Trouble

The credit crisis paining Wall Street is reaching out across the nation, afflicting municipalities, hospitals and cultural touchstones like the Metropolitan Museum of Art.

In recent days another large but obscure corner of the financial world has come under acute stress. Alarmed by the running turmoil in the debt markets, investors have refused to buy certain securities that not long ago many regarded as equivalent to cash.

Even though the securities are long term, banks hold auctions periodically to set the interest rates. During the last three days, almost 1,000 of these auctions failed because there were not enough buyers. The banks that marketed the instruments, known as auction-rate securities, also declined to buy.

The Port Authority of New York and New Jersey now finds itself paying a rate of 20 percent on $100 million of its debt, almost quadruple its costs a week ago. The Metropolitan Museum of Art is now paying 15 percent on auction securities. It is unclear how long such high rates will persist, or when the market for these instruments will revive, if at all.

“What is going on here is a credit crunch,” said G. David MacEwen, chief investment officer for fixed income at American Century Investment, the big mutual fund company. “And the cost of the credit and the availability of credit even for good borrowers has clearly taken a big hit.”

The failed auctions are tied to and exacerbating the larger problems in the financial markets. On Thursday, financial stocks led the market down and bond investors drove up mortgage rates.

At the top of investors’ list of worries are the bond insurers MBIA and the Ambac Financial Group, longtime linchpins of the capital markets. Many fear the insurers, which guarantee interest and principal payments on nearly half of all municipal bonds, will lose their triple-A credit ratings. On Thursday, Moody’s Investors Service downgraded the triple-A rating of a smaller insurer, the Financial Guaranty Insurance Company.

At a daylong hearing on Thursday in Washington, members of the House Financial Services Committee discussed the possibility of a federal bailout for the largest bond insurers, a move the insurers said was not needed.

The auction-rate securities market, which totals about $330 billion, accounts for a small fraction of the debt sold by municipalities. But this source of financing has suddenly become astronomically expensive, even though the Federal Reserve has cut short-term interest rates to stimulate the economy. The turmoil has heightened worries about how states and towns, particularly poorer ones, will pay their bills as a weakening housing market and potential recession squeeze tax revenues.

For some communities and government authorities, even a small increase in interest rates — costs usually measured in hundredths of a percentage point, or basis points — can hurt. The Port Authority, for example, will have its weekly interest payments on $100 million in auction-rate securities soar to $389,000 from $83,600.

Other recent casualties in the auction-rate market include universities like Georgetown, student loan providers like the College Loan Corporation, municipalities like Washington, states like Wisconsin and cultural institutions like the de Young Museum in San Francisco.

Faced with higher costs, some borrowers are moving to overhaul the variable-rate auction securities. Among the options municipalities are considering are redeeming the bonds, reorganizing them into long-term fixed-rate securities, or turning to banks for alternative financing.

Wisconsin is moving fast after the rate on some of its $950 million of auction securities jumped to 10 percent this week from 5.2 percent last month. The rate is reset every 28 days.

“We are in the process of replacing some or all of this program with something else,” said Frank R. Hoadley, Wisconsin’s director for capital finance.

Some borrowers are considering another short-term note called variable-rate demand obligations, which also have their rates reset daily or weekly. Unlike auction-rate securities, the demand obligations are supported by bank letters of credit, which allow buyers to “put,” or sell, the bonds to the banks.

This may have been an easy fix a few weeks ago, but now Wall Street banks have become more reticent to issue such letters, or are demanding higher interest rates, because they do not want to be left holding billions of dollars of these floating-rate bonds.

“It is becoming difficult to get letters of credit, and we’re trying to avoid paying too much,” said Sharon A. Dumas, director of the department of finance for the city of Cleveland, whose auctions have been successful but which has had its interest rate climb.

The problems in the auction-rate market resemble the crisis that hit so-called structured investment vehicles last summer. After a plan brokered by the Treasury Department sputtered, many of the banks ended up taking the SIVs back onto their own books; others SIVs were liquidated. The first sign of trouble in the auction-rate market came in August, when several auctions for bonds backed by mortgage-related securities failed. But much of the market returned to normalcy as big investment banks that underwrite the bonds bid in the auctions to support clients like municipalities and student loan companies.

But in recent weeks the investment banks, which have had to write down billions in mortgage-related securities, have scaled back their support of the market.

Industry officials say much of the auction-rate market is backed by highly rated securities that, broadly speaking, are not experiencing high default rates. Most investors — even those who have not been able to sell their holdings — are likely to get their money back, analysts and officials say.

“This is not a credit event, it’s a liquidity event,” Jon D. Maier, a Merrill Lynch analyst, wrote in a research note.

Mr. Maier was specifically referring to about $63 billion in auction-rate securities that are issued by closed-end funds, which are variations on mutual funds. These funds invest in stocks and bonds and raise money by selling shares and issuing bonds, including auction-rate securities. The funds have also seen auctions fail recently.

But the dearth of buyers this week that caused interest rates to spike may attract new buyers in coming auctions, especially because investors view issuers of auction-rate securities like the Port Authority and the State of Wisconsin as very safe.

“At the end of the day,” said Cathryn P. Steeves, portfolio manager at Nuveen Investments, “people will still be willing to buy paper from the Metropolitan Museum of Art at very favorable tax-exempt rates.”