What Are Build America Bonds?
Let me explain what Build America Bonds, or BABs, actually are. These were taxable municipal bonds that came with federal tax credits or subsidies either for the bondholders or for the state and local government issuers. They got started in 2009 as part of President Obama's American Recovery and Reinvestment Act, aimed at creating jobs and boosting the economy. Remember, the whole Build America Bonds program wrapped up in 2010.
Understanding Build America Bonds (BABs)
Right after the 2008 financial crisis, many savers were scared to put money into anything but federal government bonds. They even avoided municipal bonds. That's why the federal government brought in Build America Bonds to make sure local municipalities and counties could still get the capital they needed during the recession.
BABs were designed to push investment into local areas. These were debt securities issued by states, municipalities, or counties to fund capital expenditures. The federal government subsidized the interest rates, which cut down the borrowing costs for infrastructure projects for those state and local governments.
Plus, back then, investors preferred bonds from government bodies. Corporate bonds seemed too risky with high default chances right after the 2008 crisis.
Types of Build America Bonds (BABs)
Generally, there were two main types of BABs: tax credit BABs and direct payment BABs. With tax credit BABs, bondholders and lenders got a 35% federal subsidy on the interest paid, coming as refundable tax credits that reduced their tax liability. If their tax bill wasn't big enough to use the full credit, they could carry it over to future years.
Direct payment BABs worked similarly but paid the subsidy to the bond issuer instead. The U.S. Treasury sent a direct payment to the issuers, covering 35% of the interest they owed investors. This lowered the effective borrowing cost for issuers, letting them offer competitive rates in the market. Take California's $5.2 billion BAB issue in early 2009—it offered investors 7.4% interest, but the state only paid 4.8% of that, with the federal government covering the difference.
Restrictions on Build America Bonds (BABs)
There were limits on who could use the BAB program. Traditional tax-exempt issuers like private party issuers and 501(c)(3) organizations weren't eligible. The program only applied to new issue capital expenditure bonds issued before January 1, 2011. You couldn't use BABs for refinancing old debts.
Key Takeaways
- Build America Bonds (BABs) were taxable municipal bonds that featured federal tax credits or subsidies for bondholders or state and local government bond issuers.
- The Build America Bonds program expired in 2010.
- The federal government introduced Build America Bonds (BABs) to ensure that local municipalities and counties were able to raise much-needed capital during the recession.
- In general, there were two distinct types of BABs: tax credit BABs and direct payment BABs.
Build America Bonds vs. Traditional Muni Bonds
The big difference between Build America Bonds and traditional municipal bonds is that income from regular muni bonds is exempt from federal taxes and sometimes state taxes too. With BABs, the interest income was taxable at the federal level.
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