March 24 (Bloomberg) -- New York paid 10 securities firms more than $600,000 since mid-February to handle bids for auction-bonds even though the sales failed, saddling the state with penalty interest rates.

Citigroup Inc., Goldman Sachs Group Inc. and eight more firms receive $10 million a year to oversee periodic bidding that sets rates on about $4 billion of auction bonds. When there aren't enough buyers, the yields rise. A total of 188 of the state's 201 auctions since Feb. 12 have failed, according to data supplied by the state.

``We are contractually obligated to pay these fees regardless of whether the auction fails, and we will fulfill our commitment,'' Matt Anderson, a spokesman for New York's Division of Budget said in an e-mailed statement.

State and local governments pay almost $8 million a week in fees to banks for auctions-rate bonds, based on standard fees. About two-thirds of auctions in the $330 billion market have failed since mid-February, including periodic sales of preferred stock for closed-end bond funds, Bloomberg data show. Securities firms are receiving the same fee even when investors who wanted to sell are unable to do so because bankers haven't found enough bidders.

`Systemic Problems'

Banks covered shortfalls in demand at auctions in the $330 billion market buy purchasing bonds for their own account, even though they weren't obliged to. They didn't tell investors or issuers about the extent of the activity, which was one of the practices cited by the Securities and Exchange Commission in 2006 when it fined 15 banks a total of $13 million for bid- rigging.

New York isn't trying to renegotiate the contracts with the 10 broker-dealers it uses for auction bonds, Anderson said. The firms also include Bank of America Corp., Wachovia Corp., UBS AG, JPMorgan Chase & Co., Merrill Lynch & Co., Bear Stearns Cos. Morgan Stanley and Lehman Brothers Holdings Inc.

``These failed auctions were not caused by these banks, but by systemic problems within this market beyond their control,'' he said.

A spokeswoman for New York-based Citigroup, Danielle Romero-Apsilos, declined to comment, as did Michael DuVally, a spokesman for New York-based Goldman. Citigroup was the biggest underwriter of auction-rate debt from 2000 to 2007, according to Thomson Financial. Goldman is the most profitable investment bank.

Higher Rates

When there aren't enough bidders in auctions that typically take place every seven, 28 or 35 days, rates get set by formulas spelled out when the debt is issued. In New York, the penalty rates ranged from 3.59 percent to 5.64 percent in the week ended March 14. That compares with yields on the variable-rate demand bonds, an alternative to auction-rate notes, that were less than 3 percent for 27 of 43 issues, according to state data.

Seven-day auction rates averaged 4.36 percent on March 19 for borrowers in New York, New Jersey, California and Massachusetts, up from 3.47 percent on Feb. 6, the last week before New York auctions began failing, according to index data published by the Securities Industry and Financial Markets Association. The rate peaked at 5.98 percent March 5.

Before the failures, auction-rate bonds were a way to sell long-term bonds at money market rates. They were the least expensive kind of borrowing for New York until demand began to weaken in September, according to a state report.

Bank Contracts

Anderson said copies of the contracts with banks handling the auction bonds weren't available. Anderson and Ronald Greenberg, a first deputy director of the budget, said state officials are in daily contact with bankers about auction bonds. He declined to respond to questions about the shortage of bidders since Feb. 12.

``Contracts for handling auctions are written by broker dealers and presented to issuers as part of a negotiated transaction,'' said Joseph Fichera, chief executive officer of Saber Partners, a New York based adviser to companies and governments. ``They can be terminated or renegotiated, like any contract.''

Fichera, a financial adviser to the New York State Dormitory Authority, declined to comment on the state's bonds.

There is precedent for broker-dealer agreements that don't pay banks a fee when auctions fail.

After auctions failed to attract enough bidders in 1990 for bonds of Tucson Electric Power Co., now a unit of Unisource Energy Corp., Fichera arranged a new contract that rewarded bankers with a higher fee for selling bonds that resulted in a lower auction rate, and no fee if bonds sold at the highest permitted rate.

To contact the reporter on this story: Michael Quint in Albany, New York, at mquint@bloomberg.net.

Last Updated: March 24, 2008 09:40 EDT