Schwarzenegger signs law allowing bond buy backs

By Adam Tanner

SAN FRANCISCO (Reuters) - Gov. Arnold Schwarzenegger signed a bill on Wednesday allowing California government entities to buy back variable rate bonds during interest rate spikes, a move that applies to $67.5 billion in debt.

"This measure will protect taxpayers from further financial harm by helping governmental entities buy back these bonds and resell them when market conditions are more favorable," State Treasurer Bill Lockyer said in a statement.

The measure applies to $27.8 billion of auction rate securities and $39.7 billion worth of variable rate demand bonds from a wide array of entities including hospitals, local utilities, housing authorities, cities, counties and the state of California, according to Lockyer spokesman Tom Dresslar.

The new law comes in response to the turmoil in financial markets in recent months. Backers said its passage was a way to save government entities money, although investors holding impacted bonds could see lesser returns.

The law affects mostly local entities. The state of California's total outstanding debt is $60.3 billion, of which $4.5 billion -- or 7.5 percent -- is in variable bonds, Dresslar said.

Although government issuers once typically offered only fixed-rate bonds, in the past two decades some such entities have offered variable rate bonds.

"Taxpayers had nothing to do with the capital markets turmoil and bond insurance meltdown that has exposed government-issued bonds to substantial spikes in short-term interest rates," Lockyer said. "Yet they have paid the price for the meltdown to the tune of millions of dollars."

The law, which takes effect immediately, assures that a state or local government buyback would not impact the bonds' tax-exempt status. It also means that the debt is not extinguished by the buyback.

With lower property and other tax receipts, as well as higher fuel and other costs, government entities in California are facing budget deficits, prompting officials to seek areas in which they can cut costs.

(Editing by Toni Reinhold, Gary Hill)