The City and County of Honolulu is moving to extract itself from exposure to auction rate certificates, an obscure part of financial markets that has been paralyzed by liquidity problems.

Yesterday it said it plans to issue up to $226.2 million in wastewater system bonds, in part to pay off the $106.8 million of auction-rate certificates it issued in 2003. The city has had to pay higher interest rates on the auction-rate bonds since the liquidity crisis hit, and wants to have more certainty about what rates it will pay in the future.

"We're paying a premium that shouldn't be there because there's a problem in this market," said Edlyn Taniguchi, chief of treasury for the city. "It's not a favorable situation anymore like when we first started the program."

The city only has limited exposure to the auction-rate bond market given its total borrowing. And for the most part its dabbling with auction-rate certificates has been a good experience, with borrowing costs on the certificates averaging 2.66 percent versus the 4.5 percent to 5 percent it probably would have paid with fixed-rate bonds.

While fixed-rate bonds' interest rates are set at the time of issue, rates on auction-rate bonds are set periodically, such as 35 days for the city's auction-rate certificates.

This market has operated smoothly for the most part, but the subprime mortgage crisis and resulting liquidity crunch in financial markets touched on auctions of the bonds earlier this year. Nationally, it's estimated most of the rate-setting auctions for $330 billion of certificates and preferred securities in this market is frozen.

An auction setting new rates for the city certificates failed on March 6, triggering a default rate that is now at 5.163 percent.

The city's default rate is tied to a benchmark index and will be reset again if the April 10 auction on their certificate fails. In effect, the certificates have become like an adjustable-rate mortgage that resets every 35 days.

If all goes as planned, the city will be issuing fixed-rate bonds in coming weeks and use proceeds to refund holders of its auction-rate certificates. Taniguchi said a new bond issue hopefully will be done at a lower interest rate since long-term interest rates are at historic lows.

She said just as importantly the city will obtain more stability in forecasting interest costs into the future.

"We don't know if its (auction-rate interest rates) are going up or down, so it's just prudent to fix it right now," Taniguchi said.

HAWAI'I COUPLE LOSES MONEY

The news keeps getting worse for people who invested in auction-rate securities and now can't get their money out because auctions are failing.

Last week Big Island residents Kurt and LaDonna Shively learned the value of their life savings had been cut because they've got it tied up in auction-rate preferred securities, a form of auction-rate instruments that are issued by closed-end mutual funds.

The Shivelys haven't been able to get at their money since mid-February after auctions failed to attract new investors. What's more, instead of resetting at a higher rate because there were no takers, the default rate was lower.

Instead of the about 5 percent they had been receiving, it was reset at about 3.5 percent, LaDonna Shively said.

It's unknown how many people in Hawai'i hold similar auction-rate preferred securities, but nationally it's estimated more than $60 billion have been sold. The Shivelys say they were told the investments were as safe as placing their cash into a money-market account and could be withdrawn with a week's notice.

Nationwide, investors are trying to figure out if they'll ever see their money again, with lawsuits against the investment houses that sold the auction-rate securities facing class-action lawsuits.

LaDonna Shively said the couple has yet to join a lawsuit and is wondering why government regulators aren't taking steps to do something.