Build America Bonds (BABs) Explained: Types, 2010 Expiry, and Pricing Insights

What Are Build America Bonds (BABs)?

Build America Bonds (BABs) were taxable municipal bonds launched in 2009 under President Obama's American Recovery and Reinvestment Act (ARRA). Designed to generate employment and boost the economy during the recession, BABs provided federal tax credits or subsidies to bondholders or state and local government issuers. This innovative program ended in 2010.

Important Note

The Build America Bonds program officially expired in 2010, limiting their issuance to a short period.

Understanding the Purpose of Build America Bonds

Following the 2008 financial crisis, many investors preferred federal government bonds over other options, causing a decline in municipal bond investments. To support local governments in securing critical funding for infrastructure and other capital projects, the federal government introduced BABs. These bonds offered subsidized interest rates, effectively lowering borrowing costs for states, counties, and municipalities.

During this period, investors sought safer investments, making government-backed bonds like BABs more attractive compared to corporate bonds, which carried higher perceived default risks.

Types of Build America Bonds

There were two main types of BABs:

• Tax Credit BABs: These bonds provided bondholders with a 35% federal tax credit on the interest earned, reducing their overall tax liability. If the credit exceeded the tax owed, it could be carried forward to future years.
• Direct Payment BABs: In this case, the federal government paid a 35% subsidy directly to the bond issuer, lowering the issuer’s effective borrowing costs. For example, California issued $5.2 billion in BABs in early 2009 with a 7.4% interest rate, but thanks to the federal subsidy, the state’s net cost was only 4.8%.

Restrictions on Build America Bonds

Not all issuers qualified for the BAB program. Private entities and 501(c)(3) organizations were excluded, and only new capital expenditure bonds issued before January 1, 2011, were eligible. BABs could not be used to refinance existing debt.

Key Takeaways

• BABs were taxable municipal bonds with federal tax credits or subsidies to support state and local governments.
• The program was active only from 2009 until its expiration in 2010.
• Two types existed: tax credit BABs and direct payment BABs, each benefiting bondholders or issuers differently.
• BABs helped municipalities raise capital during the recession by reducing borrowing costs.

Build America Bonds vs. Traditional Municipal Bonds

Unlike traditional municipal bonds, where interest income is generally exempt from federal and sometimes state taxes, interest earned from BABs was federally taxable. This trade-off was balanced by the federal subsidies that lowered borrowing costs for issuers and offered attractive yields to investors.

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