Misery loves company

County joins homeowners in being victimized by the sub-prime mortgage mess

Local homeowners dealing with balloon payments, jacked-up interest rates and foreclosure threats now have good company when it comes to being rocked by the nation’s home-lending crisis: Sacramento County.

Investor jitters over a company that insured bonds backing sub-prime mortgages caused the firm’s credit rating to drop. That had a ripple effect on the county’s $346 million auction-rate bond that pays retiree pensions, since it is insured by the same firm. The auction-rate bond’s interest rate of 6.5 percent in December rose to 8.5 percent in January.

The fallout from this will likely come back to hit locals with yet another financial whammy. To cover the increased debt caused by the interest-rate spike, the county will be under increased pressure to cut services, raise fees and find other painful solutions.

The roots of the mess extend back to February 2004, when county supervisors overwhelmingly approved a move into the auction-bond market. Supervisor Don Nottoli, whose fifth district encompasses much of the county’s southeast area, still defends his yes vote.

“It worked to our advantage the past couple of years as far as the low rates we were getting,” Nottoli said of the financial instrument that has charmed other municipalities nationwide.

It’s easy to see why: Sacramento County enjoyed low rates set every 28 days in auctions overseen by respected investment banks such as Citigroup Inc. in a $330 billion market.

What no one figured into the equation was the mortgage crisis that began in the sub-prime sector. Scores of homebuyers secured loans with low interest rates that rose sharply within a year or less. As the monthly mortgages rose, many could not keep up with their payments, the mortgages went into default and the homeowners lost their homes.

Armonk, N.Y.-based MBIA Inc., which insured the bonds that backed many sub-prime mortgages, also insured Sacramento County’s auction-rate bond. Investors who bought the county bond became worried whether MBIA could also cover its sub-prime losses as the company’s red ink rose, and MBIA’s credit rating by agencies such as Moody’s Investors Service, Fitch and Standard & Poor’s dropped, said Chris Marx, the county debt officer.

Then investors who bought Sacramento County’s auction-rate bond chose not to bid on its pension bond. The banks that oversaw the auctions refused to be the bond buyers of last resort due to their losses of $416 billion in the sub-prime mortgage crash, Bloomberg News reported.

In such failed bond auctions (per the fine print in auction-rate contracts), the low rates reset to higher rates automatically. The county rate rose $18,571 daily. That translates into an annual $2.4 million increase in the county debt beginning July 1, and officials will look evenly at the taxpayer-supported general fund and enterprise (user) funds such as the airports department to recoup its losses, Marx said.

In the meantime, the Board of Supervisors voted March 4 to refund the $346 million auction-rate bond to a fixed-rate bond that adds $6.5 million to county expenses through the budget year that ends on June 30. That’s better than the alternative: the auction-rate bond would have cost $9.7 million over the same period.

A proposal to refund a $76 million auction-rate airport bond that the county issued in 2006 goes before the board April 1.

Despite the refinancing, the county faces a potential deficit of $40 million to $60 million, or 6.6 percent to 10 percent of the general-fund budget, for the fiscal year that begins July 1, reported its Office of Budget and Debt Management. Declines in property and sales taxes are the underlying causes.

Not all local officials were mesmerized by auction-rate bonds.

“I spent 25 years as a pension-investment manager and saw the underlying risk in these auction-rate bonds,” said Tom Berke, the interim Treasurer and chief investment officer for the city of Sacramento. “The teaser of low interest rates for the bond issuers [borrowers] and high interest rates for buyers [lenders] caused me to steer clear of them.”

For Berke, if an investment sounds too good to be true, it is. He admits his is a conservative approach, and he prefers bonds with interest rates similar to those of U.S. Treasury bonds, widely viewed as safe and stable.

His avoidance of auction-rate bonds will not add more debt to the city, but Sacramento still has financial woes of its own. The city, burdened by a $58 million shortfall in its $450 million general-fund budget for 2008–09, is looking at hundreds of city job layoffs and unclear service cutbacks.

Misery loves company.