U.S. faces future without Build America Bonds

* States prepare to spend less, pay more interest

* Tax deal was considered best shot at extending program

* More than $174 billion of BABs have been sold

By Lisa Lambert

WASHINGTON, Dec 17 (BestGrowthStock) – U.S. state and local
governments faced the realization on Friday that in just 14
days they will no longer be able to sell taxable Build America
Bonds, the federally subsidized debt created in the economic
stimulus plan to fund infrastructure projects and create jobs.

Investors, analysts, underwriters and federal policy-makers
also confronted a future without taxable BABs, which made up
more than a quarter of all new municipal debt sold this year
and which have been largely credited with restarting stalled
municipal credit markets.

As a result, prices of tax-free municipal bonds,
particularly with longer maturities, are apt to fall, along
with capital spending by states and local governments.

President Barack Obama once called for the BABs program to
be made permanent. But the program will expire at year end
after Obama decided against including its extension in a tax
deal he cut with Republicans in Congress.

Lawmakers had considered the $858 billion deal on the
so-called Bush tax cuts the best vehicle for extending BABs,
which expire with the stimulus plan. The U.S. House of
Representatives killed the possibility of an extension when it
approved the deal late Thursday.

As prospects for a continuation of BABs dimmed over the
last few weeks, top-rated 30-year tax-exempt bond prices
dropped, pushing yields to their highest in nearly two years,
according to Municipal Market Data.

Typically, BABs were sold with maturities of 15 years or
longer. Issuer preference for taxable BABs ate into supplies of
longer-term tax-exempt debt creating a scarcity factor that
boosted prices and depressed yields on that part of the
tax-free yield curve.

That will now change, Michael Decker, managing director and
co-head of the Securities Industry and Financial Markets
Association’s Municipal Securities Division, told Reuters’
Insider on Friday.

“The problem is we’re going to see significantly higher
yields, especially for long-dated tax-exempt bonds, which
translates into higher borrowing costs for state and local
governments, like we’re seeing in the market over the last
couple of days,” he said.

“And we’re going to see a lot more market volatility. We’re
going to see periods of illiquidity and periods of pretty wide
price swings as investors come in and out of the tax-exempt
market,” he added.

Issuers, who receive federal rebates equal to 35 percent of
the bonds’ interest costs, had hoped the program would be
extended for a year or two. California issuers have sold the
most BABs since the program debuted in April 2009.

“It will have a very real impact on communities, either
with increased taxes or decreased building,” Maryland State
Treasurer Nancy Kopp said. “What that does to the workforce, I
don’t know.”

Kopp said the state saved $55 million through selling BABs
and other direct rebate bonds from the stimulus plan instead of
tax-exempt debt. The amount, she said, was large enough to
cover the costs of building three or four elementary schools.

Maryland limits how much debt service it can pay. The
federal BABs rebates allowed it to sell more debt because they
made borrowing cheaper. The limit, along with rising interest
rates on tax-exempt bonds, will force Maryland to issue less
debt and cut capital projects next year, Kopp said.

Issuers have been rushing to sell BABs. So far in December
they have sold nearly $9 billion of BABs, compared to $8.1
billion in all of December 2009, according to Thomson Reuters
data. This year they have sold $110.4 billion, and over the
life of the program they have brought more than $174 billion of
BABs to market.

Obama has signaled he would like an extension passed next
year, but the White House has not provided details of possible
legislation. Congress will consider just a few pieces of
legislation before 2010 ends, providing limited opportunities
to attach BABs to another bill.

Just six months ago, an extension with a slightly lower
subsidy rate seemed all but assured. The House had passed it
twice. In September, the extension stalled in the Senate when
it was attached to politically divisive tax legislation.

Last month, the Senate Finance Committee chairman said he
was committed to passing an extension and the most vocal BABs
critic, Republican Sen. Chuck Grassley, said he would not
oppose an extension if it helped get a tax cut deal through.
(Additional reporting by Karen Pierog in Chicago, Michael
Connor in Miami, Joan Gralla and Edith Honan in New York and
Jim Christie in San Francisco; Editing by James Dalgleish)

U.S. faces future without Build America Bonds