March 5 (Bloomberg) -- Auction-rate bond failures show no sign of abating after investors abandoned the market for variable-rate municipal securities.

Almost 70 percent of the periodic auctions in the $330 billion market failed this week as investment banks stopped buying the securities investors didn't want. Yields on the debt averaged 6.52 percent as of Feb. 28, up from 3.63 percent before demand evaporated in January.

States from New York to California and lawmakers including House Financial Services Committee Chairman Barney Frank are attempting to revive the market. Rising yields are pinching state and local governments just as a slowing economy and falling property values slash tax revenue by more than $6.6 billion, according to a report by the U.S. Conference of Mayors.

``Even if the auction-rate market survives, we're not going to see the kind of rates we're used to,'' said Roger Roux, chief financial officer at Rady Children's Hospital in San Diego, which spent an additional $940,000 on its auction bonds since rates reset as high as 15 percent last month.

There were 536 unsuccessful auctions in the market for the floating-rate securities today, a failure rate of 68 percent of all auctions, according to data compiled by Bloomberg from brokers at Wilmington Trust Corp., Bank of New York Mellon Corp., Deutsche Bank AG and Wells Fargo & Co. The rate of failures reached 87 percent on Feb. 14 and has since ranged from 61 percent to 69 percent, according to Bank of America Corp.

Bankers Retreat

Goldman Sachs Group Inc., Citigroup Inc. and other brokers began permitting the failures last month after investors, concerned that insurers backing the bonds might be downgraded, stopped bidding in the auctions conducted every seven, 28 and 35 days. From 1984 through 2006, only 13 auctions failed as brokers stepped in to buy the bonds when demand was weak.

States and local governments account for about $166 billion of the outstanding auction-rate debt, according to estimates by Bank of America Corp. Closed-end mutual funds also use the market to raise capital, as do student-loan corporations and some issuers of taxable debt.

The California Statewide Communities Development Authority said yesterday it is considering raising $10 billion to finance buying back the bonds it sold for local governments and hospitals. The issuers would then pay fixed interest on the debt, which would be held by the authority, for a year.

California Efforts

``The notion here is to buy embattled governments some time, and at a very low rate of interest,'' said Bill Doyle, a partner with the law firm of Orrick, Herrington & Sutcliffe LLP in San Francisco, who is working on the plan.

The California Health Facilities Financing Authority said today it will meet on March 11 to review plans to refinance auction-debt issued on behalf of hospitals. Six borrowers have reserved spots to consider $4.6 billion of their debt.

The New York Dormitory Authority said on Feb. 26 it plans to disclose bidding details and open the process to more banks for about $1.3 billion of its auction bonds in the hopes of lowering interest rates. New York Comptroller Thomas DiNapoli is considering buying auction bonds for the state's $154.4 billion pension fund, according to spokesman Robert Whalen.

When auctions fail, bondholders are left holding the securities and interest rates reset at a level spelled out in official statements issued at the initial bond sale. Rates on Port Authority of New York and New Jersey bonds rose to 20 percent on Feb. 13, from 4.3 percent a week earlier after an auction failed.

Debt Refinancing

Issuers including 14 hospitals in California and Massachusetts last month asked the Securities and Exchange Commission to let them bid on their own securities to prevent failures and lower rates until they could refinance the debt. Bond lawyers are concerned the issuers will run afoul of securities laws by bidding at their own auctions.

Lehman Brothers Holdings Inc. wouldn't let the University System of New Hampshire bid on some of its $150 million in auction debt last month, according to Ken Cody, associate vice chancellor for finance. Lehman underwrote the bonds and is also the auction broker.

``When it got within an hour, their in-house counsel forbid us to do it,'' said Cody, who added that he got clearance from his lawyers at Hawkins Delafield & Wood in New York. ``They said it was against SEC rules.''

The Securities Industry and Financial Markets Association, which represents brokers, wrote to the SEC on Feb. 21 asking what dealers can do to prevent failures. The SEC in May 2006 fined Citigroup, Goldman and 13 other banks $13 million after alleging they manipulated the market by giving some clients information about rival bids in the supposedly blind auctions.

Self-Bidding Process

U.S. Senator Charles Schumer, a Democrat from New York, joined a growing list of lawmakers this week urging regulators to let borrowers bid on their own bonds. A Feb. 28 letter from four members of the House Financial Services, including the chairman Barney Frank, a Democrat from Massachusetts, said it's ``urgent'' that regulators permit the bidding.

SEC Commissioner Paul Atkins expressed skepticism about issuer bids, saying he's hesitant to take any action that would change the terms of contracts between buyers and sellers.

``We have to be mindful of underlying contractual obligations,'' he told reporters on March 3.

The market has collapsed because of subprime mortgage- linked losses investment banks face, not because municipalities will default, said Dexter Torres, a trader at fixed-income investment firm Samson Capital Advisors LLC in New York.

``It's still a liquidity issue, not a credit issue,'' Torres said.

To contact the reporter on this story: Michael McDonald in Boston at Mmcdonald10@bloomberg.net

Last Updated: March 5, 2008 18:18 EST