[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
TAX-EXEMPT AND
TAXABLE GOVERNMENTAL BONDS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
MAY 21, 2009
__________
Serial No. 111-22
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
62-996 WASHINGTON : 2011
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected].
COMMITTEE ON WAYS AND MEANS
CHARLES B. RANGEL, New York, Chairman
FORTNEY PETE STARK, California DAVE CAMP, Michigan
SANDER M. LEVIN, Michigan WALLY HERGER, California
JIM MCDERMOTT, Washington SAM JOHNSON, Texas
JOHN LEWIS, Georgia KEVIN BRADY, Texas
RICHARD E. NEAL, Massachusetts PAUL RYAN, Wisconsin
JOHN S. TANNER, Tennessee ERIC CANTOR, Virginia
XAVIER BECERRA, California JOHN LINDER, Georgia
LLOYD DOGGETT, Texas DEVIN NUNES, California
EARL POMEROY, North Dakota PATRICK J. TIBERI, Ohio
MIKE THOMPSON, California GINNY BROWN-WAITE, Florida
JOHN B. LARSON, Connecticut GEOFF DAVIS, Kentucky
EARL BLUMENAUER, Oregon DAVID G. REICHERT, Washington
RON KIND, Wisconsin CHARLES W. BOUSTANY, JR.,
BILL PASCRELL, JR., New Jersey Louisiana
SHELLEY BERKLEY, Nevada DEAN HELLER, Nevada
JOSEPH CROWLEY, New York PETER J. ROSKAM, Illinois
CHRIS VAN HOLLEN, Maryland
KENDRICK B. MEEK, Florida
ALLYSON Y. SCHWARTZ, Pennsylvania
ARTUR DAVIS, Alabama
DANNY K. DAVIS, Illinois
BOB ETHERIDGE, North Carolina
LINDA T. SANCHEZ, California
BRIAN HIGGINS, New York
JOHN A. YARMUTH, Kentucky
Janice Mays, Chief Counsel and Staff Director
Jon Traub, Minority Staff Director
______
Subcommittee on Select Revenue Measures
RICHARD E. NEAL, Massachusetts, Chairman
MIKE THOMPSON, California PATRICK J. TIBERI, Ohio, Ranking
JOHN B. LARSON, Connecticut Member
ALLYSON Y. SCHWARTZ, Pennsylvania JOHN LINDER, Georgia
EARL BLUMENAUER, Oregon DEAN HELLER, Nevada
JOSEPH CROWLEY, New York PETER J. ROSKAM, Illinois
KENDRICK B. MEEK, Florida GEOFF DAVIS, Kentucky
BRIAN HIGGINS, New York
JOHN A. YARMUTH, Kentucky
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of May 14, 2009, announcing the hearing................. 2
WITNESSES
The Honorable Alan B. Krueger, Assistant Secretary for Economic
Policy, United States Department of the Treasury............... 5
Robert L. Culver, President and Chief Executive Officer,
MassDevelopment, Boston, Massachusetts......................... 18
Patrick J. McCoy, Director of Finance, NYS Metropolitan
Transportation Authority, New York, New York................... 21
Michael Decker, Co-Chief Executive Officer, Regional Bond Dealers
Association, Alexandria, Virginia.............................. 28
James P. Esposito, Managing Director, Goldman, Sachs & Co., New
York, New York................................................. 37
Gary W. Bornholdt, Counsel, Nixon Peabody LLP, Washington, D.C... 45
SUBMISSIONS FOR THE RECORD
Cadmus Hicks, Nuveen Investments, statement...................... 67
Dean A. Spina, statement......................................... 70
Peter B. Coffin, Breckinridge Capital Advisors, Inc., statement.. 71
Seamus O'Neill, Liscarnan Solutions, statement................... 72
TAX-EXEMPT AND
TAXABLE GOVERNMENTAL BONDS
----------
THURSDAY, MAY 21, 2009
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:07 a.m., in
Room 1100, Longworth House Office Building, Hon. Richard E.
Neal (Chairman of the Subcommittee), presiding.
