Will the Build America Bonds Push Cities into Bankruptcy?

Update: “Build America Bonds” ended in 2010. The discussion has come up again as part of the 2021 debate over financing and increased federal infrastructure spending. 

Build America Bonds

Build America Bonds were created in 2009 as part of the American Recovery and Reinvestment Act. The federal government offered state and local issuers a 35 percent subsidy on interest costs if they sold the bonds on a taxable basis. Now the Treasury says it will reduce the subsidy by any amount the state or municipality owes the federal government.

This forced states and cities to come up with cash to pay the government at the same time that they are faced with severe budget deficits. As revenue declines faster than expenses in the recession, debt-laden cities had to consider filing for Chapter 9.

A Different Kind of Bankruptcy

Chapter 9 bankruptcy was created in the wake of the Great Depression to give municipalities protection from creditors while developing a plan to pay off their debts. It is generally considered a last resort because it creates uncertainty for everyone from city employees to bondholders. By compromising the security of bonds, a traditionally low-risk investment, municipalities considering bankruptcy make it harder to raise money from investors, slowing economic recovery even more.

Some municipalities have raised taxes to help relieve the problem, but experts say a surge in municipality bankruptcy filings is inevitable, especially with the change to the Build America Bonds program.