The "Build America" Debt Bomb
November 29, 2010
Build America Bonds (BABs) were created as part of the stimulus bill to re-energize the municipal bond market, which contracted sharply in late 2008, says Steven Malanga, a senior fellow at the Manhattan Institute.
States and cities jumped deeply into this new market.
- California alone has issued some $21 billion in BABs, mostly as a substitute for its general obligation debt to support everything from school construction to sewer projects.
- New Jersey has used up to $500 million to recapitalize its depleted transportation trust fund.
- Columbus, Ohio, issued $131 million in BABs to start construction of a downtown convention hotel.
- In Dallas, Texas, when no private operator would finance a new convention hotel, the city went ahead with a government-subsidized hotel, courtesy of $388 million in BABs.
But the BAB program hasn't been the unqualified success its advocates claim, says Malanga.
Indeed, in June, based on the cost of insurance contracts, CMA Datavision listed California and Illinois among the 10 biggest government default risks in the world. Illinois was at greater risk of default than Iraq. Yet thanks to the BAB subsidy, Illinois was still able to borrow some $300 million in bonds by offering a 7.1 percent interest rate.
Meanwhile, investors are realizing that states and localities face long-term costs in addition to their muni debt, especially retirement obligations.
- Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester assess the 50 states' unfunded pension bill at $3 trillion, and they say that the municipal tab for pensions could reach $500 billion.
- That is on top of some $2.8 trillion in outstanding state and local borrowing, according to the Federal Reserve.
Source: Steven Malanga, "The 'Build America' Debt Bomb," Wall Street Journal, November 22, 2010.
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