FROZEN MARKET

When so many places in the U.S. are facing or in a recession, the price of borrowing has gone through the roof.

New York Faces Double Whammy as Swaps Compound Failed Auctions
By Michael Quint

Feb. 28 (Bloomberg) -- Local government officials from New York to Houston who followed the advice of their bankers and issued auction-rate bonds in combination with interest-rate swaps are now getting squeezed by both.

The contracts typically require buyers to pay fixed rates in exchange for variable payments from the banks arranging them. These variable rates, based on Libor, roughly matched the cost of auction bonds for more than five years, making the fixed rates -- still far lower than what borrowers would have paid on traditional bonds -- well worth it.

Since Sept. 9, the average seven-day auction rate rose to a record 6.89 percent from 3.88 percent, according to the Securities Industry and Financial Markets Association. At the same time, one-month Libor dropped to 3.12 percent from 5.82 percent as the Fed lowered its rate for overnight lending between banks 2.25 percentage points.

The failure of the financial instruments compounds the pain for borrowers stuck paying record-high interest on auction-rate debt billed as a cheap alternative to traditional bonds. Investors got skittish last year, retreating from auctions that determine new rates every seven to 35 days. Now UBS AG, Goldman Sachs Group Inc., and other brokers are refusing to be bidders of last resort, and the $330 billion market is frozen.