal, and the banks make money every time they participate,'' said Houston City Councilwoman Anne Clutterbuck, head of the council's budget and fiscal affairs committee. The city's borrowing costs rose by $3 million a month in February when rates on some of its debt soared to 7.8 percent from 4.25 percent. "It's going to put pressure on us as we prepare our budget.''

....The banks, including Goldman, Merrill, Citigroup Inc. and UBS, stopped buying unwanted bonds amid $181 billion of credit losses and writedowns triggered by the collapse of the subprime mortgage market.

"Investment banks created the securities,'' said Peter Morici, professor at the University of Maryland School of Business in College Park. ``Now that the market has exploded they're going to force losses on their clients.''

Another bait-and-switch screwing the average citizen.