(Adds comments from fund manager, background)
NEW YORK Jan 8 President-elect Barack Obama
proposed on Thursday having the U.S. Federal Reserve buy
municipal bonds to cut lofty borrowing costs for cash-strapped
cities and states.
The facility would be similar to a backstop program that
helped thaw the commercial paper market, Obama said in an
outline of his plan to revitalize the economy posted on his
"This new facility should be designed to protect taxpayer
resources while ensuring that state and local governments can
continue to provide vital services to their residents," he
The Regional Bond Dealers Association said the proposal
recognizes the weakness in the municipal bond market brought
about by the credit crisis and recession, and can help states
and localities finance their operations.
For the last year, the credit crisis has shaken the muni
market, chipping away at investor confidence and hurting
issuers' ability to raise needed funds.
Investors have fled tax-free munis and sent yields to
historic highs following the freeze of the auction-rate market,
downgrades of muni insurers and the loss of huge liquidity
providers such as Bear Stearns & Co. For more, see
In addition, the sputtering economy has cut tax revenues
for states and cities. As many as 41 U.S. states and the
District of Columbia are grappling with budget deficits in the
current fiscal year, according to the Center on Budget and
Policy Priorities, a nonpartisan think-tank.
California, for example, faces a $42 billion deficit
through fiscal 2010, and is warning that it may run out of cash
by February and be forced to issue IOUs in lieu of salaries to
public sector workers.
"Small businesses and state and local governments are
having serious difficulty obtaining necessary financing from
debt markets," Obama said.
He proposed basing the municipal bond facility on the Fed
program to buy commercial paper. The Fed's substantial
purchases of commercial paper have almost single-handedly
propped up the market for short-term corporate borrowing.
Investors welcomed the proposal as a first step toward
supporting the market.
It signals a federal willingness to consider aiding local
governments and is helping revive investor confidence in
municipals, according to Dominick Mondi, senior managing
director at Mesirow Financial Inc in Chicago.
"It just shows that the Fed and the Treasury are not going
to ignore it," Mondi said. "There are budget deficits they are
facing and they need to be able to finance. If the states and
locals need a bridge, I personally think that's marvelous."
Tom Dresslar, a spokesman for California State Treasurer
Bill Lockyer, agreed.
"It's heartening that we're starting to see a recognition
on the part of the federal government, particularly the
president-elect, that municipal government issuers have not
been operating in some parallel economy and have been hurt
along with taxpayers," Dresslar said.
Outgoing Washington State Treasurer Mike Murphy said a
federal backstop is an "interesting" idea although he had some
"I'm not real clear who they would be guaranteeing ... If
the Feds were to get involved in this business then would there
be another layer of regulation?" he asked.
States have repeatedly called for government aid but have
so far been left out of the bailouts that benefited the
financial and auto industries.
Lawmakers in the U.S. House of Representatives on Wednesday
pledged that they would include assistance for state and local
government in the economic stimulus bill planned by the new
(Reporting by Ciara Linnane; Additional reporting by Michael
Connor in Miami and Lisa Lambert in Washington; Editing by Tom