'It was like the dam broke'
Commonwealth scrambles to borrow amid meltdown
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On Sept. 29, minutes after Congress rejected a $700 billion bailout, state Treasurer Timothy P. Cahill got an urgent e-mail on his BlackBerry at 1:55 p.m.: "The Dow is down 700 points."
He knew instantly what the alert from his staff meant. The turmoil in the markets would again make it impossible for the state to borrow money that day, leaving the treasury short on $1.7 billion in payments due within hours. He was running out of options.
A few days earlier, his office had to postpone a bond sale that would generate $750 million. Now the backup plan, to raise money through commercial markets, wasn't going to work, either. "It was like the dam broke," Cahill said. "Everything just shut down."
The unprecedented chaos and uncertainty that froze the financial markets left the state facing a cash crunch no one could have predicted. In a 17-day span, Cahill's office would have to postpone the bond sale three times as panic swept through economies around the world. Banks kept collapsing. Investors fled the markets. Loans were nearly impossible to get.
At one point, Cahill reached out to Eric Rosengren, the head of the Federal Reserve Bank of Boston, to ask for a loan if the state couldn't raise any money. But it wouldn't come to that.
A behind-the-scenes look at the treasury's struggles shows how tumult in international markets can trickle down to a state and its taxpayers. It also shows how investors, gripped by market fears, came to treat Massachusetts, a state with pristine credit, as if it were a high-risk borrower, delaying completion of even a routine debt transaction.
The battle to raise money through normal channels turned out to be costly. Along the way, to sustain the state's cash flow, the treasury wound up borrowing $200 million at higher-than-normal interest rates, resulting in millions of dollars in additional costs for taxpayers.
Short-term borrowing is critical to the daily operations of governments because the flow of tax revenues is uneven - it varies from month to month and quarter to quarter. So the state regularly looks to debt markets for cash to pay bills, fund services, and meet payroll.
Normally, these are simple transactions. But in the past few weeks, the market for municipal bonds has shifted unpredictably, with interest rates on a key weekly index hitting a historic high of nearly 8 percent. Short-term rates typically hover between 1 and 2 percent for reputable borrowers.
Tom Green, a Citibank managing director contracted to work with the Massachusetts treasury last week, said states across the country are facing extreme fiscal difficulty. "I've been in banking since 1985, and I've seen a lot of cycles," said Green. "I've never seen anything like this."
The biggest lending crisis since the Great Depression came to a head on Sept. 15, when the bankruptcy of investment banker
The turmoil was particularly worrisome to Colin MacNaught, Cahill's assistant treasurer for debt management. MacNaught spends many of his days talking with investment bankers, trying to get a read on the debt markets, where he goes to sell state bonds to raise money.
On that morning, he recalled, panic was spreading quickly.
"The market was in total disarray," he said.
MacNaught said speculation was running rampant, with bankers and analysts wondering whether toxic mortgage-related debt was going to take down another bank. "Everyone was asking, 'Who's next?' " he said. These risky loans had plummeted in value as the housing market declined, leaving many banks with heavy losses.
The frenzy was unsettling for the treasurer's office. The sudden doubts about the solvency of the nation's largest banks increased interest rates, making it more expensive to borrow. Banks and investors were reluctant to lend at all, as they hoarded cash, fearing more borrower defaults.
All this was compounded by losses in money-market mutual funds, the primary buyer of the kind of municipal bonds the state sells. On Sept. 16, the Reserve Primary Fund, a pioneer of money market funds, announced that it had reduced the value of its shares to below $1, a threshold known as breaking the buck. In simple terms, it means investors were losing money on shares typically thought to be as safe as cash.
In the following days, the problems began to spread, hitting Boston's Putnam Investments and other firms. Investors withdrew billions of dollars from mutual funds, essentially deflating demand for municipal bonds.
By Sept. 22, three days before the planned launch of the state's $750 million bond sale, Cahill knew he had a decision to make. "It didn't feel good," he said. "We had to put it off."
After delaying the bond sale, Cahill had to move quickly. In eight days, the state was scheduled to make $1.7 billion in payments, including $1.3 billion in local aid for services in cities and towns and about $200 million to state service vendors, among other payments.
