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Debt crisis spreads to U.S. municipalities

Section: Daily Dispatches

By Aline van Duyn and Michael Mackenzie
Financial Times, London
Wednesday, February 13, 2008

A collapse in confidence in a $330 billion corner of the debt market has left US municipalities and student loan providers facing spiralling interest rate costs.

The implosion of the so-called auction-rate securities market is the latest incarnation of the credit crisis.

The market, heavily used by municipal borrowers and backed by triple-A rated guarantees from bond insurers, including Ambac and MBIA, was used as a safe place for investors to park cash and earn slightly higher returns.

Its slump this week has pushed interest rates as high as 20 per cent for bodies such as the Port Authority of New York & New Jersey and a Minneapolis hospital.

"The auction securities market is falling apart," said David Cooke, chief financial officer at Park Nicollet Heath Services in Minneapolis.

Municipal borrowers are scrambling to seek letters of credit from banks and other new sources of finance, but anxiety in the credit markets and uncertainty about the stability of bond insurers is making this difficult.

The sector has grown in recent years, along the same lines as the structured investment vehicle and asset-backed commercial paper markets. Fears that bond insurers will not be able to maintain their triple-A ratings due to exposure to risky mortgage-backed securities have led numerous investors pulling out of the market in recent months.

Banks acting as dealers in the market have been propping up the sector but many of these have pulled back this week amid a realisation that it may not be possible to restore confidence and attract investors back.

"Dealers who would normally pick up a slump are not doing so because their balance sheets are full," said Jon Schotz, chief investment officer with Saybrook Capital.

The importance of bond insurers to municipal borrowers is one reason regulators are pushing banks to provide capital or credit lines so that bond insurers can retain triple-A ratings.

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