Build America Bonds

[don]

Fraud Fatigue, Anyone....

Stimulus Bond Program Has Unforeseen Costs

By JULIE CRESWELL

They are supposed to help states and cities that are short of cash build roads, schools and bridges.

But Build America Bonds, part of President Obama’s economic stimulus plan, are also building something else: controversy.

States and cities have embraced these taxable bonds to borrow money at what they assume are favorable interest rates. The federal government pays 35 percent of the interest costs on the bonds, a huge potential saving.

But questions about this multibillion-dollar program are piling up.

For one, Wall Street banks are charging larger commissions for selling Build America Bonds than they do for normal municipal bonds, increasing the costs to the states and cities. For another, the new bonds may be priced too cheaply, enabling quick-footed investors to turn a fast profit as the prices climb, but raising interest costs for taxpayers.

Those imbalances have caught the eye of the Internal Revenue Service, which is asking municipalities whether the bonds are being priced and sold correctly. Alarmed by the uncertainty, Florida, which has sold more than $1.6 billion of Build America Bonds, has retreated from the market.

As if all this were not enough, Wall Street banks — which have pocketed hundreds of millions of dollars in fees from the program — are now releasing research reports warning that states’ financial woes may make the bonds less attractive. Some banks are even telling investors how to bet against Build America Bonds.

While most states have embraced the program, two, California and New York, account for a third of the money raised through it, said Senator Charles E. Grassley, a Republican from Iowa and a critic of Build America Bonds. “The program might be better named the Build California and New York Bonds Program,” Mr. Grassley said.

The Obama administration wants to make the program permanent, but Senate Republicans last week introduced a bill that would let it expire as scheduled at the end of this year.

A clear winner has been Wall Street. Banks have collected nearly $700 million in fees for helping to issue the bonds. (That number is low because fees are not reported in a third of the transactions.)

For banks, Build America Bonds are more lucrative than traditional municipal bonds. Weighted by size, municipal issuers paid $6.55 per $1,000 of Build America Bond sold in June, compared with $6.08 for traditional municipal bonds.

Bankers argue that the fees are fair because Build America Bonds are new.

Even as it sells the bonds, however, Wall Street is thinking about how to play both sides of the new market. In an April 29 report to clients, a Citigroup analyst wrote that investors who are tuned in to the “widely known municipal budget struggle” can now use derivatives and other financial mechanisms to sell short Build America Bonds.

The I.R.S., which is involved with disbursing the federal subsidies under the program, is taking a closer look at Build America Bonds, too. It is asking states for information on how the bonds were priced after some traded at significantly higher levels shortly after being issued. That could cause municipalities to pay higher yields than necessary.

“When you see bonds sold almost immediately at a different price, that raises a question. It may be fine, or it may not be fine,” said Steven Miller, deputy commissioner of the I.R.S.

Interest rates, including those that states and cities pay on traditional municipal bonds, are at their lowest levels in decades, said Thomas Doe, chief executive of research firm Municipal Market Advisors, a research company.

But taxpayers will be paying the bill for the Build America Bonds program for years, he added.

“What’s clear is that the federal government, over the life of the Build America Bond issues, will be writing checks in excess of $50 billion to cover the interest,” he said.

http://www.nytimes.com/2010/06/16/bu...ef=todayspaper

[chr5648]

Re: Build America Bonds

Fraud Fatigue, Anyone....

Stimulus Bond Program Has Unforeseen Costs

By JULIE CRESWELL

They are supposed to help states and cities that are short of cash build roads, schools and bridges.

But Build America Bonds, part of President Obama’s economic stimulus plan, are also building something else: controversy.

States and cities have embraced these taxable bonds to borrow money at what they assume are favorable interest rates. The federal government pays 35 percent of the interest costs on the bonds, a huge potential saving.

But questions about this multibillion-dollar program are piling up.

For one, Wall Street banks are charging larger commissions for selling Build America Bonds than they do for normal municipal bonds, increasing the costs to the states and cities. For another, the new bonds may be priced too cheaply, enabling quick-footed investors to turn a fast profit as the prices climb, but raising interest costs for taxpayers.

Those imbalances have caught the eye of the Internal Revenue Service, which is asking municipalities whether the bonds are being priced and sold correctly. Alarmed by the uncertainty, Florida, which has sold more than $1.6 billion of Build America Bonds, has retreated from the market.

As if all this were not enough, Wall Street banks — which have pocketed hundreds of millions of dollars in fees from the program — are now releasing research reports warning that states’ financial woes may make the bonds less attractive. Some banks are even telling investors how to bet against Build America Bonds.

While most states have embraced the program, two, California and New York, account for a third of the money raised through it, said Senator Charles E. Grassley, a Republican from Iowa and a critic of Build America Bonds. “The program might be better named the Build California and New York Bonds Program,” Mr. Grassley said.

