Recently, I stumbled across an article entitled, “BABs saves issuers $12 billion, Treasury says.” According to the Treasury, “state and local governments will save $12.3 billion in borrowing costs by issuing federally subsidized taxable bonds, called Build America Bonds, during the first year of the program.” Up until now, I had never heard of BABs, and as it turns out, they were part of the American Recovery and Reinvestment Act of 2009.
But, what exactly is a Build America Bond (BAB)? Build America Bonds are taxable municipal bonds with special tax credits and subsidies. There are two types of BABs: tax credit and direct payment. The former carries a federal subsidy that gives the bondholder a refundable tax credit. The latter carries a federal subsidy of 35% of the interest being paid to the issuer.
In the case of direct payment BABs, according to The Wall Street Journal, “the interest rates paid to investors are higher. But the U.S. government pays 35% of the interest, bringing the amount that” the state or local government pays to less than what “it would have paid with tax-exempt bonds.” For example, consider the “$1.3-billion Build America Bond issued in October to rebuild the San Francisco-Oakland Bay Bridge and make it earthquake-resistant … the amount that the Bay Area Toll Authority [paid] … [was] 4.07% over 40 years compared with 5.5%.”
Unfortunately, one common misconception regarding BABs is that they will make it less expensive for the government, as a whole, to borrow. In reality, the federal government, which is operating at a deficit, must take on additional debt to deliver the promised subsidy. Thus, the federal government must auction more Treasury securities, but only so many securities can be auctioned before the market reacts and interest rates begins to rise. Even if interest rates did not rise, unless the federal government is capable of auctioning Treasury securities at an interest rate below the difference in interest rates between BABs and traditional bonds (i.e., the latter is what state and local governments would normally use), the government, as a whole, is paying more to borrow.
As evidenced by a financial audit performed by the Government Accountability Office (GAO), this is not the case. For 2008 and 2009, the following information was presented:
Although the average interest rate for Treasury Bills, which have a maturity date of less than one year, dropped from 1.6% to 0.3% from 2008 to 2009 (primarily due to the lowering of the federal funds rate), the average interest rate for Treasury Notes and Treasury Bonds, which have maturity dates of one to thirty years, dropped from 4.1% to 3.0% and 7.1% to 6.5%, respectively (interest rates for Treasury Notes and Treasury Bonds are affected less by the federal funds rate in comparison to Treasury Bills). However, since nearly two-thirds of the federal debt held by the public (this excludes intragovernmental holdings) is in Treasury Notes and Treasury Bonds, the average interest rate is well above the 0.3% average for Treasury Bills. In reality, the average interest rate on the debt (including debt held by the public and intragovernmental debt holdings) is approximately 3.2%.
Therefore, in the case of the Bay Area Toll Authority, which paid “just 4.07% over 40 years compared [to the] 5.5% it would have paid with [traditional] bonds,” the government, as a whole, is paying more to borrow.
As a final note, does anyone else besides me find it absolutely ridiculous that the federal government says they are saving us money by loaning it to the state and local governments? One fundamental characteristic of government is its inability to produce wealth; all that it possesses was taken from someone else through taxation of some sort. Thus, the government is incapable of repaying its debts without continued taxation of its citizens. With that said, the BABs program was bogus from the start.Published in