EDMOND — Have you ever been in a situation where you feel like you just got cheated, but you’re not quite sure how? Well, here is another one. Perhaps you have heard about “Build America Bonds.” Sounds kind of patriotic, doesn’t it? I hope you like the theme because you’re paying for it.

Part of the stimulus package was a program to increase the number of possible buyers of state-issued debt. Why? Because many states were having trouble issuing debt in 2008 and early 2009 at what the states considered “reasonable” interest rates. Back at the height of the financial meltdown investors were looking at states whose finances were in shambles and asking themselves, “Are these states a good risk?” The answer was obviously “No!” Because of that, states like California had to pay as much as 5-6 percent to issue bonds back then. Keep in mind that is the tax free rate.

So, along comes the Build America program, where the federal government tells states that it will subsidize their interest payments on bonds that are issued for infrastructure projects. Build America Bonds are like municipal bonds, except that the interest is taxable instead of tax free like most municipal bonds. This widens the number of participants that might buy them. For bonds issued in 2009 and 2010 the subsidy is 35 percent. For bonds issued in 2011 the subsidy is 32 percent; and for bonds issued in 2012 the subsidy is 30 percent. Who pays for that subsidy? You do.

So how does it work in reality? Let’s say you are a state and would like to raise money by issuing bonds. If you are considered a quality credit risk, then typically the interest you will pay is 20-25 percent less than the corresponding treasury bond. However, if you are a questionable credit risk — perhaps because you don’t pay your bills, or haven’t balanced your budget, or made the required payments to your pension plan, or whatever — then your cost of issuance, or interest rate, could be even higher than treasuries.

Let’s say Illinois would like to do something to rebuild its crumbling infrastructure, which also might create a few jobs. But the state is in terrible financial shape because it spends like a drunken sailor and has the fiscal responsibility of a teenager. (Not to pick on Illinois, because California and several others are just as bad.) Actually, I think drunken sailors might be offended because they’re not as bad.

Currently, the state has $5 billion of unpaid bills from last year alone and a budget gap of more than $1 billion for this fiscal year. In short, they are in terrible financial shape. You would think that a state in this sort of situation would have no luck whatsoever in getting anyone to loan them money for something less than a very high interest rate and that would force them to take serious austerity measures. Oh contraire! Build America to the rescue! In comes the U.S. government (which is code for “taxpayers across the nation”) to subsidize the interest on a bond deal for Illinois. Why? In the name of stimulus, of course! If they cannot balance their budget, pay their bills or provide for their retirees, then we taxpayers must give it to them! Are you feeling the pain yet?

Illinois recently sold $900 million in Build America Bonds with a yield around 6.96 percent. There were previous offerings also. Keep in mind, this is 35 percent subsidized by me and you. Illinois pays 4.56 percent of the interest; you and I pay the rest. The only reason Illinois would issue these bonds is if they could not borrow at 4.56 percent on their own, tax free, because investors think they are a bad risk. Incredibly, the bonds drew extensive bidding despite recent downgrades to Illinois’ credit rating.

The bonds are supposed to be used for infrastructure projects, but Illinois has made it clear it is going to be using them to fund what amounts to a make-work jobs program. Look for a lot of bridge-building, school-cafeteria retrofitting and an asphalt jungle of expansive roadwork, regardless of whether the project is needed or makes financial sense. Every taxpayer in the United States will be partly on the hook for Illinois’ fiscal irresponsibility. Build America Bonds funnel new debt to issuers that would otherwise, and correctly, be precluded from borrowing.

Then there’s your friendly neighborhood TARP bank, Citigroup. Remember them? We bailed them out and still own much of them. They were the underwriter on this issue. We paid them (ourselves) a nice little fee for their services on the offering. Interestingly, the bonds were not actively marketed to U.S. investors. Instead, the director of capital markets spent his time doing a road show in Asia to market the bonds heavily there. Apparently foreign investors think a 6.96 percent yield on a bond that is ostensibly one-third backed by the U.S. government is a better deal than a 4.10 percent treasury.

Why would we allow this to go on? Because we are addicted to debt and it is the one answer that we hear to cure our problems. How about austerity instead?  Even Europe is starting to figure that one out. The U.S. government is spending $1.4 trillion it does not have, and states are meeting their required obligations by borrowing more and more, and we as consumers are being begged and bribed to spend on credit with programs for houses, cars, appliances, etc. The days of being able to keep it up are almost over. Then what will they do? Thanks for reading.



NICK MASSEY is a financial adviser and owner of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc., member FINRA/SIPC.