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California Appeals To Feds

SAN FRANCISCO - California Treasurer Bill Lockyer and 19 state municipal bond issuers sent a letter on Friday to U.S. House Speaker Nancy Pelosi and other Democratic lawmakers, requesting Federal Reserve aid for issuers that need liquidity for variable-rate debt.

"The economic crisis has inflicted serious, widespread harm on our budgets and, much more important, on the taxpayers we serve," Lockyer said in a statement. "Mounting troubles in the short-term bond market are deepening those wounds. It's time for the federal government to help."

The issuers are asking the Fed to either buy short-term munis or to lend money to banks expressly for the purpose. The letter leaves open the exact form of the program issuers are requesting.

The Fed and U.S. Treasury have created an alphabet soup of new programs this year to buy corporate commercial paper, to inject capital into banks, and to assure short-term liquidity for financial institutions. However, the Fed and Treasury have thus far rebuffed requests to help ease the credit crunch in the muni market in particular, preferring measures that would create liquidity more broadly.

The Federal Reserve had no comment on the letter, said David Skidmore, a spokesman for the Fed in Washington.

The California issuers' plea for federal assistance was addressed to Pelosi, House Financial Services Committee chairman Rep. Barney Frank and California's two senators, Barbara Boxer and Dianne Feinstein.

"We think this is consistent with the federal government's interest in helping the financial industry," said Lockyer deputy Paul Rosenstiel, who heads the treasurer's public finance office.

He said banks and the financial system more broadly would benefit from a program that increases liquidity for variable-rate munis that are getting put back to banks by the billions.

Municipal issuers use variable-rate demand obligations to fund infrastructure projects like roads, bridges, airport terminals, and convention centers. VRDOs allow governments to access short-term rates for long-term obligations because the bonds are remarketed daily or weekly.

Local governments pay banks to provide standby bond purchase agreements and letters of credit to provide liquidity so that investors could put the bonds back to the issuer at remarketing. They have to renew the agreements periodically, usually every one to three years.

The market has broken down since the bankruptcy of Lehman Brothers Holdings Inc. and a wave of downgrades on bank credit ratings this year. Nervous investors refuse to own VRDOs if they don't trust the liquidity bank backing them, regardless of the creditworthiness of the local government.

Many of the bonds have been put back to banks, forcing local agencies such as the California Housing Finance Agency and San Francisco International Airport to pay penalty rates and to accelerate repayment of their debt, as they plan to restructure the debt.

Market participants say banks have stopped offering new liquidity agreements for fear that they'll face massive liquidity draws at a time when they can ill afford it.

That's forced issuers like the San Francisco airport, the Bay Area Toll Authority, and the California Department of Water Resources to refinance debt in higher fixed rates. Since those bonds are backed by user fees, increase in interest rates could lead to higher electric and water bills, more expensive airline landing fees, or higher tolls on bridges and highways.

But even with the ability to raise fees to cover the new payments, it's not easy to refinance in the current market. The California DWR last week tried to refinance $523 million of variable-rate debt as fixed-rate bonds because it couldn't find new letters of credit to provide liquidity for the debt. The state only found buyers for $173 million of the bonds.

It will have to allow $350 million in variable rate power revenue bonds become bank bonds next week. It will pay an escalating penalty rate as it repays that debt over an accelerated amortization period.

Market participants have been unsuccessful in pushing the Fed to open up its existing liquidity and borrowing facilities to tax-free securities.

For instance, tax-exempt commercial paper remains excluded from the Fed's Commercial Paper Funding Facility that was announced in October. Under the facility, the Fed has created a special purpose vehicle to purchase three-month corporate - but not municipal - CP directly from eligible issuers.

California Gov. Arnold Schwarzenegger wrote Treasury Secretary Henry Paulson in September to request federal help when the state feared it would be unable to borrow in the short-term markets. After being rebuffed, the state raised $5 billion, mostly from retail investors, paying much higher than normal rates.

More recently, the mayors of Philadelphia, Atlanta, and Phoenix appealed to Treasury earlier this month for assistance under its $700 billion Troubled Asset Relief Program, asking for $50 billion to finance infrastructure projects under a fund that would be managed by Treasury.

But Paulson has thrown cold water on requests for direct assistance. Speaking at a Nov. 12 press conference, he said that the aimof TARP was not to purchase state and local debt or to assist transit agencies facing millions in exposure to beleaguered insurance giant American International Group Inc.

That is "not the focus of TARP," he told reporters. "The focus of TARP, as you know, is to stabilize financial institutions and strengthen the financial system for both lending and so on."

Some muni market participants are hopeful for indirect assistance. Ben Watkins, director of the Florida division of bond finance, wrote to Paulson on Nov. 5, asking him to consider helping states and localities by using TARP funds to rehabilitate bond insurers in some way that would ultimately help stabilize the tax-exempt bond market.

A congressional aide suggested Friday that the muni market's issues were not a top priority on Capitol Hill. Asked if lawmakers planned to push the Fed to assist the muni market, one source said: "We have nothing going at the moment."

But with rejections and costs mounting, Lockyer and other California issuers are hopeful congressional Democrats will encourage the Federal Reserve to take action to stabilize the variable-rate bond market.

The letter was signed by Lockyer and finance officials from 19 local agencies, including major California issuers like the city and county of San Francisco, the Bay Area Toll Authority, the Metropolitan Water District of Southern California, the Los Angeles County Metropolitan Transportation Authority, and the East Bay Municipal Utility District.

Andrew Ackerman and Patrick Temple-West contributed to this story.

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