Last year, Congress authorised states and local governments to issue a new type of taxable muni bonds that would be subsidized by the federal government as long as they were used to finance capital expenditures. The idea behind the program was to encourage new capital spending as part of the government’s effort to stimulate the economy out of the recession.
States and local governments, however, want to use a new bond program authorised by Congress to refinance debt used for old programs, according to the industry paper Bond Buyer. Many states and municipalities continue to have auction rate securities—some $78 billion are outstanding—and now bond attorneys are asking the IRS and the Treasury Department to clarify whether ambiguities in the law will allow them to issue the bonds to refinance old spending rather than pay for new spending.
The bond program, called Build America Bonds, allow the state or local government to elect between receiving a cash subsidy from the federal government or have it provide bondholders with a tax credit. Either would essentially make the bond issuance cheaper for state and local governments. The hope was that this would prompt new issues that would fund new projects, which would in turn result in spending, jobs, stimulus.
In a move that is now familiar to anyone paying attention, it seems that the state governments might prefer to use the subsidy to help them pay off old debt rather than borrow and spend on new projects. It’s the photographic negative of banks receiving bailout funds but then electing to use the funds to shore up their balance sheets rather than lend it out. At the heart of both is the fact of too much bad debt that must be addressed before new lending, borrowing or spending will occur.
The bailout law was so hastily drafted that it may have left this option open to state and local governments by accident.
“Legally there’s a good argument that a refunding would be OK if the old bond financed capital expenditures,” an attorney who asked not to be identified tells Bond Buyer. “It does not say the capital expenditures must be incurred on a specific date or after a specific date.”