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Let BABs Die
The Sunday talk show economic topic was what to do with the Bush tax
cuts that expire at the end of this year. I thought I heard a unanimous
voice from the likes of Zandi, Corzine, Tyson and (surprisingly
/importantly) Senator Corker (R.Tenn.) that Congress should act quickly
to agree to do nothing on those tax increases for at least another year.
Look for that terrible choice to be made sometime in the next month.
There is another government program that is headed for the sunset New
Year’s Eve. The Build America Bond (“BAB”) subsidy program was one of
those “emergency” measures taken back in 09. The program was part of the
ARRA stimulus legislation. This deal has Wall Street "deep thinking"
all over it. I think it is a legacy idea from Hank Paulson. Geithner
probably took some notes at a meeting in 08 and a year later it was law.
One of the many risks to the economy back then was whether the
municipalities across the country would be able to access the capital
markets to fund big ticket projects like schools, water treatment and
other infrastructure investments. BABs addressed the problem by allowing
the municipalities to fund in the taxable market. The audience for
taxable bonds is very big. BABs opened the door for muni’s to issue
taxable debt. However, when issuing taxable debt those same borrowers
faced a much higher cost than if they had issued tax-exempt securities.
Muni’s trade about 20% richer (historical) to taxable because of the tax
break. To offset this cost and to encourage local governments to borrow
and spend Uncle Sam has agreed to rebate the borrower for 35% of the
interest expense.
I expect that the BABs legislation will be rolled into the Bush tax
roll-over and they will both be extended for at least another twelve
months. Shame on us. BABs should die because:
-This was an emergency measure. It was deliberately keep on a short time
frame. This stopgap measure is no longer needed economically. But more
importantly we need to get off the federal life support and see how the
patient is breathing.
-Tax-exempt muni yields have collapsed. Even California bonds have been a
big winner. Their five-year yields have fallen from the 4’s to the 2’s.
A graph of the price action:
There is no justification for extending BABs looking at this graph. There is no shortage of demand for municipal bonds.
-Since the program began $123b of long term BABs have been issued. The
average coupon was ~5%. That comes to $2B (and growing) per year for a
very long time. This is just a stupid way of spending spare federal
dollars.
-The Muni market is about $2.8T. It is a very large and well-developed
market. The BABs issuance has competed with the traditional tax exempt
issuance. If allowed to continue there will be two negative
consequences. (1) The depth of the Muni market will be negatively
impacted. (2) Taxable issuance of Muni’s will compete with the corporate
bond sector. The latter is a non-issue today. But wait a year or two
and watch the pendulum swing.
-BABs enables municipal borrowing. This is at the heart of the matter.
Should we have policies that encourage more debt? With few exceptions,
the “deciders” would say “yes”, more debt is good. It is true that
DEBT=GROWTH. And we all know the deciders are desperate for growth.
-Possibly the most compelling argument against extending the BABs
legislation is a review of who is supporting it. High priced lobbyists
paid for by the big shots on Wall Street. From The Bond Buyer:
According
to congressional lobbying records and interviews with market
participants, 78 organizations have either hired lobbyists or lobbied on
their own for BABs, and as many as 202 lobbyists have taken on the
issue since the taxable stimulus bonds were created in February 2009.
But activity spiked most noticeably this year, as muni market
participants began pushing for a BAB extension
Goldman
reported in March that it earned $54 million to underwrite $34 billion
of BABs and charged slightly higher fees for BABs than for tax-exempt
bonds.
Bank of America NA, Citigroup Management Corp. and Goldman have all reported BABs in lobbying records since last fall.
Wasn’t FinReg supposed to fix this stuff? Nah…
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Isn't the BAB subsidy for taxable muni bonds roughly equivalent to the foregone tax revenue from a tax-exempt muni bond? The only difference I can see is that it is arguably a more efficient use of tax dollars since the value of the subsidy isn't dependent on the tax bracket of the bondholder, as it is with tax exempt bonds, which are consequently too rich for highest-bracket holders. Seems like the US Treasury is trying to push municipal issuers into the taxable market, possibly as a prelude to eventually removing the tax exemption.
That is the theory, not the reality. Much of this paper has ended up in non taxed accounts like overseas investors. Also the effetive tax rate for most investors is pretty low. It is not 35%. As a guess, the tax income back to the feds is at most 15%. Therefore the subsidy is 20%.
If they did away with the tax break for munis it would detroy a 2.8 T market. They are dumb, but not that dumb. (I hope)
Obama has proposed to extend this at a 21% rebate back to the borrower. This is an effort to get budget neutral on this.
I would expect that they keep the 35% for a few more years, then pare it down to 20% over the next five. This subsidy will become a permanent feature.
Someday we will face tight money conditions. When that happens the Muni market will be closed. The ability to issue taxable debt will compete with the private sector under those conditions. That is a 'black swan' situation.
If Munis became taxable Federally, US Treasuries
would become taxable by states and sales would drop.
Citizens currently by how much ? 60-65%?
They should kill the Bush tax cuts. Which costs more BABs or the Bush tax cuts?
BABs is cheap. Billions over a few years. The Bush tax cuts are worth Trillions.
Bruce is more interested in grilling Democrats. The Bush tax cuts and Bush's sleeping on the job with regulation, and allowing credit markets to run wild is the real cause of this mess. But that would mean having to blame 8+ years of Republican policies and Republican spending that goes all the way back to Reagan. Mr. Krasting isn't interested in that. Want to know the real start of this mess??? See here:
http://www.huffingtonpost.com/hale-stewart/ronald-reagan-fiscal-disa_b_8...
FYI I am a lifetime Dem. On some issues I am a commie. When it comes to money I am on the far right.
This particular thread misses the entire point. The BAB's - as Bruce accurately describes them - is just a wasteful program that will likely have any number of unintended consequences. Hundreds upon hundreds of these types of follies exist in the government. It's not a political statement per se...
Whatever helps to bring down the Ponzi faster.
Thanks for bringing this up Bruce.
There are plenty more reasons to do away with BABs.
They will most likely become a Trojan horse of Federal mandates on local sovereignty. This is a retroactive trap of a subsidy much like the TARP program.
BABs are more naturally underwritten in NY for international distribution. This is a slap down to the regional underwriting business; it promotes east coast shenanigans into local vendor dynamic. This moves underwriting spread profits to NY. It is similar to how TBTF is destroying community banking.
Treasury models that they get back almost all the subsidy payments in tax receipts. Yet, BABs are being distributed into tax-qualified accounts and to foreign investors in a much larger percentage than expected. This negates the neutral trade-off of the subsidy.
The BAB program is a giant sucking sound of power flowing to NY and Washington. Arizona immigration laws are a sideshow.
The major problem with BABS is that they are another
profit center for their underwriters thusly.
They close the deals, keep most of the bonds,
age them a bit and then mark them up 5 points
BEFORE ANY investors can buy them.
BABS = ABSOLUTE SCAM !!
My Gawd, is there no end to this onslut of greed?? Even street whores have some morality. If I were Gawd and had to acknowledge that these were my creations I would ask the Devil for absolution of my limitations. Milestones
Since there is no good economic reason for BAB's to exist and since they most likely have adverse consequences for both the tax-exempt market and the corporate bond market, I predict they will be extended and that the program will be expanded.
Wasn’t FinReg was supposed to fix this stuff?
CONgress set up a blue ribbon suckfest panel on why we had this economic collapse. Final report due out in December, after Nov. elections of course, convenient? Answer this, asked by Santelli of CNBS. "Why was FinReg passed before the blue ribbon suckfest concludes? hmmm
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