The Obama administration wants to make the program permanent, but Senate Republicans last week introduced a bill that would let it expire as scheduled at the end of this year.

A clear winner has been Wall Street. Banks have collected nearly $700 million in fees for helping to issue the bonds. (That number is low because fees are not reported in a third of the transactions.)

For banks, Build America Bonds are more lucrative than traditional municipal bonds. Weighted by size, municipal issuers paid $6.55 per $1,000 of Build America Bond sold in June, compared with $6.08 for traditional municipal bonds.

Bankers argue that the fees are fair because Build America Bonds are new.

Even as it sells the bonds, however, Wall Street is thinking about how to play both sides of the new market. In an April 29 report to clients, a Citigroup analyst wrote that investors who are tuned in to the “widely known municipal budget struggle” can now use derivatives and other financial mechanisms to sell short Build America Bonds.

The I.R.S., which is involved with disbursing the federal subsidies under the program, is taking a closer look at Build America Bonds, too. It is asking states for information on how the bonds were priced after some traded at significantly higher levels shortly after being issued. That could cause municipalities to pay higher yields than necessary.

“When you see bonds sold almost immediately at a different price, that raises a question. It may be fine, or it may not be fine,” said Steven Miller, deputy commissioner of the I.R.S.

Interest rates, including those that states and cities pay on traditional municipal bonds, are at their lowest levels in decades, said Thomas Doe, chief executive of research firm Municipal Market Advisors, a research company.

But taxpayers will be paying the bill for the Build America Bonds program for years, he added.

“What’s clear is that the federal government, over the life of the Build America Bond issues, will be writing checks in excess of $50 billion to cover the interest,” he said.

http://www.nytimes.com/2010/06/16/bu...ef=todayspaper

I smell a future bailout.

[Rajiv]

Re: Build America Bonds

Here is a good piece by Mike Konczal referring to a talk by Stiglitz which bears on this topic.
- The Innovation of Fee Churn, FTT Research Desk Answer

One part about financial ‘innovation’ that isn’t always brought up is the fee churn factor in innovation. Here’s Joe Stiglitz, Senior Fellow at the Roosevelt Institute (which is rad), here, with this great quote about what constitutes financial innovation:

There are alternatives out there. They could have done it right. The Danish mortgage bonds system, there are other mortgage products out there. But they did not generate the fees that have motivated the industry. And it goes back to the fundamental problem that I mentioned in the beginning of failure of alignment between private rewards and social returns. When I was on the council of economic advisors I saw that not only was the financial sector not innovative, they resisted our innovation. We came up with this idea of having inflation indexed bonds, and it was initially resisted by treasury, resisted by the financial markets. I scratched my head and I asked why. And then we figured out why. People buy these products and hold them to retirement. If you hold them to retirement you don’t make fees, because you don’t have people selling and buying them. And so for the financial sector they were disastrous. For Americans worried about the risk of inflation, they were a fantastic product.

I love that. The most innovative product for a financial firm is one that always has volume and, sometimes, always has volatility. Many investors would prefer neither, they would prefer their investments boring. So there’s a clash here.

I thought about that when reading the following from my former co-guest blogger Dylan Matthews, at his new Research Desk Answer feature: How to raise $100 billion from a financial transactions tax:

As you can see, the main revenue sources would be in stocks, bonds and swaps. Even if trading is cut in half, the tax still raises $176.9 billion a year, which would make it the federal government’s third-largest revenue stream after individual income and payroll taxes (see Table 1-8 in the CBO’s FY2011 budget analysis).

How much trading would actually be affected is an open question; the authors have in the past called (PDF) a 25 percent drop “implausibly high,” suggesting that the probable revenue would be somewhere between $353.8 billion (the figure for no drop in trading) and $265.3 billion (the figure for a 25 percent drop). Proponents hope that at least some meaningful drop in trading would occur. One point of the tax is to deter high-frequency trading and to reduce the size of the financial services industry, which would not be accomplished if trading does not fall. There’s thus a trade-off between the revenue gains to be had from an FTT and the size of its effect on the financial sector.

In any case, an FTT would produce far more revenue than alternative taxes on the banking sector. A new Institute for Policy Studies paper, set to be released tomorrow, shows that FTT revenue (as measured in the Baker et. al. paper) pales in comparison to what would be generated by the Obama administration’s proposed bank levy ($9 billion a year) and the IMF’s proposed financial activities tax ($28 billion a year). Of the three, only an FTT would make a big dent in the deficit.

Even a small FTT would cut so much of the churn factor out of the financial markets that can increase volatility or lead people to think they have liquidity in bad times that they in fact don’t.
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Stiglitz video