Bankrupting of the United States Bonds

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In January the U.S. Treasurer, Rosie Rios, traveled to Dallas to join local officials at the construction site of a new convention hotel being built with money raised through Build America Bonds. The purpose was to celebrate the success of the so-called BABs, which are federally-subsidized bonds created by the 2009 stimulus package.

Of course, what no one at the Dallas "celebration" pointed out is that the $388 million in BABs that the city floated with federal aid were necessary because no private developer would cough up the money for the risky project. In fact, local officials wanted to build the controversial hotel because years of frenetic, publicly financed convention center construction by cities had saddled the country with much more meeting space than it needs, and now meeting planners are telling cities they must to ante up money for additional amenities, like new subsidized hotels, or risk losing business.

This is what passes for success in Washington these days, where apparently any level and manner of publicly subsidized debt for any kind of dubious project is considered a home run.

"There's nobody that I know who does not view the Build America Bonds program as an enormous success with the possible exception of one person," John Buckley, majority chief counsel for the House Ways and Means Committee, told a rapt audience of state treasurers in Washington recently. The one critic that Buckley was referring to is Iowa Sen. Charles Grassley, who has objected to the big fees that Wall Street firms have been getting for underwriting BABs.

But the real objection to BABs is far more substantial. These bonds are enabling our already overburdened states and cities, which heaped on debt at a record pace in recent years including back when they were running budget surpluses, to pile it still higher, even as their budgets now groan under bulging debt payments. Moreover, at a time when private firms are scrambling for investment, BABs just further the misallocation of resources already characteristic of municipal finance by luring money away from private investment and into grand (and often misguided) government building schemes that can't attract private capital.

Washington included BABs in the stimulus package after the municipal bond market seized up in 2008, when insurers who back munis ran into difficulty and investors balked at the deteriorating financial condition of cities and states. The feds rushed in with BABs, which are somewhat different from traditional municipal bonds that provide a tax break to the buyer. BABs, by contrast, give a direct subsidy from Washington to states and cities, which use it to issue bonds that feature attractively high interest rates. The bonds appeal to a whole new class of investor which can't benefit from the tax-free nature of munis, such as big pension funds or overseas buyers. So far, cities and states have heaped on some $64 billion in new debt thanks to BABs, and now the Obama administration has proposed making this "temporary" component of the 2009 stimulus program permanent, at least for the next 10 years.

But although the actual cost of the program to the U.S. Treasury will be small compared to other budget busters, the mentality that sees BABs as a grand success is symptomatic of what's wrong in Washington right now. Since 2000 state and local debt outstanding has grown 60 percent after adjusting for inflation to $2.3 trillion, a faster rate of debt accumulation than American households took on over the same period (and we know how that worked out). In California, the cost of servicing state debt has increased 143 percent in 10 years to $6 billion and is projected to increase to about $10 billion in several years. New York State's outstanding debt has soared to a whopping $120 billion, according to a local watchdog group, the Citizens Budget Commission, which estimates that within just four years the cost of serving that debt will consume 10 percent of the state's budget.

Washington touted BABs as a way for states and cities to keep investing in essential infrastructure, but that ignores how governments actually borrow these days. While state and local debt is soaring, the portion of debt used for traditional purposes like transportation or utilities projects has remained relatively constant. Instead, municipalities have pumped money into "state capitalist" projects like subsidized convention centers and hotels, arenas and sports stadiums which often have little economic impact beyond the short-term construction jobs they produce.

States and municipalities have also used debt for some of the most egregious fiscal practices, like floating bonds to finance pension obligations and make pension funds seem more fully funded then they actually are.

Even in cases where governments are using BABs to fund more traditional projects, the new bonds are often just enabling dysfunctional state and local fiscal practices to continue. For instance, among the so-called BAB ‘success' stories touted by the Obama administration in January was $750 million in borrowing by New York's Metropolitan Transportation Authority for investments in Gotham's subway system. Congressman Charlie Rangel and the Treasury Department's chief economist showed up at an MTA construction site to ‘celebrate' that success.

But as my colleagues Nicole Gelinas and E.J. McMahon pointed out last month, the MTA is in grave financial peril and could bring down all of New York State finances, in part because state legislators have absconded with taxes designed to support the transit agency and forced the MTA to issue debt to finance more and more of its capital needs. It's a process that's happening around the country as fewer and fewer essential projects get built on a pay-as-you-go basis with tax dollars and more and more are constructed with borrowing, a pattern that's unsustainable.

BABs also provide yet another taxpayer-subsidized incentive for investors to divert capital that might otherwise be channeled into private initiatives. A study in the early 1990s by economist Peter Fortune published in the New England Economic Review estimated the social cost of tax-free munis was billions of dollars in lost private sector output in the U.S. economy because of dollars diverted from private investment. I imagine the cost is far higher now, and BABs will increase it even more because they provide yet another type of investor with the incentive to snap up subsidized government debt with money that might otherwise be invested in stocks or corporate bonds or private equity.

But apparently this isn't a problem in today's Washington, where no amount of debt seems worrisome, and where the best investment is apparently investment in government. This is how Washington now defines success.


Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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