‘Build America Bonds’ Building Debt?
by Ashley Muchow Steve Malanga’s article in the WSJ today covers a topic that is both timely and closely connected to Illinois’s deteriorating fiscal condition. One measure about to reach the lame-duck Congress floor is a call to extend Build America Bonds (BABs)–bonds used by states and municipalities to accrue nearly $160 billion in new debt...
by Ashley Muchow
Steve Malanga’s article in the WSJ today covers a topic that is both timely and closely connected to Illinois’s deteriorating fiscal condition.
One measure about to reach the lame-duck Congress floor is a call to extend Build America Bonds (BABs)–bonds used by states and municipalities to accrue nearly $160 billion in new debt over the last year and a half.
According to Malanga:
Build America Bonds were created to re-energize the municipal bond market, which contracted sharply in late 2008. Investors had become wary that the credit crunch would spread to municipals, as insurers who back state and local bonds got hurt in other markets and stopped insuring public debt. Facing declining tax revenue and growing deficits, some local governments suddenly couldn’t borrow.
How have these bonds impacted Illinois’s fiscal condition?
One sure signal has been the sharp rise in the cost for investors to insure against default. In June, the price of a contract protecting an investor from a default by Illinois on its bonds rose to a record high of $309,100 on $10 million of debt over five years, according to CMA Datavision. The national average for states is $190,000 per $10 million in debt. At that point, Illinois surpassed California as the worst credit risk among U.S. states.
A more telling signal was that, based on the cost of insurance contracts, CMA Datavision listed both states in June among the 10 biggest government default risks in the world. Illinois was at greater risk of default than Iraq. Yet thanks to the BAB subsidy, Illinois was still able to borrow some $300 million in bonds by offering a 7.1% interest rate.
Yes, that’s right, Illinois was still able to rack up its debt by some $300 million by offering a worthwhile interest rate to entice brave investors. We blogged on this issue in July when Illinois trumped California for the worst bond rating of all 50 states. Illinois now has a greater risk of default than Iraq.
It hasn’t always been like this. Illinois has only been downgraded 17 times in its entire history, most coming in the last 8 years.
Why is Congress deliberating to extend BABs when they were strategically designed to end in 2010? Malanga writes:
Dozens of governments and other municipal issuers (like New York’s Metropolitan Transportation Authority and the University of California) have hired lobbyists to push Congress to extend BABs beyond this year. And in its 2011 budget, the Obama administration proposed making Build America Bonds permanent, with an interest-rate subsidy of 28%.
The Obama administration believes the BABs’ direct federal subsidy is a more efficient way to raise money than traditional tax-free municipals.
Aside from the fact that state and municipal governments are in desperate need of tangible revenue rather than more borrowed funds, when funds that would otherwise go to private business flows into federally subsidized government activities, resources are misallocated and the U.S. economy is worse off because of it.
Malanga argues:
There is also a future bailout risk, given that the federal government might not allow a state or local government to default on a Build America Bond. None of this is what voters signed up for on Nov. 2.