We keep reading that we live in the era of deleveraging, when everyone borrows less. But if that’s true, there is one great exception: government. U.S. cities, states and the feds have issued more than $2.5 trillion of new debt since 2008, with another nearly $2 trillion scheduled in 2010.
So now the Obama Administration and Congress are moving to subsidize even more federal and municipal borrowing through a program called Build America Bonds. These are a new type of state and local municipal bond, authorized by the 2009 fiscal stimulus bill as a temporary way to help open credit markets that were frozen. They no doubt did some good in the crisis, but naturally the politicians can’t leave well enough alone and now want to make it permanent.
Unlike traditional munis, these new bonds aren’t tax-exempt but rather carry a direct federal subsidy of one-third of their interest payments. Thus on a bond with a 7% interest rate, the issuing city government pays roughly 4.5% of the interest, and the feds pay 2.5%. These bonds also expand the pool of muni bond purchasers to nontaxable entities, such as pension funds, foundations and foreign investors. Conventional munis are mostly purchased by individuals in high-tax brackets. Treasury is proposing to reduce the federal subsidy to 28% of the interest but make it permanent.
There’s no denying that direct subsidies for local debt have been a hit with Wall Street, mayors, state legislators and unions. In 2009 nearly 800 states and localities issued some $58 billion of these new bonds, more than twice what was expected. The New Jersey Turnpike Authority sold $1.3 billion of Build America Bonds last April, five times more than the $250 million it originally needed, because investor demand was so great. Evansville, Indiana is financing a $127 million sports stadium thanks to the federal largesse.
The Securities Industry and Financial Markets Association estimates that another $85 billion in Build America Bonds will be sold this year, on top of $450 billion more in new tax-exempt bonds.
Meanwhile, Wall Street firms have pocketed more than $1 billion in fees in less than a year from selling the bonds. Average underwriting fees are $8.20 per $1,000, according to a March 10 Journal story, compared with traditional tax-exempt fees of between $5 and $6 per $1,000. Goldman Sachs, a major Build America Bonds underwriter with some $10 billion in sales, has taken out advertisements urging Congress to make the program bigger and permanent. This is one banker bonus the politicians don’t seem to mind.
We aren’t surprised that everyone with government connections is happy when Washington pays cities and states to borrow more money. But no one mentions the downside: Build America Bonds will add hundreds of billions of dollars of new liabilities to the balance sheets of cities, states and Uncle Sam.
This new subsidized borrowing comes when governments are already buried in debt they will struggle to repay. States and cities are expected to run deficits of more than $100 billion in each of fiscal years 2010 and 2011. California, which has a $20 billion annual deficit and the worst bond rating of any state at A-minus, issued another $5 billion under the program last year. It was the state’s biggest debt offering in history. The New York Metropolitan Transportation Authority, which can barely pay its bills, plans to auction $600 million of the new subsidized bonds soon.
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New Jersey Turnpike construction
States and cities face $1 trillion to $2 trillion of additional unfunded liabilities in opulent state employee pension and health-care plans. Even as states can’t maintain their roads and bridges, politicians have diverted hundreds of billions in tax money to finance salary and pension increases for government workers. Build American Bonds subsidize states and cities so they can avoid a day of reckoning over those benefits.
Build America Bonds are also expanding federal costs much faster than expected. Over the life of the up to 30-year bonds, Uncle Sam could owe up to $90 billion in interest. The program’s first-year cost of $1.38 billion already exceeds what the White House estimated it would cost over three years.
The recent jobs bill extended Build America Bonds through this year, and the House wants to add another three years. But the federal government already subsidizes local borrowing through the muni bond tax exemption, and the nation doesn’t need another bonus for Wall Street and spendthrift states and cities.