By Keith B. Richburg and Karl Vick
Washington Post Staff Writers
Saturday, October 4, 2008; A02

NEW YORK, Oct. 3 -- The U.S. financial crisis is hampering the ability of many state and local governments to borrow cash for short-term expenses and is threatening to delay long-term road, school and airport projects, including some in the Washington area.

The most dramatic impact of the Wall Street meltdown is in California, where Gov. Arnold Schwarzenegger (R) warned Treasury Secretary Henry M. Paulson Jr. this week that his state may need an emergency federal loan of $7 billion to meet its operating expenses.

"While some states may be able to absorb a delay or obtain high-interest financing through private banks, California is so large that our short-term cash flow needs exceed the entire budgets of some states," the governor wrote in a letter Thursday.

Many states routinely rely on short-term borrowing at this time of year to cover operating costs as they balance the ebb and flow of revenue. Most rely on tax receipts that generally do not arrive until spring.

"It's not just California," said Scott Pattison, executive director of the National Association of State Budget Officers. "People will tell you publicly that they are doing okay, but state financial officers are very concerned. At the moment, there's enough cash in the bank, but by November or December, if they still can't get access to the markets to borrow money to meet payroll or other expenses, then you might have 10 to 12 states that may not be able to cover their costs."

Experts were uncertain whether congressional passage of the $700 billion rescue plan would unclog credit channels next week.

"Now that the House has passed the legislation, we can hope the credit markets start working again," said Jeffrey Esser, executive director of the Government Finance Officers Association. "But I don't think anyone has any idea."

As state and local governments' access to short-term credit has been severely restricted, the bond market has also gone sour. Some governments have been forced to withdraw bond sales for long-term projects because no one is interested in buying them right now.

The Metropolitan Washington Airports Authority has postponed plans for a $2.2 billion bond sale to cover the costs of expanding the terminals at Dulles International and Reagan National airports. Maine put on hold a planned $50 million bond sale to finance 10 highway construction projects.

"There's probably about $100 billion of new infrastructure projects that haven't come to market," said Matt Fabian, senior analyst with Municipal Markets Advisors, a strategy and consulting firm specializing in municipal bonds. Unless the bond market recovers soon, he said, "projects will either be scaled back, postponed, or they'll have to rely more on government revenue."

Government officials and finance experts said the problems in the long-term bond market seem in many ways an irrational reaction among buyers, who normally flock to state and local bonds as a haven during times of economic uncertainty. Municipal bonds are considered extremely safe because governments rarely default.

A major problem for states and localities is that many of the large Wall Street investment houses that underwrote municipal bonds have collapsed, merged with others or fallen on hard times. "The muni industry has lost almost half of its large underwriters," Fabian said.

Also, many of the most aggressive buyers of municipal bonds frequently used borrowed money -- funds no longer available.

States and localities that did venture into the bond market usually found that interest rates had skyrocketed. Some chose to withdraw, while others were forced to pay the higher rate.

"We've seen the cost of variable rate loans for schools to finance projects increased from 3.25 percent on September 12 to 10 percent on September 30," said Liz Boyd, spokeswoman for Michigan Governor Jennifer M. Granholm (D).

Officials from states with no immediate borrowing plans and enough reserves to deal with temporary cash-flow problems said they are not suffering from the credit crunch. But they need it to ease.

Officials from New Mexico, Minnesota, Ohio, Indiana, Vermont and New Jersey, among others, said they have enough revenue to carry them through the crisis.

Local jurisdictions also reported they could weather the storm.

Virginia officials said Friday that they do not plan to ask the federal government for money despite a budget shortfall of as much as $3 billion over two years. "We're working through our budget problems," said Gordon Hickey, a spokesman for Gov. Timothy M. Kaine (D). "We don't need to ask the feds for money. We will balance our budget."

Local officials in Northern Virginia offered reassurance that their books are sound, the result of years of conservative policies.

In Maryland, Deputy Treasurer Howard S. Freedlander said his state is not at similar risk as California because Maryland issues bonds only to pay for capital expenditures, not day-to-day operating costs. Maryland sold bonds last month and does not have another sale scheduled until early March, Freedlander said.

The credit markets froze at the worst possible time for California. The largest state's notoriously unreliable budget process produced a spending plan later than ever before, with Schwarzenegger and the legislature taking until late August to produce the $145 billion agreement. Revenue was sharply reduced by a housing slump that hit the Golden State especially hard.

Only when the budget figures were known could state accountants determine how much money California would need to borrow to tide itself over during the shortfall that usually comes toward the end of each fiscal year on June 30. The figure came to $7 billion.

Normally, it would be raised by bridge loans, money routinely raised to keep the state treasury afloat in the months before April 15, when income tax revenue floods in. The notes must be sold by Oct. 30, when cash reserves will be exhausted. By Friday, not one had been offered.

The typical four-week time line has been "compressed by the late enactment of the budget, and then you combine that with the paralysis in the credit markets. It's made for a scary situation," said Tom Dresslar, a spokesman for the California state treasurer.

For a week and a half, the investment banks California hired to peddle the notes, Goldman Sachs and Bank of America, have told their client the market is simply not functioning. "We haven't actually tried to sell, because we're told it's frozen if you had tried to go into the market," Dresslar said.

With funding threatened for necessities including teachers, police, fire safety and nursing homes, Schwarzenegger e-mailed his plea to Paulson.

Vick reported from Los Angeles. Staff writers Ashley Surdin in Los Angeles, Kari Lydersen in Chicago, and Peter Whoriskey, Anne Bartlett, John Wagner, Anita Kumar and Fredrick Kunkle in Washington contributed to this report.