June 7 (Bloomberg) — The bonds designed by the U.S. government to help municipalities recover from the worst recession since the Great Depression may cost them millions of dollars in unforeseen borrowing costs instead of saving them money.
Build America Bonds were part of the American Recovery and Reinvestment Act, passed in 2009. The government offered state and local issuers a 35 percent subsidy on interest costs if they sold bonds on a taxable basis, making such financing cheaper than borrowing in the traditional tax-exempt market. Now the Treasury says it will reduce the BAB subsidies by any amount issuers owe the government.
This would force municipalities to come up with the cash to repay debt service at the same time they are trying to fill holes in their budgets. Three major cities that have discussed chapter 9 bankruptcy this year — Detroit, Los Angeles and Miami — have sold a combined $4.5 billion in BABs. The last thing these issuers need is a surprise.
Issuers have sold more than 1,200 BAB issues totaling $107 billion since last year, making it the most successful program in the $2.8 trillion municipal market.
Pushing municipalities a little closer to the brink of the unthinkable isn’t what those who created BABs, or those who have tapped the market with such issues, had in mind. The state of Florida suspended BAB sales until the government guarantees the subsidy.
Good for Florida for taking a stand.
Not Everyone Loves BABs
Some people have always been suspicious of BABs.
Purists said it was a way for the Treasury to kill the tax- exempt market, which it has been trying to do for years, because it regards tax-exemption as an inefficient subsidy.
Some issuers — I haven’t come across any, although some bond lawyers and bankers assure me they are out there — were wary of the program because they feared that the 35 percent subsidy would be reduced or done away with.
And some people disliked BABs because the program, they said, encouraged municipalities to go out and borrow money for needless projects.
State tax-supported debt increased by 10.3 percent in 2009, Moody’s Investors Service said in its “2010 State Debt Medians Report” published last month. This was double the rate posted in 2008 (4.7 percent) and 2007 (5.1 percent). You have to go back to 2003 (16.8 percent) and 2004 (11.7 percent) to find similar increases.
Is This Necessary?
States borrow more in hard times. The BABs program encouraged them to borrow even more than they might have. What we’re now seeing looks like a public finance bait-and-switch.
Except it’s not: “According to Treasury officials, this withholding practice is required by law and must be implemented when a state or locality or other governmental BABs issuers owes the federal government for any programs even if it is unrelated to debt issuance,” Moody’s explained in a report last week.
Most borrowers budget for 100 percent of debt service costs, said Moody’s, so repaying bonds isn’t the issue. Adding to budget shortfalls is. “Any diminution of interest rate subsidies will reduce an issuer’s ability to pay other bills and, over time may overburden available resources and put negative pressure on ratings,” Moody’s said.
BABs were supposed to save governments money and encourage them to tackle deferred capital projects. It wasn’t supposed to cost them money. You have to wonder, with state and local finances in such a parlous state: Is this necessary?
IRS Audits
In other BABs news, the Internal Revenue Service told the National Association of Bond Lawyers last month that it is going to conduct audits on perhaps half the BABs that have been sold, although it backtracked on that number last week. They’re still going to audit a slew of BAB issues.
The IRS is interested in how the bonds were priced. I know issuers don’t like it, but as a taxpayer, I do. One of the very first things we saw when states and localities started to sell BABs last year was the wide price disparity between where new issues were priced, and how they traded a few days later.
Of course, that wasn’t the question. The question was: Did you pay any attention at all to how the bonds were priced? Because it looks as though you could have done a lot better.
I suspect we know the answer to that question already.
–Editors: James Greiff, David Henry
To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net
To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net
Courtesy Bloomberg
