New bonds to help cash-strapped states also benefiting Wall Street

By Dan Eggen
Washington Post Staff Writer
Monday, June 7, 2010

New federally subsidized bonds that have proven wildly popular in helping cash-strapped state and local governments fund roads, schools and other construction projects also offer a windfall to a less obvious beneficiary: Wall Street banks.

Goldman Sachs, J.P. Morgan Chase and other firms that dominate the U.S. underwriting market stand to earn millions, if not billions, of dollars under a planned expansion of the Build America Bonds program, which provides tax credits to local and state governments seeking to finance capital projects. Major banks lobbied heavily for the program's expansion under a jobs bill recently passed by the House and under consideration in the Senate.

The bonds, first issued last year as part of President Obama's stimulus package, were a key factor in reviving the moribund municipal bond market over the past year. They also provide two key benefits for Wall Street firms: new customers who would not usually buy municipal debt and, in many cases, higher commissions than those for traditional tax-exempt bond deals.

Investment banks have earned more than $670 million from selling the bonds, with average fees nearly 20 percent higher than traditional tax-exempt bond issues over the past 14 months, according to new data from Thomson Reuters. The data also show that fees have come down in recent months as the bonds have become more widely known to investors.

Wall Street firms and financial trade groups worked hard to urge Congress to extend the program and maintain subsidies higher than those favored by the Obama administration, according to congressional aides and industry officials. Goldman extolled the program's virtues in print ads this year while the Securities Industry and Financial Markets Association (SIFMA) did the same when it hosted a conference at the Newseum.

James P. Esposito, managing director at Goldman, told a House subcommittee last month that the bonds "are proving to be a major success with issuers and investors alike" and that they provide "a compelling financing tool for states and municipalities to meet their borrowing needs."

But the bond boom has prompted criticism from some taxpayer advocates and lawmakers, including Sen. Charles E. Grassley (Iowa), the ranking Republican on the Senate Finance Committee, who has blasted the Build America program as another de facto bailout package for major banks. The crux of the argument is that federal subsidies allow banks to charge higher fees than needed because state and local governments are already saving so much money on the deals. Grassley also worries that the program is encouraging governments to pile up too much debt.

"These are sweetheart deals for everybody but the taxpayer," said Steve Ellis, vice president for programs at Taxpayers for Common Sense. "The real winners are the banks who are putting together these deals, raking in great fees and trading the bonds in the secondary market. . . . Investors can turn around, resell and pocket a quick profit. Nice gig if you can get it."

The IRS has signaled that it might step up audits on Build America Bonds over concerns that issuers are pricing them too low. The warnings rattled municipal bond markets in recent days, prompting IRS officials to reassure investors that its review will be limited.

Few would dispute that the program has been popular. The Treasury Department said last week that more than $106 billion in Build America Bonds have been issued since April 2009, with estimated savings of $12 billion to local governments and other issuers. The bonds now constitute over 20 percent of the municipal bonds market, officials said.

"Build America Bonds have had a very strong reception from state and local governments as a way to provide financing for critical building projects in a way that minimizes costs to taxpayers," Alan B. Krueger, chief economist at Treasury, said in a statement last week.

Under the current program, Treasury pays a 35 percent subsidy on the interest rate of the bonds directly to the city, state or other government entity that issues them. The arrangement dramatically lowers the borrowing cost for local governments while providing lower costs for investors, including pension funds and other major funds that do not usually dabble in the municipal market.

The House jobs bill approved late May would extend the program through 2012 and slowly lower the federal subsidy to 30 percent. The administration favored 28 percent, which it considers revenue-neutral, though Grassley's office disagrees. The net cost of the program approved by the House would be about $4 billion, according to the Congressional Budget Office.

Among the customers is the Metropolitan Washington Airports Authority, which has conducted two bond issues under the program to fund the planned 25-mile Metro extension along the Dulles Toll Road.

E. Lynn Hampton, the authority's interim president and chief executive, said the bank fees were not out of line considering the complexity and newness of the project.

"I think over time the fees will come down as taxable investors get more used to these products," Hampton said.

That may already be happening, according to new Thomson Reuters data. Starting at an average of nearly $8 per $1,000 a year ago, the average bank fee for Build America Bonds dropped to about $6.25 per $1,000 in the second quarter, the data show. Treasury says that is nearly the same as the average fee charged for traditional municipal bonds during the same time period.

Michael Decker, a municipal securities expert at SIFMA, said that the criticism of bank commissions is overblown and that many parties -- from state and local investors to major retirement funds -- benefit from the availability of Build America Bonds. "It means local and state governments are able to build more roads and other projects at a lower cost," he said.

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