Build America Bonds (BABs)

Introduction

When it comes to financing infrastructure projects, governments often face challenges in raising funds. One innovative solution that emerged in the aftermath of the 2008 financial crisis is the Build America Bonds (BABs) program. BABs have gained popularity due to their ability to attract investors and provide a cost-effective way for governments to fund public projects. In this article, we will explore the concept of Build America Bonds, their benefits, and their impact on the financial market.

What are Build America Bonds?

Build America Bonds are taxable municipal bonds issued by state and local governments in the United States. These bonds were introduced as part of the American Recovery and Reinvestment Act of 2009 to stimulate economic growth and create jobs in the aftermath of the financial crisis. Unlike traditional tax-exempt municipal bonds, BABs offer taxable interest income to investors.

The key feature of BABs is that the U.S. Treasury Department provides a direct subsidy to the issuer, covering a portion of the interest payments. This subsidy, known as the “tax credit,” allows issuers to offer higher interest rates to investors while reducing their borrowing costs.

The Benefits of Build America Bonds

Build America Bonds offer several benefits to both issuers and investors:

• Lower borrowing costs: The direct subsidy from the U.S. Treasury Department reduces the borrowing costs for issuers, making it an attractive financing option for infrastructure projects.
• Attractive yields for investors: Since BABs offer taxable interest income, they provide higher yields compared to tax-exempt municipal bonds. This makes them appealing to investors seeking higher returns.
• Increased investor base: The taxable nature of BABs attracts a broader range of investors, including pension funds, insurance companies, and foreign investors who may not benefit from tax-exempt income.
• Job creation and economic growth: By financing infrastructure projects, BABs contribute to job creation and economic growth, fulfilling their original purpose.

Case Study: California's Use of Build America Bonds

One notable example of the successful implementation of Build America Bonds is California's use of this financing tool. Facing a significant budget deficit and a need for infrastructure improvements, California issued a series of BABs to fund various projects, including transportation, education, and water infrastructure.

By utilizing BABs, California was able to attract a diverse group of investors, including international buyers seeking higher yields. The state's ability to tap into this broader investor base allowed it to raise funds at lower interest rates compared to traditional tax-exempt bonds.

Furthermore, the issuance of BABs helped California create jobs and stimulate economic growth. The funds raised through these bonds were used to finance projects that directly contributed to the state's infrastructure development, such as the construction of new schools and highways.

The Impact on the Financial Market

The introduction of Build America Bonds had a significant impact on the financial market. Here are some key observations:

• Increased demand for taxable municipal bonds: BABs opened up a new market for taxable municipal bonds, attracting investors who were previously focused on tax-exempt bonds. This increased demand led to a surge in issuance of taxable municipal bonds.
• Lower borrowing costs for issuers: The direct subsidy provided by the U.S. Treasury Department allowed issuers to offer higher interest rates to investors while reducing their borrowing costs. This made it more cost-effective for governments to finance infrastructure projects.
• Improved liquidity: The introduction of BABs improved the liquidity of the municipal bond market. The increased investor base and higher trading volumes resulted in greater market efficiency.
• Positive impact on credit ratings: The use of BABs helped some issuers improve their credit ratings. The direct subsidy from the U.S. Treasury Department reduced the default risk associated with these bonds, making them more attractive to investors.

Conclusion

Build America Bonds have proven to be a valuable financing tool for governments seeking to fund infrastructure projects. By offering attractive yields to investors and reducing borrowing costs for issuers, BABs have successfully stimulated economic growth and job creation. The introduction of BABs has also had a positive impact on the financial market, increasing demand for taxable municipal bonds and improving market liquidity. As governments continue to invest in infrastructure, Build America Bonds are likely to remain a popular choice for financing public projects.