Treasury, Fed Eye Guaranty for Munis

WASHINGTON - Treasury Department and Federal Reserve officials are considering a plan to provide federal guarantees or other assistance to short-term cash-flow notes issued by state and local governments, congressional and other sources said yesterday.

Officials from the Fed and Treasury discussed ideas Friday at a meeting at the Federal Reserve Bank of New York, which was attended by three municipal issuers and at least one underwriter, the sources said.

State and local issuers have repeatedly asked for federal assistance during the past few months, without much response. However, federal officials are now turning their attention to the matter partly because of the projected cash-flow shortage in California and warnings from state officials there that they will be unable to sell short-term notes at economically viable rates without some form of federal assistance.

The issues surrounding California's short-term borrowing costs have become so pressing that they were a topic of discussion at a cabinet meeting involving senior White House officials last week, according to sources.

Friday's meeting at the New York Fed came the day after House Financial Services Committee chairman Barney Frank, D-Mass., and other committee Democrats circulated draft legislation that would authorize the Fed to create a liquidity facility for short-term muni debt. But federal officials are considering taking action now because it could take Congress months to consider and approve the legislation.

Treasury Secretary Timothy Geithner touched on the matter yesterday at a National Press Club luncheon when he said the Obama administration has been in close touch with California and other local governments. However, he denied that the administration is considering a full-fledged muni bailout.

"I wouldn't use the word bailout or federal," Geithner said, according to Bloomberg News. "I would say we're in close consultation with the people who are looking at ways to make sure these markets are working so that states and munis can meet their needs."

Spokesmen for the Fed, the New York Fed and the White House either declined to comment or were unavailable.

Tom Dresslar, a spokesman for California Bill Lockyer, said state officials are "continuing conversations with Treasury officials about our proposals."

Specifically, Lockyer last week asked the Treasury to agree to buy tax and revenue anticipation notes or revenue anticipation warrants from letter-of-credit banks if a state or local government defaults on its debt. The idea is to soothe banks' fears about providing credit enhancements for governments that are facing declining and unpredictable collections because of the economic meltdown.

"We could complete a short-term borrowing without credit enhancement, but the question is at what price glory?" Dresslar said yesterday. "Taxpayers are suffering sufficiently, to put it mildly, and the treasurer's goal is to make sure that on top of everything else that they're enduring, they don't have to pay hundreds of millions of dollars extra to complete the cash-flow borrowing that we're going to need next fiscal year," which begins July 1.

Dresslar stressed that Lockyer is not asking for federal assistance just for California and that the state is not asking for a bailout. "A lot of dollars flowed to Wall Street folks who put us in this position, and we're just asking for equal consideration," he said. "Actually, for less, because we would pay for the privilege."

Meanwhile, a source said yesterday that a separate plan is "on track" under which mortgage giants Fannie Mae and Freddie Mac would run a temporary liquidity facility for variable-rate demand obligations sold by state and local housing finance agencies. The facility would be limited to housing VRDOs, unlike a more general facility that would be authorized under the legislation drafted by House Financial Services Committee Democrats.

In a brief interview on Friday, Frank responded to arguments by Republican members of his committee who have said that federal intervention in the muni market is unneeded. It is necessary, Frank said, because issuers are "paying more than is justified for building things."

"There's also a problem with people being not so much swindled as much as misled by their investment advisers, so anyone who doesn't see the problem there, I don't know what they're looking at," he added.

Frank also recounted testimony given to his committee last year by Ajit Jain of Berkshire Hathaway Assurance Corp. Jain said that if rating agencies rated municipal bonds by the same criteria that they rate corporate debt, "nobody would sell municipal bond insurance because it would be clear [municipalities] do not need any."

"Municipal bonds got into trouble in many cases because their insurers got into trouble," he said. "They shouldn't have to have insurance."

Asked about the proposed reinsurance program in the draft legislation, Frank said it is "less problematic" than providing federal guarantees to general obligation debt, which his staff had initially planned to include in the legislative proposals but dropped because the committee "had a problem figuring out caps" for them.

Of the four draft bills that the committee circulated Thursday night, one would authorize the Fed to create a temporary liquidity facility for VRDOs. Another would authorize Treasury to provide $50 billion a year for five years to reinsure new credit enhanced muni debt. A third would require that all muni financial advisers to register with the Securities and Exchange Commission and submit to its oversight. The fourth would require that municipal and other bonds be rated on the likelihood of default.

The bills would make clear that the liquidity and reinsurance programs would not provide federal guarantees that would jeopardize the tax-exempt status of bonds. Frank said the bills would not have to go through the House Ways and Means Committee.

The Financial Services Committee plans to hold a hearing on the muni bills Thursday.

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