When Is a Contract a Contract?

Includes: BAB, CMF, MUB
by: Richard Shaw

The current US administration does not seem to regard contracts as “a deal is a deal” when the other party is the owner of capital.

Bond holders took the pipe in the auto company bankruptcies at the hands of the administration. In the Congress, Barney Frank talked tough about bank bond holders perhaps needing to take a haircut. Now the IRS is effectively putting Build America Bond (NYSEARCA:BAB) holders at risk in its credit and collections between the federal and state governments.

Too bad for the honest souls who bought Build America Bond, it seems. They opted for BABs based on promises from the states and the federal government, and may have to suffer if Uncle Sam won’t chip in the money promised to induce investors to take positions.

March 18 (Bloomberg) — Florida temporarily suspended sales of Build America Bonds on concern that the Internal Revenue Service may block federal interest-cost subsidies, said Ben Watkins, who oversees the state’s debt sales.

The fourth-largest U.S. state by population halted issuance after a recent conference call in which the IRS said it may offset the 35% subsidy payments if an issuer owes the federal government for other programs, such as Medicaid, Watkins said today at the National Municipal Bond Summit in Miami.

Buyer beware on traditional muni’s in lousy credit states, like California. Beware of traditional muni’s in terms of likely attempts by Congress to phase out tax-exempt income on outstanding and future issues. Now beware of Build America Bonds which may not payout because the states cannot, and the feds may decide that they will not.

The rules keep changing, and the sanctity of contracts seems to be increasingly subordinated to the “greater good” as some see it. We wonder how the “greater good” will fare when private capital won’t play in games where the other side is also the referee, score keeper, judge and in some cases executioner.

Related Securities:

MUB, CMF, BAB and many more.

Holdings Disclosure:
As of March 18, 2010, we do not have current positions in any securities discussed in this document in any managed account.

Opinions expressed in this material and our disclosed positions are as of March 18, 2010. Our opinions and positions may change as subsequent conditions vary. We are a fee-only investment advisor, and are compensated only by our clients. We do not sell securities, and do not receive any form of revenue or incentive from any source other than directly from clients. We are not affiliated with any securities dealer, any fund, any fund sponsor or any company issuer of any security. All of our published material is for informational purposes only, and is not personal investment advice to any specific person for any particular purpose. We utilize information sources that we believe to be reliable, but do not warrant the accuracy of those sources or our analysis. Past performance is no guarantee of future performance, and there is no guarantee that any forecast will come to pass. Do not rely solely on this material when making an investment decision. Other factors may be important too. Investment involves risks of loss of capital. Consider seeking professional advice before implementing your portfolio ideas.