Congress is not honoring its Build America Bond promises to state and local governments, even as state and local governments are pledged to make payments to their investors and to rebuild the nation’s infrastructure critical to the future economy, jobs, and competitiveness of the country. The combination of the second year federal sequester, itself a repudiation of federal promises, and now the Congressional shutdown of the federal government could have severe repercussions not just for state and local leaders, but also for the nation’s future competitiveness.
The problem is that the credit of a so-called Build America Bond is backed by the state or municipality issuing the bond, not the federal government. A federal government now on the precipice of defaulting on its own full faith and credit U.S. Treasury bonds has already reneged on its commitment to the nation’ state and local governments — and increased the threat of defaults.
A warning or foretaste was issued last month in a 394-page document released by the White House listing a breakdown of spending or sequester cuts for this federal fiscal year. The document showed the Treasury could reduce the 35% federal rebate to state and local government BABs issuers for interest costs on $181 billion of debt issued between April 2009 and December 2010 to save $255 million. That is save the federal government $255 million, and pass the buck to state and local governments and their taxpayers — none of which, unsurprisingly, incorporated the funds to make up for the promised federal payments to bondholders in the budgets they adopted for this fiscal year. Nor, it appears, did any state legislature, county board, city council, or any state, regional, or local authority increase taxes or rates to compensate for the second year federal sequester of 7.2% of BAB subsidies that went into effect on October 1st. Nevertheless, because it is their obligations to the bondholders — not Congress’— those issuers will have no choice if they wish to avoid default.
And that is just for the current federal fiscal year. The federal default on its obligation or promise is scheduled to last the decade, absent action by Congress to halt the sequester. It seems as if there has been a massive Congressional “bait and switch” operation in which state and local tax and ratepayers have been put at risk. Even as Congress and the White House have steadily disinvested in the nation’s physical infrastructure, the actions in the last few weeks promise to undercut state and local investment. There appears to be a new federal policy: stop thinking about tomorrow.
The glib promise from Washington was that while state and local governments would be forced to sell their Build America Bonds at higher yields in the taxable markets, once they were reimbursed by the federal government by subsidy payments, their net costs to state or local budgets would be less. Neither the Treasury, nor the Congress included in the fine print that federal promises should not be relied upon or trusted, especially when a state or local government puts its full faith and credit behind making payments to its bondholder investors.
Investors in the $3.7 trillion state and local municipal bond market generally viewed the rebate as a big help for states, cities, and other issuers to make payments on the taxable debt, which had been a stellar performer in the fixed-income market. One expert noted, for instance, that “(State and local governments) wouldn’t have been able to sell the (Build America) bonds if there were any doubt to the willingness (of the federal government) to put up the money.”
But not just investors, because the threat of the second year BABs 7.2% sequester that went into effect on October 1st, even as the federal government shut down, meant that states and local governments, already facing sagging revenues from the federal failure to operate and threat of federal insolvency and bankruptcy on October 17th, would be on the hook to make the interest payments without having fully budgeted for the money and with a further cut in the promised federal payment. Thus, noted Assured Guaranty’s John Hallacy, then a municipal market strategist at Bank of America Merrill Lynch: “The question is: how are they going to come up with the money?” For the Golden State, the biggest seller of BABs, at $13.8 billion of debt, the sequester will reduce the promised federal share to California by $16.2 million; but the shutdown could mean a reneging of as much as $226.8 million — funds which the state is on the hook for to the owners of its issued BABs.
Moreover, if the decade-long sequester undermined federal accountability, the October 1 shutdown by Congress of the federal government created a much greater risk to state and local governments and their bondholders. Instead of a 7.2% federal repudiation, there is a 100% repudiation — unless and until the federal government reopens for business. Even though Direct Payment (or qualified) BABs, which provide a federal subsidy through a refundable tax credit paid directly to state or local government issuers in an amount equal to 35% of the gross interest payable to investors, have permanent, indefinite budget authority to make the cash payments, it appears that payments to municipalities and states are not being processed, because over 90% of IRS employees have been furloughed; consequently, the IRS has announced that refunds are not being processed. This is what the former mayor, county leader, governor, and U.S. Senator George Voinovich used to call the federal “shift and the shaft.”
This time the broken federal commitment and promise could be significantly harsher for smaller cities and counties. For instance, Stevens Point, Wis., one of the first issuers of BABs, sold about $11 million of the debt backed by its general obligation pledge in three deals. John Schlice, Stevens Point’s Comptroller and Treasurer, had estimated this year’s federal sequester would cost the city thousands of dollars more for debt service, noting: “What they are doing is passing the problem to the local level and local taxpayers.” But elimination of the entire federal IOU would be many times as damaging.
But it is not just full faith and credit or general obligation bonds that could significantly and adversely affect state and local taxpayers and governments; elimination of BABs payments under the shutdown for Build America Bonds backed exclusively by revenue from a government enterprise, such as a city or county water and sewer system, where the municipal, county, or state rates for the services may incorporate the full BABs payment, would leave the state or local government or agency far short on debt service funds. As Nevada State Treasurer Kate Marshall has warned: a big portion of the sequester has been aimed at the heart of state and local governments. But a complete reneging could have far more adverse consequences. As Treasurer Marshall has note, “It is not a cost saving at the end of the day if you are simply shifting those costs from one part of the public sector to another.”
At the time Ronald Reagan was elected president, federal assistance for state and local public infrastructure investment accounted for 60% of such public investment in the nation’s future. By the end of the 1980s, the largest federal investment in the nation’s public infrastructure was provided through the federal tax code — the reciprocal immunity from federal taxation for bonds issued by state and local governments that mirrors the immunity from state and local taxation enjoyed by U.S. bonds issued by the federal government. Now, as an increasing number of members of Congress propose to eliminate state and local authority to issue municipal bonds, describing such as “inefficient federal subsidies,” one understands that any reliance on alternatives offered by members of Congress could well be a recipe of jeopardy to the nation’s future competitiveness.