A bubble in the making

US President Barack Obama’s proposal to permanently extend the popular Build America Bonds program beyond its 2010 sunset date could lure more institutional buyers to the market for this new type of municipal debt.

“It would make more investors care about it,” George Friedlander, the head of municipal strategy at Morgan Stanley Smith Barney, said at a public forum on Build America Bonds at New York University.

Obama: wants to extend BABs

In Friedlander’s view, “if you say now it is a permanent programme, there is an incentive for potential buyers, institutional buyers to have somebody on their team understand better the nature of local credits because for the foreseeable future there will be an investment choice that includes these credits.”

The bonds, introduced a year ago by the $787 billion American Reinvestment and Recovery Act, have been widely used by state and local governments to finance their infrastructure needs throughout 2009. Approximately $64 billion of the securities were issued last year alone, according to the US Treasury.

Despite their popularity, though, Friedlander and other speakers at the forum did not foresee much competition between Build America Bonds and other forms of public works financing, such as public-private partnerships (PPPs). Charles Peck, a vice president in investment bank Morgan Stanley’s public finance division, said municipalities will continue to run a multi-track process of assessing the relative attractiveness of Build America Bonds versus PPPs side by side.

Peck said he was currently working on a deal to help the city of Pittsburgh raise money by leasing its parking assets to the private sector – an instance in which a PPP was clearly the best alternative. “In other cases, it’s not so straightforward,” he added.

Falling subsidy
 
President Obama’s proposal could cause Build America Bonds issuance to surge toward the end of 2010. Under current regulations, issuers can get 35 percent of their interest cost reimbursed by the federal government. Under the president’s proposal, that subsidy would fall to 28 percent starting next year, if the programme is extended.

Friedlander said this could cause a rush to market later this year as issuers try to take advantage of the higher subsidy rate before it expires. The fourth quarter theoretically could see a torrent of Build America Bonds, he said, predicting that total Build America Bond issuance could top $100 billion this year. 

Looking beyond 2010, an extension of the Build America Bonds programme is almost assured said Matt Fabian, a managing director at Massachusetts-based Municipal Market Advisors, at the forum. Fabian attributed his confidence to broad support for the extension among lobbying groups and members of Congress.

The forum, Growing Our Way Out of Crisis: Private Perspectives on Public Work, was sponsored by New York University’s Institute for Public Knowledge.