UPDATE 1-Multiple muni issuers see notes fail at auction

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By Joan Gralla

NEW YORK, Feb 12 (Reuters) - U.S. muncipal bond issuers were hit with "multiple" failures of auctions of their paper paper on Tuesday, industry sources said, as investors were concerned about the safety of the bond insurers backing the debt.

As a result, states, counties, cities and towns around the nation now are being forced to pay sharply higher short-term interest rates.

Investment banks including Merrill Lynch (MER.N: Quote, Profile, Research), Citigroup (C.N: Quote, Profile, Research), Goldman Sachs Group Inc (GS.N: Quote, Profile, Research) were involved, according to the industry sources.

With cash at a premium, banks increasingly are reluctant to tie up their capital, and several of these players for the past few weeks have had to mop up supplies of unwanted muni auction-rate paper, explained one of the sources.

Spokesmen for Merrill and Goldman declined comment. A Citi official could not immediately comment on the muni auctions but noted that on Monday Citi confirmed the failures of other such instruments, including student loan asset backed paper.

On Feb. 12, two muni auctions failed, and experts said that was the first time this had ever happened. Conditions have only worsened since then, they explained.

Rates for auction-rate paper are reset periodically, and an auction fails when no buyer can be found and the dealer does not take it back.