Muni Losses May Put Taxpayers on Hook for $7 Billion

Bloomberg reports:

On the evening of Jan. 22, Minooka, Illinois, school Superintendent Al Gegenheimer stood in front of the village board and said it had a problem: The district was running out of room to house its 3,700 students.

Minooka needed $55 million to build two schools and renovate two others in the town 50 miles (80 kilometers) southwest of Chicago, he said. Two months later, the district sold 10-year tax-exempt bonds at a 4.16 percent yield, 0.8 percentage point more than Treasuries of similar maturity. It's the first time the district sold bonds yielding more than the taxable benchmark Treasury, data compiled by Bloomberg show.

``We need to have the buildings up and running by the fall of 2009,'' Gegenheimer, 51, said in an interview. ``We're kind of behind the eight ball.''

The premium, which translates into $6.5 million in extra interest over the life of the bonds, has less to do with the Minooka school district's A1 rating and more to do with the credit crunch that has led investors to spurn all but the safest of government debt.

State and local borrowers across the U.S. may pay about $7.2 billion more in interest over 10 years after municipal bonds lost 0.82 percent on average last quarter, their worst start since 1996, as a drop in debt prices pushed yields higher, according to a Merrill Lynch & Co. index.

Higher Than Treasuries

The extra interest is based on the $90 billion of fixed- rate bonds borrowers typically sell this quarter and tax-exempt rates that now average about 0.3 percentage point more than Treasuries. Because of the tax benefits, municipal bonds due in 10 years typically yield about 0.5 point less than U.S. government debt, Bloomberg data show.

Rates on municipal bonds have surpassed Treasuries for five straight weeks, the longest period in at least 17 years, according to Bloomberg data.

This is a huge story.The marketplace is starting to price in the risk of muni bonds.