Build America Bonds Program's End Poised to Batter Municipal-Debt Market
The looming end of the federally subsidized Build America Bonds program may push up yields in the $2.8 trillion municipal securities market and put more financial pressure on cash-strapped states and cities, investors said.
Senate Democrats backing the subsidy, which has helped finance bridges, roads and other public works, fell short in a bid to get the program added to a bill extending the 2001 and 2003 income-tax cuts. That failure was the latest in efforts to keep the Build America program alive beyond its scheduled end on Dec. 31.
The securities, which carry taxable interest rates similar to corporate debt, have allowed state and local governments to access investors abroad and others who don’t buy traditional tax-exempt bonds. That has eased the supply of tax-exempt bonds and buoyed prices, which move inversely to yields, a trend that may reverse next year if the program is killed.
“It could get pretty ugly,” said Rob Novembre, managing director at Arbor Research & Trading Inc. in New York, who runs the company’s municipal-trading operation. “Whoever owns munis could potentially experience some pain.”
Build Americas were created under President Barack Obama’s stimulus legislation as a means of driving down borrowing costs for localities and funneling money to job-stoking construction projects. More than $179 billion of the securities have been sold since April 2009, funding clean-water projects in Ohio, highways in Kansas, dormitories at Rutgers University in New Jersey and a new bridge spanning the San Francisco Bay.
‘Great Success Story’
“The BABs program has been a great success story,” California Treasurer Bill Lockyer said in a statement today. “If Congress lets it expire, it will damage our economic recovery and inflict a multibillion-dollar injury on taxpayers, not just in California but in every state in the nation.”
California and local issuers in the state have sold about $36 billion of the taxable debt, he said. In an interview today on Bloomberg Television’s “InBusiness With Margaret Brennan,” Lockyer said the Build America program has helped create “tens of thousands of jobs.”
While Obama and Democrats have supported prolonging the program, they have run into opposition from Republicans critical of the stimulus package. Extensions have twice passed the Democratic-controlled House only to stall in the Senate, where the Republican minority has sufficient power to block legislation. The U.S. government pays 35 of the interest costs on Build America bonds.
Republicans Taking Control
With Republicans poised to take control of the House next month, local governments, banks and other advocates have pressed to extend the Build America program during the current so-called lame-duck session of Congress. Analysts including those at JPMorgan Chase & Co. had anticipated that a measure to prolong Bush-era rates would be the vehicle for Congress to extend it.
State and local governments, the U.S. Chamber of Commerce and representatives of the construction industry are among the program’s advocates.
The prospect of its end has weighed on the municipal bond market as public officials have rushed to borrow money at subsidized rates. The San Francisco Utility Commission, which plans to issue $350 million in Build America Bonds next week, put the securities to market months ahead of schedule to ensure it would capture the subsidy, said Charles Perl, deputy chief financial officer of the commission.
“We were trying to beat the clock, so we fast-tracked the financing to take advantage,” he said today.
Investors have expressed concern that traditional tax- exempt debt issuance might surge next year. That may push up the interest-rates investors demand to hold tax-exempt bonds. It would most heavily hurt long-dated bonds, where issuance of Build America securities was concentrated, investors said.
California’s Lockyer estimates the end of the program may push up tax-exempt yields by as much as a full percentage point, which he said could cost taxpayers nationwide as much as $30 billion in higher borrowing costs.
“This can’t be positive for the long end of the curve,” said Ed Reinoso, who manages $300 million as chief executive officer of Castleton Partners in New York. “It’s going to be a lot more expensive for issuers.”
The tax-exempt market is dominated by individual investors seeking income-tax breaks. Households own more than $1 trillion in municipal bonds directly, while almost $1 trillion more are held in mutual funds where individuals invest, according to the Federal Reserve Board.
Last month, tax-exempt bonds had their worst monthly returns of 2010 as rising U.S. Treasury yields and record state and local debt sales sparked withdrawals from mutual funds.
Tax-free securities lost 2.29 percent in November, the third consecutive monthly drop and the longest slide since 2004, according to the Bank of America Merrill Lynch Municipal Master Index, which accounts for price changes and interest income.
The failure by Congress to extend the Build America program may hurt taxpayers by pushing up the cost of financing local projects at a time when public officials are already wrestling with budget deficits, said Novembre.
“They could be putting their own voters in harm’s way,” he said.
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