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BABs may ignite stalled bond market

A California traffic jam

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Kai Ryssdal: The Treasury released data on Build America Bonds yesterday. BABs as they're called, are municipal bonds on which the federal government pays part of the interest. Since the program was rolled out this past April after the stimulus bill passed, cities and counties in 34 states have raised almost $18 billion from BABs. The name kind of implies a grand plan for construction and creating new jobs. Which it is. But Sally Herships reports from New York, there's some financial engineering going on, too.


SALLY HERSHIPS: We need Build America Bonds, not just to build America, but to rebuild the municipal bond market. Local governments sell muni bonds to raise money for things like schools and freeways. And when the market works properly, it looks like a freeway.

Bonds fly back and forth as local governments sell and investors buy. But to keep those bonds on the road, the market needs a key player: the bond insurer.

AMY RESNICK: For about the last 20 years bond insurance was part of the market.

Amy Resnick is editor in chief of the newspaper Bond Buyer.

RESNICK: And about 50 percent of all municipal bonds sold carried an insurance policy that promised the investors that even if the government couldn't pay it back, the insurance policy would cover you, and you would get your money back.

For years, bond insurance kept the muni market running smoothly. Until last September, when the financial crisis hit, and our smooth running freeway turned into a parking lot.

Nobody wanted to buy muni bonds after they learned the insurers were guaranteeing billions in mortgage-backed securities. As those securities turned toxic, some insurers looked like they might not be able to cover their liabilities. They stretched way too thin.

RESNICK: So that insurance policy that investors relied on was now maybe not even any more reliable then the underlying government that was being insured.

Muni bonds are stuck in traffic right when municipalities need money more than ever. Charles Jones is a professor of finance at Columbia University. He says enter the U.S. Treasury, like a tow truck riding to the rescue.

CHARLES JONES: So the idea here is we come in and we jump start the market with the government's Build America Bonds.

Jones says the Treasury is offering a special deal. It subsidizes just over a third of the interest payments on every build America Bond sold. That lets the municipality jack up the interest rate and makes the bonds more attractive to investors.

JONES: And the advantage of this form of subsidy is that it's going to broaden out the set of investors who can buy this.

It also means a municipality pays out less in interest then it did before.

JONES: With a municipality, if it pays a lower interest rate it can do more investing in roads and other projects.

Hopefully getting traffic in the bond market and the economy flowing again.

I'm Sally Herships for Marketplace.

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