Nov. 7 (Bloomberg) -- Michigan's municipal bond yields have surged as investors demand higher yield premiums to compensate for risk of the faltering U.S. auto industry.

Yesterday, Michigan's building agency sold bonds maturing in 10 years with interest rates almost 1 percent higher than top-rated municipal bonds. That was before General Motors Corp. reported a $4.2 billion third-quarter loss and said today that it may not have enough cash to keep operating.

``The panic has painted the entire state as a sell,'' said Matt Dalton, chief executive of Belle Haven Investments in White Plains, New York.

Michigan ranked last among U.S. states in economic growth in the five years through 2007, according to Moody's Investor's Service. The state's unemployment rate in September was 8.7 percent, 2.6 percent more than the nation's. Since last year, the state has lost 85,000 jobs and the bankruptcy or consolidation of G.M., Ford Motor Co. and Chrysler LLC would cost tens of thousands more.

``After missing out on the growth enjoyed by other states in the period from 2004 through 2007, Michigan now faces a possible national recession that may further erode the strength of its most important industry,'' Moody's said in a Nov. 3 report.

The Michigan State Building Authority yesterday sold $192.3 million bonds backed by lease payments appropriated annually by the Legislature. The bonds will be used to refinance more expensive debt and pay for capital projects.

Bond Premium

Bonds maturing in 2018 were priced to yield 5.13 percent, 0.88 percent more than top-rated AAA municipal bonds, according to Municipal Market Advisors. For an investor in the top-tax bracket, that yield is equivalent to 7.89 percent.

Moody's rates the state's building authority bonds A1, its fifth-highest investment grade, and one level lower than the state's general obligation debt.

Anxiety about the state economy has created opportunity for non-risk-averse investors to buy Michigan municipal bonds at premiums not seen in 20 years, Dalton said.

``With the fear tied to the auto industry, now is a great time to buy quality credits in Michigan,'' Dalton said.

Governor Jennifer Granholm, a Democrat, has urged Congress and President-elect Barack Obama to approve a rescue package of $50 billion in new loans for the carmakers.

To contact the reporters on this story: Martin Z. Braun in New York at mbraun6@bloomberg.net.

Last Updated: November 7, 2008 15:37 EST