Billions of dollars of sales slam muni bonds

NEW YORK (Reuters) - Tender option bond programs on Friday were selling "multiple billions" of dollars of U.S. municipal bonds, a money manager said, which is accelerating a market slide that experts call the worst in decades.

Prices have dropped for the past 12 days, partly due to the problems borrowers and investors are having with short-term municipal markets.

Two of these markets, auction rate and variable demand note obligations, have frozen because investors fear some bond insurers that backed this debt are no longer credit-worthy as a result of their bad bets on subprime mortgage investments.

These dislocations have hurt tender option bond trusts, which buy long-term muni bonds and finance them by selling floating notes. But now they are losing money -- or are about to -- because their borrowing costs have skyrocketed.

At the same time, the value of their long-term municipal bonds has plunged.

"Tender option bond selling is in the multiple billions," said Gary Pollack, a managing director at Deutsche Bank Private Wealth Management. Tender option bond programs are created by both hedge funds and dealers, and they typically are highly leveraged, which intensifies their influence on the market.

Dealers have been struggling to cope with the flood of supplies from these trusts because they must save their cash.

Banks and dealers have turned into cash-hoarders because they face billion-dollar write-downs from the sinking subprime sector and need to dress up their balance sheets because they are so close to end of the financial quarter.

And municipal bond issuers, from states to cities to agencies, are abandoning short-term muni markets and transforming these issues into long-term debt. This source of new supply -- expected to hit soon -- also is hurting prices.

(Reporting by Joan Gralla; Editing by Andrea Ricci)