The bond sale had been planned months in advance to raise money right before the Sept. 30 deadline for the payments. But by Sept. 24, the municipal bond market was paralyzed, leaving the state without its primary method of raising quick cash.
MacNaught hit the phones again, pursuing the only avenue left: selling short-term debts known as commercial paper that the state uses periodically to raise funds. Usually commercial paper carries cheaper borrowing costs than bonds because the terms are shorter. But not this time. Market instability drove up interest rates dramatically. Between Sept. 24 and Sept. 26, the state treasury borrowed $200 million at rates between 4 and 6 percent, several times higher than the typical 1- to 2-percent rate.
That meant millions of dollars in unanticipated costs for taxpayers. As bad as it was, the situation was about to get worse.
On Sept. 29, Cahill and MacNaught spoke in the morning, hopeful the state would be able to continue raising money in the commercial paper market. Congress was supposed to approve a $700 billion bailout to buy bad debts off bank balance sheets, a move to restore confidence in the financial system.
Cahill was returning to the State House from a school building assistance meeting when he received two e-mails from MacNaught just before 2 p.m. The first said Congress had rejected the bailout; the second said the Dow Jones industrial average was in free fall.
MacNaught told him raising money in the commercial paper market wasn't going to work anymore. The state was able to sell only $32 million, leaving it $168 million short of the $400 million in borrowing they wanted to be sure they could complete the payments the following day.
Cahill huddled with MacNaught and James MacDonald, his assistant treasurer for cash management. They decided to take $168 million out of the state's coffers to make the payments. That withdrawal left only about $700 million in the treasury; ideally the state likes to keep a $1 billion balance.
The treasury still had to find a way to move forward with the bond sale, to avoid having to dip into emergency cash reserves, known as the "rainy day fund," a move that could affect its credit rating and increase borrowing costs.
Concern was escalating throughout state government. Cahill was conferring regularly with top lawmakers and Governor Deval Patrick's administration. Officials were worried not just by the roiling debt markets but by the effects of a slowing economy on tax receipts. During September, the state recorded a sudden $188 million shortfall in tax revenues.
"The difficulty accessing the debt markets was a sign of how severe the fiscal crisis was starting to become," said Leslie Kirwan, Patrick's secretary of administration and finance. "Everyone was painfully aware of the market dynamics."
On Oct. 2, Cahill wanted to try another bond sale, but held off because the credit markets were still stunned by Congress's failure to pass the bailout.
With a weekend to let tensions calm, Cahill decided to try again the following Tuesday. But Sunday brought another financial tempest, with news of losses buffeting European banks.
On Monday, the Dow plunged 800 points before closing down 370. MacNaught said he struggled to take the pulse of the bond market, but interest rates were "all over the map."
That left Cahill in another bind. Postponing the sale again could send a bad signal, but going to the market could cost countless millions in higher borrowing costs. At 4 p.m., he decided to hold off another day.
On Tuesday, Cahill changed the structure of the sale to ensure its success. Rather than a conventional bond offering, he hired investment bankers
That put the sale in motion on Wednesday, the day the Federal Reserve Bank cut its benchmark interest rate a half-point to pry open the lending market. Cahill and MacNaught were on the phone early in the morning, conferring with Citibank and Goldman before moving forward. In the end, they decided to go for all the money the state needed.
"The decision was to go all in," Cahill said.
MacNaught kept in constant contact with investment bankers until 1:45 p.m., 15 minutes before the scheduled sale. The interest rate quotes were favorable, and the sale proceeded, with investors purchasing $750 million in notes at 2.2 percent, just slightly higher than normal and well below the 4 to 6 percent the treasury had paid on its commercial paper just weeks before.
But with the stock market off 40 percent and the economy heading for a recession, Cahill knows the state still faces serious challenges. He is watching closely as the Patrick administration prepares hundreds of millions of dollars in emergency budget cuts this week.
"We're not out of the woods yet," Cahill said. "This just buys us some time."
Casey Ross can be reached at cross@globe.com.
