Oct. 17 (Bloomberg) -- California, the biggest U.S. state borrower, raised $5 billion to avert a cash shortage by turning to the bedrock of the municipal bond market: its own taxpayers.

California, a bellwether for state and local government debt, was able to boost its offering of short-term notes this week by 25 percent from $4 billion after a marketing campaign targeting individuals helped draw more than $3.9 billion of orders, an all-time high.

``Mom and Pop really came through,'' said Tom Dresslar, spokesman for California Treasurer Bill Lockyer in Sacramento.

Demand from individuals helped California avoid asking for emergency help from the federal government, a prospect Governor Arnold Schwarzenegger said may be needed as the credit crisis gripping the world economy deepens. It also left the state less dependent on the Wall Street firms, hedge funds and other institutions that have retreated from the $2.66 trillion market, underscoring the growing importance of individual investors.

Households increased their municipal holdings to $912 billion at mid-year from $900.4 billion in the first quarter, according to the most recent Federal Reserve data. That gives them 34.3 percent of the market, making them the largest single group of investors.

The interest by individuals contrasts with waning demand from institutional investors and decreased support from banks and securities firms beset by $660.8 billion in writedowns and credit-market losses since the start of 2007, according to data compiled by Bloomberg.

Sales Pulled

Municipal borrowers from Hawaii to Maine pulled more than 200 debt offerings totaling at least $14 billion since mid- September, when Lehman Brothers Holdings Inc. filed its record bankruptcy, Bloomberg data show.

``The market's been virtually frozen,'' said David Joyner, head of the North Carolina Turnpike Authority in Raleigh, which shelved plans to raise $600 million to begin work on a toll road. ``The cost of capital is beyond what we can afford at the moment.''

Individuals are attracted to tax-exempt yields that rose to 6.01 percent this week on 20-year general obligation bonds, the highest since 2000, based on the weekly Bond Buyer 20 index. The yield is a record 1.77 percentage points more than Treasuries, compared with an average 0.67 percentage point less during the past two decades.

``This is viewed as a historic opportunity for the individual investor,'' said Joe Darcy, who manages $5 billion in municipal bonds for Dreyfus Corp. in New York.

New York Boosts

Individuals, known as retail buyers, also purchased almost four out of every five bonds that New York sold this week, according to a release from the city. The most populous U.S. city more than doubled the deal to $550 million after orders exceeded the amount of bonds available. Michael Bloomberg, New York's mayor, is founder and majority owner of Bloomberg News parent Bloomberg LP.

Demand from retail investors helped Sarasota County sell $74 million of revenue bonds in September, said Richard Gleitsman, a debt service manager for the county.

``We sold 86 percent of those to retail,'' Gleitsman said in an interview. ``There's still a market for retail sales because people are looking to park in high quality debt.''

California, seeking to lure this core audience, routinely runs radio and newspaper advertisements in major cities before debt sales, and last year started a Web site to aid individual investors. This week, ads featured Schwarzenegger, who said he purchased $100,000 of the notes that will provide needed cash for salaries and services until tax revenue arrives.

Three Days

California was able to boost the size of its borrowing because of the demand from individual buyers, and lower the yield range on the debt by a quarter of a percentage point.

More states and municipalities may begin to increase the period they sell bonds directly to individual investors to three days from one in response to waning institutional support for the market, said Fred Parkes, vice president of municipal finance at Toussaint Capital Partners LLC in New York. New York was the first to introduce a so-called retail order period about a decade ago, he said.

``That experiment paid off remarkably well,'' said Parkes. Toussaint Capital Partners was one of the brokerage firms that participated in California's note sale.

California, which has more than $45 billion of general obligation bonds, still had to pay a yield of 4.25 percent on the notes due June 22, 2009, the most on record relative to Treasuries.

`Screaming Giveaway'

``At those yields, the notes are a screaming giveaway,'' said Jim Lebenthal, known for promoting tax-exempt bonds in radio and television ads as founder of Lebenthal & Co. in New York. ``If you can compare them to anything of a similar quality, they are irresistible.''

California's rate exceeded the 3.37 percent it paid last year on a similar, larger note sale, when Treasuries were yielding more.

``The good news'' is the state got the deal done, said Paul Brennan, who oversees about $12 billion in municipal bonds for Nuveen Asset Management in Chicago. ``The bad news is that it's at much higher yields than they had obviously contemplated just a few weeks ago.''

With investors wary of owning all but the safest U.S. government bonds, New York's cost of borrowing for 15 years increased 1.59 percentage points from its previous sale on Sept. 10, a week before Lehman's failure deepened the credit crisis that began last year.

Record Weekly Outflow

Investors pulled almost $400 million out of municipal bond mutual funds during September, the first monthly outflow this year, according to AMG Data Services of Arcata, California. Redemptions accelerated this month, with fund outflows rising to $3.4 billion so far, including a record $2.3 billion in the week ended Oct. 15, the data show.

``We are still in a situation of no buying and lots of forced selling,'' said Ron Fielding, senior portfolio manager at OppenheimerFunds Inc. in Rochester, New York, with $23 billion under management.

Wall Street firms had already been pulling back earlier in the year. Broker-dealers, which abandoned the $330 billion auction-rate market after being inundated with unwanted securities, cut their holdings of municipal bonds and notes 22 percent to $51.8 billion from a record $66.1 billion at the end of the first quarter, according to Fed data.

Postponements

Ohio and Boston-area agencies put off their plans to raise money for transportation projects this week, adding to the estimated $100 billion of capital-improvement bond issues shoved aside by market turmoil this year, according to Municipal Market Advisors, a Concord, Massachusetts-based research firm.

The Massachusetts Bay Transportation Authority, operator of Boston's mass-transit system, held off borrowing $350 million after investors demanded yields of about 6 percent, a full percentage point more than anticipated, said Jonathan Davis, chief financial officer. The bonds, rated AAA by Standard & Poor's, were intended to refinance debt, replenish reserves and pay for projects.

``I just about choked when I saw the interest rate,'' Davis said. ``We're hoping we'll see some downward pressure on interest rates in the next couple of weeks. It all depends on buyers coming back.''

MTA Sells

The Metropolitan Transportation Authority that runs buses, trains and subways around the New York City area had delayed the start of its latest revenue bond offering earlier this week amid rising costs. Underwriters led by JPMorgan Chase & Co. revived the deal yesterday, taking orders from retail investors. The final amount from them wasn't immediately available.

The bond sale was completed today with $550 million, $50 million more than planned at the beginning of the week. The authority, which also ran radio ads to promote the sale, offered 20-year tax-exempt securities rated A by S&P at a price to yield 6.75 percent, about 2.4 percentage points higher than benchmark taxable Treasury bonds.

The last time the MTA, operator of the largest mass-transit network in the U.S., sold fixed-rate transportation revenue bonds in early February, the agency offered a maximum yield of 4.86 percent on debt due in 2037.

Even smaller municipal issuers able to harvest demand from individuals are likely to see similar jumps in their borrowing costs, said Matt Dalton, chief executive of Belle Haven Investments in White Plains, New York.

``They're going to be shocked at the cost of funds,'' Dalton said. ``They've been through a decade'' of getting financing at around 3 percent to 4 percent ``and that's over.''

To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net; William Selway in San Francisco at wselway@bloomberg.net.

Last Updated: October 17, 2008 14:03 EDT