BOSTON (Bloomberg) - The fallout from the collapse of the auction-rate bond market has infected New Hampshire, where the state college and university system was forced to tap its reserves to cover more than $1 million in extra borrowing costs.

"It hurts," Ken Cody, associate vice-chancellor of finance for New Hampshire's state college and university system, said in a phone interview. "We have very limited resources."

Yields on the system's bonds rose to as high as 7.8 percent last month from 3.9 percent in January after auctions run by Wall Street firms failed, depleting funds for campus maintenance, Mr. Cody said. The system converted $84.3 million of bonds to debt with fixed payments and plans to bid at an auction of its remaining $63.6 million of securities this week to reduce rates, he said.

New Hampshire is among municipal borrowers likely to offer to buy their own securities after the US Securities and Exchange Commission said March 14 that the bids wouldn't run afoul of laws against market manipulation. Lehman Brothers Holdings Inc., which managed the auctions, prevented the system from bidding last month, Cody said.

The $330 billion market for auction-rate securities imploded in February after dealers who supported it for more than two decades stopped bidding for bonds investors didn't want, pushing interest costs to as high as 20 percent. Since then, almost 70 percent of the auctions for debt sold by cities, colleges, student lenders and closed-end funds have failed each week, according to data compiled by Bloomberg.

Auction-rate bonds have interest rates determined through bidding run by dealers every seven, 28 or 35 days. When there are not enough buyers, the auction fails and rates are set at a predetermined level set in documents when the bonds were issued. Bondholders who wanted to sell are left holding securities.

Auction rates on debt that resets every seven days were 6.41 percent as of March 12, up from an average 3.94 percent in the previous year, according to a Securities Industry and Financial Markets Association index. The average rate reached a high of 6.89 percent on February 20.

Zurich-based UBS AG, Europe's biggest bank by assets, was sued on March 14 by a client for investing in auction-rate bonds. UBS marketed the securities as being "just as good as cash," according to the complaint filed in Manhattan federal court. A UBS spokeswoman, Kris Kagel, said in an e-mailed statement that the bank is "working with clients on a case-by- case basis, to restore their immediate liquidity needs."

Issuers from Cleveland to Chicago's school system to Jefferson County, Alabama, which was downgraded to below investment grade as a result of the higher auction costs, face resets on their debt this week.

The Port Authority of New York and New Jersey, owner of bridges, tunnels and airports around New York City, sold $700 million of bonds on March 12 to refinance auction securities after rates on its debt soared to 20 percent Feb. 12 from 4.3 percent the week before.

State and local governments sold more than $20 billion of bonds the past two weeks, about the same amount for all of February, data compiled by Bloomberg show. About $4.2 billion of bonds are scheduled to be offered this week, including Wisconsin, which is selling $965 million to replace auction debt.

As issuers rush to get out of auction debt, the new bonds they sell are weighing on the municipal market. Long-term tax- exempt municipals fell last week, pushing 30-year yields five basis points higher to 4.88 percent, Municipal Market Advisors data show. A basis point is 0.01 percentage point.

"There's been a big move up in yield," said Anthony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York. The higher yields are an "opportunity," said Mr. Crescenzi, and his company is establishing an asset management division to buy municipal bonds.

The bonds, which are tax-exempt, yield more than Treasuries, whose interest is taxable. The 30-year Treasury bond yielded 4.36 percent on March 14.

The University System of New Hampshire converted two series of its auction-rate securities last week to one-year bonds yielding three percent, according to Mr. Cody. The $84.3 million in debt is insured by Ambac Assurance Corp.

Ambac, a unit of New York-based Ambac Financial Group Inc., was cut to AA from AAA by Fitch Ratings in January. It is still rated AAA by Standard & Poor's and Moody's Investors Service. Concern that the creditworthiness of bond insurers may deteriorate amid writedowns on debt tied to sub-prime mortgages led investors to shun debt backed by the guarantees.

New Hampshire's university system has $63.6 million in auction debt outstanding insured by XL Capital Assurance, which was downgraded from AAA by all three rating companies. It will convert that debt to variable-rate demand bonds this month, Cody said.

"It's worse than worthless," he said about the XL insurance. The system is also converting $97.3 million in variable-rate demand bonds insured by XL, a unit of Hamilton, Bermuda-based Security Capital Assurance Ltd. Rates on that debt rose to 11.1 percent last month, accounting for almost half the higher borrowing costs the school is confronting, Mr. Cody said.