Last year, the Obama administration implemented a Build America Bonds (BABs) program that helped states strengthen their struggling finances. The new government-backed bond, along with its related exchange traded fund, has become widely accepted and the BABs market is expected to attract billions more in assets.
BABs are a special type of municipal bond designed to help municipalities raise money to invest in infrastructure projects, scribes Matt Hougan for IndexUniverse. BABs are taxable, and to offset the tax hit, the Federal government pays a 35% subsidy on the interest payment. Basically, BABs allow municipalities to offer bonds to the taxable market without paying out more interest than on tax-free bonds.
Investors have been interested in BABs due to their attractive rates. For instance, the PowerShares Build America Bonds Portfolio Fund (NYSEArca: BAB) is paying a 5.31% 30-day SEC yield, which is higher than other non-BAB bond ETFs. Still, it should be noted that liquidity in individual BABs is limited and the BAB ETF may be more volatile than broad-based muni bonds.
Wall Street has received fees of more than $1 billion in less than a year of selling BABs, reports Ianthe Jeanne Dugan for The Wall Street Journal. Some believe that Wall Street is overcharging its services, but banks say that the higher fees are justified since they are working overtime to sell bonds to people who normally don’t buy municipal debt.
The average underwriting fees for Build America Bonds are $8.20 per $1,000, whereas the standard fee for tax-exempt issues is $5 to $6 per $1,000. Since the program’s inception in April 2009, $78 billion worth of BABs have been sold. Bankers estimate that s much as $150 billion more of the bonds will be sold – over one-third of the muni bond market – by the end of the year.
The Obama administration wants to make the program permanent, but they will scale back the subsidy to 28%. Naysayers of the program argue that money is being funneled from American taxpayers directly to Wall Street banks.
Max Chen contributed to this article