A government plan released yesterday to back banks with measures including a $250 billion capital injection could have a positive impact on the municipal market.

Although it's too early to know exactly what effect the plan will have and when it will have it, the potential benefits for the banking sector could pass through to the municipal market, perhaps stemming some selling pressure and opening up more capacity on dealers' balance sheets in the future, market observers said.

"There are reasons for and reasons against [the plan], but it should generally be a positive for the market," said Matt Fabian, managing director at Municipal Market Advisors. "You'd assume that supporting the dealer community, adding strength to the principal dealers, should be a good thing for the market."

Under the plan, the Treasury Department will inject up to $250 billion of capital into potentially thousands of banks through the purchase of preferred shares. In addition, the Federal Deposit Insurance Corp. will back certain forms of senior unsecured debt issued by banks and other financial institutions and expand the parts of its deposit insurance program.

The banks already signed up for the capital injection plan include many of the muni market's top underwriters. The market's top firm, Citi, will receive $25 billion along with JPMorgan and Bank of America - which last month agreed to acquire another top senior manager, Merrill Lynch & Co. Two other large underwriters - Goldman, Sachs & Co. and Morgan Stanley - will each receive $10 billion. Other municipal underwriters of the initial nine banks signing up for the plan include Wells Fargo & Co., which will get between $20 billion and $25 billion, and Bank of New York Mellon, which will get $3 billion.

Worldwide markets are currently in the middle of massive de-leveraging, said Guy LeBas, fixed-income strategist at Janney Montgomery Scott LLC. Rather than sell assets to de-lever, the plan allows banks to de-lever by replenishing their capital bases, he said.

"I think this move stems the bleeding, but our patient remains in intensive care," LeBas said. "We're looking at a long and deep recession with relatively little catalysts for improvement in the financial sector. Less downside but also less upside."

The municipal market has felt the pain of the broader credit market dislocations. Underwriting capacity has fallen as bank have pulled back their balance sheets and even consolidated. Rates on variable-rate demand obligations skyrocketed, and new issuance all but slowed to a crawl.

Amid worldwide market turmoil, a total of $11.25 billion of bond and note sales have been rescheduled for later dates, postponed indefinitely or canceled since Sept. 18, according to information compiled by The Bond Buyer from its offerings calendars. The municipal market could now potentially benefit from the new plan.

"The muni market's participants have discovered rather painfully there are a lot of trickle-down effects in this sector, and at the same time there are likely to be trickle-up effects," LeBas said. "As we improve capital at a lot of these financial institutions, they're able to return to profitability and have more incentive to buy munis for their own portfolios and greater ability to do so for trading purposes as well."

Fabian listed a number of other possible benefits in his weekly market comment. Aside from the potential for increased underwriting and trading capacity at banks, the government's plan could "improve the bids on bank-dependent securities," "hasten inflows back into tax-exempt money funds while giving funds more confidence to spend down cash balances," and reduce the strain funding costs have put on closed-end municipal funds, perhaps easing some of the pressures to de-lever by selling munis.

On the other hand, he also noted a number of problems the plan can't solve, such as the high costs of deferred infrastructure spending, worsening conditions for state and local budgets, and continued pressure on the secondary market from unwindings by entities such as tender-option bond programs. Participants will have to adjust to a new type of market, he said.

"The market has a lot of fundamental challenges it needs to reconcile," Fabian said. "We've been talking about the 'new normal.' Getting people out of the framework that pricing and yields are going back to where they were. I think the era of low yields and a very flat curve is over."

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