Small investors saved day for state

Since September, individual investors have bought more than half of the bonds - some $1.2 billion worth - that the state has issued in four offerings to help pay for government services. That represents a sevenfold increase in the value of purchases by individuals during the prior year, state officials say.

As it turned out, both sides needed each other during an unprecedented credit crisis that brought borrowing in global financial markets to a near standstill. For the state government, ordinary investors were its only recourse after the financial institutions that normally buy such bonds were paralyzed. For the buyers, the state bonds were a safe - and profitable - investment compared to stocks, which were falling at rates not seen since the Great Depression.

“We felt it was a stable, risk-free investment compared to other opportunities,’’ said Paul Marcus, a Boston real estate executive who significantly increased his pur chases of Massachusetts and other state bonds during the recent sales. The Massachusetts bonds are paying interest of more than 4 percent, while the Dow Jones industrial average, for example, is down 25 percent since September.

State officials were not able to pinpoint how many individual buyers participated in the recent bond sales, but said it numbered in the thousands. Scores made the minimum purchase of $5,000, or bought in $10,000 increments - a departure from the typical multimillion-dollar purchases made by institutions such as banks and mutual funds.

“There was almost a war bond mentality to it,’’ state Treasurer Timothy P. Cahill said of the buying climate. “We saw a sea change in attitude, from people looking to make huge money on stock tips to instead going back to more bread-and-butter investments.’’

Anticipating continued demand, treasury officials are now building a database of individuals who they hope will be regular investors. Officials are using the database to track buyers by ZIP code, so they can target marketing campaigns for future bond sales.

Usually, bond issuers don’t deal directly with individual investors, because it is much more work than selling to institutions, which can bite off huge amounts at a time. But individuals turned out to be the state’s best option during the credit crisis because the usual buyers became desperate sellers, as so many institutions needed to raise cash quickly.

And for investors, Massachusetts bonds became even more attractive because the usual safe haven at a time of turmoil in stock markets - US Treasury bonds - were paying a pittance in interest because of overwhelming demand from jittery investors.

Typically, US bonds pay 20 percent more than municipal bonds, which is how bonds offered by state and local governments are described. But last year that dynamic was turned on its head. On Dec. 18, 10-year US bonds were paying 2.05 percent, while 10-year municipal bonds offered an average of 4.08 percent, according to Municipal Market Advisors, an independent Concord research and strategy firm.

“You had this tremendous flight to safety, and that trend benefited the Commonwealth,’’ said Thomas Doe, chief executive of Municipal Market Advisors. “The state saw that there was strong demand, and they took advantage of it.’’

Interest on municipal bonds is exempt from federal taxes; furthermore, Massachusetts residents don’t pay state income taxes on locally issued bonds.

The Massachusetts treasury, modeling its efforts on a California program, launched an advertising campaign last fall to generate interest among individuals, spending about $170,000 on advertisements on Boston.com, the Globe’s website, as well as on newspaper and radio ads. Buyers from Massachusetts received preference over investors from other states.

It also launched a website, www.buymassbonds.com, and took the unusual step of restricting the first two days of its bond sales to individual investors, hoping a strong start would induce reluctant financial firms to jump in on the third day. It worked. The state sold out its full issue each time.

Individual purchases in the four offerings totaled nearly $1.2 billion, more than 50 percent of the $2.3 billion the state issued in the nine-month period. In the prior four years, purchases by individuals accounted for only 4 to 14 percent of total sales.

Though the interest rates were attractive to buyers at the time, they were good for the state, too, because of its strong double A credit rating. The treasury paid average interest of 4.26 percent in the four sales, several tenths of a point below what it typically pays.

One prominent buyer of Massachusetts bonds is US Representative Barney Frank, whose financial disclosure forms show he has purchased bonds from the treasury and several other state agencies during the past decade.

As chairman of the US House’s Committee on Financial Services, Frank wants to make it easier for states to pay even lower interest. He has filed a bill that would require credit-rating agencies to rate bonds issued by the states on the same scale as bonds floated by corporations, which generally enjoy lower borrowing costs even though they have higher default rates. He said the current system overstates the risk of investing in municipal bonds, effectively saddling them with unnecessary costs.

Yet states often buy additional insurance to get the same rates as corporations. Frank said that is an unnecessary expense, because while there have been a few notorious failures in the municipal bond market, generally states and local government issuers have offered stable investments.

Frank acknowledged such legislation would result in investors like him getting lower returns, but not enough to temper demand.

Today, the municipal bond market is beginning to stabilize, and state issues are paying lower rates than US bonds. Still, Marcus, the real estate executive who invested heavily this year, does not anticipate changing course any time soon, especially with the economy still on shaky footing.

“I expect my investment in bonds to stay in place for at least the next five years,’’ he said.

Casey Ross can be reached at cross@globe.com.

Correction: Because of an editing error, a story on Page 1 yesterday about Massachusetts selling bonds to individuals had the wrong date for the start of the state’s fiscal year. It begins July 1.