BUILD AMERICA BONDS- BABs

BUILD AMERICA BONDS

BAB’s

Build America bonds (babs) which were included in the American Recovery and Reinvestment Act on Feb. 17^th, made their debut in April of that year. By the end of the month the New Jersey Turnpike Authority had sold 1.32 billion of the bonds. In nearly every issue that was brought to the market they were far oversubscribed (too many buyers for too little bonds).

BABs are a new form of government bond like municipal bonds, however, unlike munis, the interest you receive is taxable, and that can make a big difference in a state like California who has one of the highest state taxes there is.

There are two general types of Build America Bonds. In the first version issuers receive a subsidy from the federal government equal to 35% on the interest paid to investors who bought the bonds. This allows issuers to issue the bonds at a higher interest rate, making them more competitive with the rates paid by corporations. Early in 2009 a massive issue went to market they paid a handsome 7.4% to their investors, however, due to the tax break the issuers had only to pay 4.48 percent and the government picked up the tab on the rest.

In the second version, the BAB bond holders themselves receive a tax credit from the federal government equal to 35% of the interest on the bond each year. If the bond holders tax liability is insufficient to use the entire 35% it can be carried over to latter years.

The government will be offering the bonds throughout the rest of 2009 and all of 2010. Sounds like a great idea right? Here’s the problem; you can’t get them. Remember, they have all been oversubscribed. That’s not entirely true. This is no surprise. Traditionally, individual investors drive much of the traffic in the municipal bond market. Tight credit markets have forced municipalities to offer higher interest rates to attract buyers. Couple this with the fact that institutional investors are seeking stable, long-term sources of income, the fact that BABs are being issued in long denominations (California's issue was a 30-year bond) and that issues are not offering a period of time set aside for what are known as "retail" orders, and institutional investors are able to buy up the bonds. Since every issue has been oversubscribed, there are none left for the retail market.