Monday night’s compromise on extending the Bush tax cuts and unemployment insurance also kept alive policies that were introduced in the 2009 stimulus package — but one was conspicuously left out.
From Bloomberg Businessweek:
An extension of the U.S. Build America Bond program was left out of a compromise that President Barack Obama struck with congressional leaders to prolong tax cuts enacted in 2001 and 2003, White House officials said. …
The fate of the Build America program, which Obama has sought to extend, may be determined by a six-member panel headed by Treasury Secretary Timothy Geithner, the White House officials said. Panel members were appointed by Obama and congressional leaders to negotiate tax issues.
The proposal under consideration would have extended the programme, with a decrease in the federal subsidy on the interest payments on these taxable bonds from 35 per cent to 32 per cent.
According to the Bond Buyer, the bill was opposed “because the Senate’s lead Republican negotiator, Jon Kyl, R-Ariz., has been a harsh critic of the program, which is set to expire on Dec. 31.” His primary complaint was that the subsidy led states and localities to borrow more than was implied by their credit ratings. Of course, the point of Build America Bonds was to make it easier for conventional issuers of muni debt to compete with yields offered by corporates.
Much was made of the big rise in muni yields last month. But we liked Bond Girl’s excellent assessment, which was that it had less to do with a sudden fall in the credit-worthiness of issuers than with a spike in supply induced by the expectation that the Bab program would indeed expire:
The pending expiration of the Build America Bond (BAB) program has pulled supply forward, and this is going to seesaw over the next several weeks. Since the BAB program was initiated, most issuers have structured their new issues with the sense that they will go to either the tax-exempt or taxable market, whichever is more advantageous at the time. It has been almost completely a supply management game since the market for these bonds was established and munis became truly bifurcated. …
What is going on now is that muni issuers are scrambling to get deals done to take advantage of the program before it expires, and this is pulling the number of new issues that would ordinarily be coming to market forward. So the looming expiration of the BAB program is creating the very conditions it was created to alleviate. Issuers are very conscious of this fact, and that is why a large number of deals are getting pulled. As more issues get pulled and supply is reduced, there will be some relief on rates, which I think is what happened today. But you can expect that muni issuers will be dancing around this until the program expires at the end of the year, so there will likely be significant volatility. There is also considerable uncertainty as to how supply issues will play out in the first quarter of 2011. The BAB program may expire, but the social-economic-political realities behind why it was established in the first place have not materially changed. It is also difficult to gauge investor demand for tax-exempt bonds when no one knows how investors will be taxed. Since our esteemed policymakers are almost guaranteed to twiddle their thumbs and “study” their options, I doubt that the muni market will reflect fundamentals any time soon (although that is pretty much true for the financial markets as a whole).
This was written on November 19, but it has proved prescient and remains entirely applicable now. As Bond Girl also notes, the program was initially put in place to make municipal debt appeal more to non-traditional classes of investors (foreign buyers, pension schemes). Why? Because traditional investors were reluctant to buy, and states and localities were having trouble selling.
There’s still a (slim) chance that a deal will get done on extending the program. But if it doesn’t get done, then it’s hard to say just what will be the impact on municipalities who need to seek funding next year, or on outstanding municipal debt.
Meanwhile, sensing an opportunity, analysts at Citi and JPM are advising clients to buy Bab bonds now after their yields have climbed this month. Their reasoning, via Bloomberg:
The rising yields, which move inversely to prices, make Build Americas a relatively good value for investors now, as an anticipated lack of supply of the debt in the first three months of 2011 will likely drive rates back down, according to Citigroup.
Sounds reasonable, but this seems like a zany market right now, and any prediction on where it is headed in the near future is probably bolder than it appears.
Related links:
Some thoughts on the muni market – self-evident
Build America left out of deal to cut taxes – Bloomberg Businessweek