Lost in the ideological battles over fiscal stimulus is one newly authorized
program that is already delivering results: Build America Bonds (BABs).
Unexpected demand has transformed this once-obscure component of the federal
stimulus legislation into the hottest bond since Daniel Craig.
California, the University
of Minnesota, the New Jersey Turnpike
Authority, and the New York Metropolitan Transportation Authority have been
among the first to issue this new class of municipal bond, which could
transform how America
finances its 21st-century infrastructure needs.
led the way with a $5.23 billion sale of BABs, a move that State Treasurer Bill
Lockyer says will save the state $1.15 billion over the next 30 years.
Just weeks after the program began, sales have reached $10 billion. Market
experts now predict that $50 billion in BABs could be sold this year,
representing more than 10 percent of the annual municipal-debt issuance.
So how do BABs differ from conventional municipal bonds (munis)? The gist is
that BABs alter the federal subsidy for state and local infrastructure
investments to more efficiently tap private bond markets.
Conventional munis are subsidized through tax exemptions: Bondholders pay no
income tax on interest payments received from the issuer. This setup offers no
financial incentive for many categories of potential investors, such as pension
funds and endowments, that already operate tax-free.
By contrast, BABs, which must be used for capital expenditures, are taxable
bonds subsidized at 35 percent. This subsidy is available either as a tax
credit to the bondholder or a direct cash payment to the local issuer. Taxable
bonds offer investors a higher rate of return in exchange for relinquishing a
portion of their interest income. That's why BABs offer investors more bang for
their buck than conventional munis. And because the tax credit is paid to the
issuer, purchasers of BABs need not be taxpayers, opening up a new market for
state and local government debt.
Whereas municipal bonds are seen as a staid, small-bore asset class, BABs
operate more like corporate bonds, with the security of semi-sovereign credit.
Their surging popularity is crowding out the supply of conventional munis,
raising prices and lowering yields.
All told, with the new subsidy in place, state and local governments should
find it cheaper and easier to access capital markets to finance their
BABs look like a win-win-win for cash-strapped local governments,
risk-averse investors, and beneficiaries of new infrastructure investment.
To be sure, the first issuers may have gotten a raw deal: BABs have proved
so popular in secondary trading markets that their yields have fallen
substantially, an indication that early investors underpaid.
We must therefore continue to monitor the program. Last fall's financial
crisis and concerns about state budget solvency wreaked havoc on municipal bond
They may be less visionary than a National Infrastructure Bank, and less
hot-button than the direct spending that's also part of the stimulus, but BABs
have gotten the money flowing again.