Do you want a high interest rate on Municipal Bonds? The city of Houston is having to pay 7.7160% interest on seven day municipal bond paper. While interest rates on new issuances of credit-worthy municipal bonds of cities are running around 3 per cent for a bond payable in a year or more and in the 5 per cent range for longer term bonds, Houston taxpayers are having to pay bond investors almost 8% for seven day paper. Bloomberg reports that Houston’s borrowing costs rose by $3 million in the month of February alone.

You might say – this doesn’t make sense. And, in normal times, you would be correct. But, these are not normal times on Wall St. or in the municipal-bond market. Municipal officials, who thought they were being clever, got involved in complex derivatives swaps in order to cut the overall interest rates they would have to pay on various municipal bonds issuances. Instead, the transactions backfired on the cities and counties that entered into these swaps; and now the short-term interest rates they are having to pay have gone through the roof.

It has gotten so bad in Jefferson County, Alabama – the home of Birmingham – that the County may have to take bankruptcy. As reported by the Wall ST. Journal,

“Jefferson County, Ala., which is struggling with the turmoil in the municipal-bond market, rebuffed demands by four banks yesterday to come up with $200 million to back a derivatives trade gone bad. The banks have demanded that the county post additional collateral because of losses on derivatives contracts it entered into over the past several years. The contracts, known as interest-rate swaps, were meant to lower the county’s borrowing costs and protect it from spikes in interest rates. But critics say the county was speculating.”

The Journal reports that Houston has its own municipal bond problems: “The city of Houston has four interest-rate swaps with a notational value of $1.3 billion.” What Houston did was sell a long bond and then enter into seven day auctions on the bonds at lower interest rates designed to lower the overall interest rate on the bond. With chaos in the credit markets, these seven day auctions began to fail in January, driving up short term rates to high levels. So, currently Houston is having to pay 7.7160% to holders of this seven day paper. Ultimately, the taxpayers of Houston will have to pay a high price for the decision of Houston officials to gamble in the speculative world of derivative swaps. Hopefully, Houston will be able to float new municipal bonds to replace these interest-rates swaps. But, there will be substantial fees that the taxpayers of Houston will have to bear for the issuance of new long term bonds to replace these interest rate swaps gone bad. The estimated costs of these new bonds is in the range of $7 million.

It makes one wonder: Is this an appropriate time for DISD and other local school districts to be issuing new bonds?

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