Build America Bonds Catching On; Could Spell End for Tax Exempt Munis

Actually I don't think tax exempt municipal bonds will go the day of the dodo, but the success of the Build America Bond program is making many wonder if the tax exempt muni market is going to shrink significantly in the future.

According to a recent Bloomberg article:

"Build America bonds, taxable securities that pay 1 percentage point more in interest than corporate debt on average, are such a hit with investors that the government is already considering expanding the program, according to John J. Cross, the Treasury’s tax legislative counsel. Municipalities sold $14.4 billion of the securities and Barclays Plc analysts predict the amount may grow 10-fold because the federal government helps pay the bonds’ interest.

The debt -- which finances everything from roads to schools to electric lines -- is helping Obama create jobs and may allow him to rein in the municipal market, where $2.7 trillion of bonds are outstanding, according to Ann-Ellen Hornidge of Mintz Levin Cohn Ferris Glovsky & Popeo PC, a law firm in Boston. Presidents since Franklin D. Roosevelt have tried to tax the interest payments from municipal bonds without success. "

Many other Presidents over the past 30 years have tried to curtain the municipal bond market but have failed due to protests from the States. But the financial crisis presented the Federal Government with an opportunity to step in and quickly set up the program. And so far, States and Municipalities like it. Why shouldn't they? The government agrees to pay 30% of the interest cost on the debt they issue.

Investors also benefit. In general Build America Bonds pay up to 1% point more in interest than corporate bonds of the same term, but with much lower risk. The Utah Transit Authority, which is rated AAA, sold $261.4 million of 5.94 percent Build America securities maturing in 2039 on May 21 that yielded 6.41 percent. At the same time, Microsoft Corp also sold bonds rated AAA in May with a yield of 5.65 percent.

For the program to be successful, the Build America Bonds will have to offer a tax-free equivalent that is as good or higher than what investor can get with tax-exempt municipal bonds. While this should be relatively easy for investors in lower tax brackets, it will be more difficult for those in a high tax bracket, who must receive a higher yield to make up for the higher taxes they will have to pay.

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