The Build America Boondoggle

Forbes ^ | 11/6/2009 | Matthew Craft

[bruinbirdman]

Taxpayers get a 20 year bill for a problem the bond markets fixed in 6 months.

The Obama administration famously refused to bail out California earlier this year on the rationale that one state bailout could well become 50. But thanks to the Build America Bonds program, part of the stimulus package passed in February, the federal government is committed to covering a portion of interest payments on at least $8 billion of the state's taxable debt for decades to come. In effect, what California saves by selling Build America Bonds gets billed to U.S. taxpayers.

States, led by California and Texas, along with cities and even universities have relied on the program to sell more than $50 billion in Build America Bonds since April. The taxable bonds are a cheaper form of borrowing for cities and states than standard tax-free municipal bonds because the federal government picks up 35% of the interest – through either a tax credit or a direct payment.

The problem, critics say, that taxpayers will pay a bill for decades to fix what the bond market – now that it's healthy again – could well handle on its own.

When the program was created in the thick of the credit crisis, investors wouldn't touch bonds unless they were backed by the U.S. Treasury, and many worried that municipal issuers would be shut out of the debt markets. Build America Bonds were meant to keep the market for municipal debt open by appealing to buyers like pension funds, endowments, and foreign central banks. Such investors have typically shunned munis because the tax exemption means nothing to a pension that doesn't pay taxes anyway. Demand from these new investors would lower borrowing costs for struggling towns and cities.

So far, everybody seems to love them. Investors like