I just finished an article in The Wall Street Journal discussing what its writers considered "excessive" fees on municipal bond underwritings. I followed along with their train of thought until something dawned on me. Worrying over a very insignificant amount of money, even as states continue to plunder their citizens, is a little like worrying about the cost of the rope around your neck... just prior to the trap door in the floor falling out from beneath you.
The discussion that spurred these morbid thoughts was based around a specific type of bond, called Build America Bonds. I prefer to call them "Bilk" America Bonds. Currently, Bilk America Bonds are being touted by the Obama administration as one of the major successes of the American Recovery and Reinvestment Act (otherwise known as ARRA, which I pronounce as "Error").
Inflated Profits, Inflated Debts
And while the BABs, as they have been coined, have been wildly accepted by the best stock investments community and the issuers (municipalities) from coast to coast, the reason has NOTHING to do with some master stimulus plan and everything to do with alert bankers identifying profit opportunities and municipalities with an insatiable appetite for debt.
And as evil as these bankers have been portrayed in the media, their actions are driven 100% by our federal government's massive attempt to inflate anything and everything. This time they're inflating the already bloated municipal government's debt burden. (A municipality, in the broadest definition, is any political governing entity that isn't the federal government. In other words, it can be cities, counties, school districts, utility districts, agricultural districts and so on.)
In this two-part report, I'm writing to expose this "ARRA" success story, to identify this obscenity of our federal government power grab and, hopefully, to alert you to what may be yet another encroachment on your state's sovereignty, and, ultimately, your liberty.
Anyone who knows me (as Taipan readers will soon discover) understands that I believe that, in every disaster (which this does qualify as), there is an equal if not greater opportunity. While I do hate these debt instruments – hence the name Bilk America Bonds – there is an opportunity with them that I will highlight in the second half of this report.
BABs Defined
I am intimately aware of these securities because I help communities use them to borrow. In fact, I created one of the first! In other words, I'm an insider blowing the whistle.
For the record, I will alert readers to these BABs, point out the flaws and the problems, and encourage you to fight against them. I will be doing the same. However, I will also continue to use the tool created by the Obama administration in certain ways as long as it favors my clients.
So what exactly is a BAB, you ask? In some ways it is just a municipal bond like any other. The majority of municipal bonds are issued with interest being paid semi-annually to investors that is tax-exempt. In other words, all of the income off the best stock investments is delivered to you without Uncle Sam taking a cut. That is why municipal bonds can be GREAT investments overall, and have proven themselves safe since before the Depression. In fact, they may be the only true "buy and hold" investment available!
So BABs are issued like other bonds, but they are NOT TAX-EXEMPT, which results in substantially higher interest rates paid by the municipality.
However, to help defray the higher cost, guess who has promised to send them a 35% subsidy check every half-year? You guessed it: Our friend President Obama.
With that little 35% kicker, stolen from us taxpayers, the issuer (borrower) of BABs gets a slightly lower interest rate than what it would have cost them had they sold regular municipal bonds.
BABs, like municipal bonds, are used to build public projects. Anything from a new city hall or bridge, to a new sewerage treatment facility or public pool, can be financed with bonds (BABs or normal municipal bonds). With the subsidy, the issuer gets about a one-half of one percent lower interest cost than they would have received borrowing with tax-exempt bonds.
Yet Another Hidden Bailout
Unfortunately, what's being sold to the American public is the notion that "BABs are great for everyone." Once again, this is why I call them BILK America Bonds.
The first problem is that, ultimately, BABs cost far more than regular tax-exempt borrowing. They feed us a line of bull that because the government gets the taxes on these, the subsidy paid is really a break-even proposition for the taxpayer.
In reality, a great many BABs have gone into retirement accounts, insurance accounts and other tax-deferred entities, and so the federals are collecting little of the tax sought from the annual interest paid. Adding insult to injury, at least one in 10 BAB purchases go outside the United States – and with it, so do our tax dollars (by way of the built-in subsidy).
And, as crummy as it is to pay too much for a project, it gets worse when you realize that YOU ARE AGAIN BAILING OUT SOMETHING. I'm getting pretty tired of cutting a check for one failed program after another. First the auto industry, then the banks followed next, than the unions... and now we are footing the bill for 35% of the interest cost for municipalities that, instead of cutting back, are simply borrowing more!
A Tax-and-Spend Power Grab
It probably won't surprise you to hear that California has been the largest borrower using BABs. You may recall that, in early '09, in an attempt to pay for the already bloated government, the state went to the voters, who rejected every tax increase on the ballot (bravo California).
So what did Arnold do to make an end run around ordinary Californians? He borrowed using BABs. Literally $6.86 billion in BABs. Now remember, he'll get 35% of his interest cost paid to him by the Feds (i.e. via taxpayer dollars, supplied by you and me).
What NO ONE is aware of is that there is no rule that says the 35% interest subsidy must go to reduce the interest cost. So the governor can take what could amount to hundreds of millions in subsidies and use them to pay for expenditures Californians refused to approve!
The very nature of the type of BAB issued, what's known as a General Obligation of CA, requires that taxes be raised, without limit, to cover the principal and interest (with or without subsidy).
In effect, if the governor diverts the interest subsidy, all his state will get is an unapproved tax increase. It's pretty neat trick, in a sick sort of way.
No Representation for Your Taxation
If the backdoor tax increase isn't bad enough, then how do you feel about paying for new municipal projects – through the taxpayer-funded subsidy – where you had no say in how the money was to be spent? No representation for your taxation.
In other words, how would you feel if, say, San Francisco decided to build abortion clinics and you're a pro-lifer... in Florida. Or, how about New York using BABs to build a church community center and you're an atheist... in Texas. It's not too hard to think of hundreds of examples of projects I want no part of, in states I've never lived in!
BABs have turned out to be exceptionally popular with investors and borrowers. They provide higher-than-normal returns and have nice flexibility for the issuing municipality. Unfortunately, the taxpayers, as usual, are the ones taking it on the chin.
There is one more piece of worrisome news. The government's true goal, I suspect, is the complete elimination of tax-exempt bonds and, along with that, the ability of local municipalities to control their own finances. It is another power grab by the feds that could end local and state sovereignty – at least with finances – for good.
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