Take cover, City Hall. The shrapnel of America's mortgage-crisis meltdown is coming your way.
It's already taking a toll on the economy. Now it's looking at your sewer systems, your water lines even your plans to build a new police or fire station could be on the line. Suddenly, some of your city's most stable assets municipal bonds are being threatened by the barbs of someone else's greed. And that threat is going to cost you money.
"The bond market is part of the capital market that's been knocked around for a little while," said John Crandall, executive vice president for George K Baum Co., an investment banking firm that underwrites a majority of Utah's bonds. "The effect is our municipalities are paying more in interest rates because of actions of others and an unregulated mortgage market."
Cities, counties and states often use their financial worth to issue multimillion-dollar bonds like taking out a loan against your house that pay for big projects, such as building city halls, fire stations, and sewer and water systems. In the past, municipalities that didn't have top credit ratings, known as "AAA" ratings, paid bond insurance companies to represent them. That way, the municipality could still pay the lower interest rates normally reserved for highly rated entities and thus afford to go ahead with its intended project.
Last fall, a number of banks that dabbled in the subprime mortgage market and offered municipal variable-rate bonds with fluctuating interest rates started to fail. Underwriters started backing away from the variable-rate bonds, and simultaneously, nonfixed interest rates started to skyrocket.
The sudden shift made cities with variable-rate bonds, like West Jordan, where interest rates on a Utah Water Finance Agency bond doubled in one month, start to panic and scramble to replace their bond with a private investor before it was too late.
"If it wasn't for the perfect storm of fiscal distress the national economy has experienced, we probably would have still been using those variable-rate notes," said David Hales, West Jordan finance director. "It's had an impact. Whether it has an impact in the future will depend on what bond rating we can get as a city and whether bond insurance is available."
Bond insurance is becoming harder for cities to come by. Five of the seven bond insurance companies Hales could have gone to in the past no longer have an AAA rating. Those companies fell when they tangled with insuring the subprime mortgage market.
"The thing about municipal bond insurance, like municipal bonds, is it's not fancy," Crandall said. "It's just not sexy. It's a basic return. You get a smaller return, but you can guarantee a return. They got big returns by insuring the subprime market. It was all greed."
Now that only two bond insurers remain, competition to provide the best rates to municipalities isn't very high. The insurers can be picky and pricey because cities often don't have any other options.
Large entities, like Utah state government, Salt Lake County and Salt Lake City are more insulated from the problem because they have the highest credit ratings on their own. Utah in general is a conservative state with low debt and high bond ratings, said Jonathan Ward, vice president of Zions Bank's public finance department.
"I think it's uncomfortable for the municipalities here in Utah, but I haven't run across anyone that is in such dire straights that they have to close their door or have the state take them over or declare bankruptcy," Ward said. "Because of the conservative fiscal management (of Utah municipalities), I don't think they'll get to that point."
Still, smaller cities are more vulnerable to the bond market's fluctuations.
One reason municipal bonds are historically so stable is cities have a low chance of default. If interest rates rise, municipalities can usually raise fees, rates and taxes and spread those on to residents. Smaller cities have fewer residents to absorb the blow, and they can become stretched to capacity more easily.
The disadvantage smaller cities have makes cities like Herriman nervous. The city recently paid off one of its bonds and isn't looking to issue any bonds soon, but a looming need to add infrastructure to the city's water system has Herriman finance director Shauna DeKorver hoping the situation will soon improve."Right now we don't have any immediate plans to issue more bonds," DeKorver said. "We're not too concerned about it at the moment, but if things continue the way they are, we could be. ... The way the economy is right now, being able to make the debt payments would always be a concern."