[The advisory announcing the hearing follows:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON SELECT REVENUE MEASURES
CONTACT: (202) 225-5522
FOR IMMEDIATE RELEASE
May 14, 2009
Congressman Neal Announces a Hearing on
Tax-Exempt and Taxable Governmental Bonds
House Ways and Means Select Revenue Measures Subcommittee Chairman
Richard E. Neal (D-MA) announced today that the Subcommittee on Select
Revenue Measures will hold a hearing on issues involving tax-exempt and
taxable governmental bonds. The hearing will take place on Thursday,
May 21, 2009, in the main Committee hearing room, 1100 Longworth House
Office Building, beginning at 10:00 a.m.
Oral testimony at this hearing will be limited to invited
witnesses. However, any individual or organization not scheduled for an
oral appearance may submit a written statement for consideration by the
Committee and for inclusion in the printed record of the hearing.
FOCUS OF THE HEARING:
The hearing will focus on issues relating to tax-exempt and taxable
government bonds, and how the issuance of recently authorized taxable
bonds may impact the demand for and supply of tax-exempt bonds. Other
changes to State and local financing contained in recently passed
legislation may also be discussed.
BACKGROUND:
Since the introduction of the Federal income tax, interest income
from debt issued by State and local governments has been exempt from
tax. The Federal tax exemption lowers the cost of borrowing for State
and local governments so that State and local services can be
efficiently and consistently provided where they might otherwise not
be. State and local borrowing issued as bonds are generally classified
either as governmental bonds, which finance governmental functions, or
private activity bonds, which provide some benefit to private
businesses and may or may not be tax-exempt.
Additionally, other alternative vehicles for State and local
government financing have been authorized. For example, tax credit
bonds, which allow the holders of such bonds to receive a tax credit
instead of an interest payment. Recently, Congress passed H.R. 1, the
``American Recovery and Reinvestment Act of 2009,'' which was signed
into law on February 17, 2009 (Pub. L. 111-5). This Act contains a
number of changes impacting State and local government financing,
including a new type of taxable government bond named ``Build America
Bonds.'' These bonds allow State and local governments to elect to
receive a direct payment from the Federal Government that approximates
the subsidy that would have otherwise been delivered through the
Federal tax credit for bonds issued in 2009 and 2010. To assist areas
impacted by high unemployment, the bill also provides taxable
government bonds with a greater subsidy and tax-exempt bonds, named
Recovery Zone Economic Development Bonds and Recovery Zone Facility
Bonds.
Already, some jurisdictions have issued new bonds under the Build
America Bonds program, while the two Recovery Zone Bond programs are
awaiting initial Treasury guidance.
In announcing the hearing, Chairman Neal stated, ``As we begin to
move this economy forward, Congress should review these innovative
financing options for State and local governments as well as the impact
on their traditional methods of borrowing. I look forward to hearing
the comments from the government issuers as well as from private sector
capital market experts.''
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Any person(s) and/or organization(s) wishing to submit
for the hearing record must follow the appropriate link on the hearing
page of the Committee website and complete the informational forms.
From the Committee homepage, http://democrats.waysandmeans.house.gov,
select ``Committee Hearings.'' Select the hearing for which you would
like to submit, and click on the link entitled, ``Click here to provide
a submission for the record.'' Once you have followed the online
instructions, complete all informational forms and click ``submit'' on
the final page. ATTACH your submission as a Word or WordPerfect
document, in compliance with the formatting requirements listed below,
by close of business Thursday, June 4, 2009. Finally, please note that
due to the change in House mail policy, the U.S. Capitol Police will
refuse sealed-package deliveries to all House Office Buildings. For
questions, or if you encounter technical problems, please call (202)
225-1721.
FORMATTING REQUIREMENTS:
The Committee relies on electronic submissions for printing the
official hearing record. As always, submissions will be included in the
record according to the discretion of the Committee. The Committee will
not alter the content of your submission, but we reserve the right to
format it according to our guidelines. Any submission provided to the
Committee by a witness, any supplementary materials submitted for the
printed record, and any written comments in response to a request for
written comments must conform to the guidelines listed below. Any
submission or supplementary item not in compliance with these
guidelines will not be printed, but will be maintained in the Committee
files for review and use by the Committee.
1. All submissions and supplementary materials must be provided in
Word or WordPerfect format and MUST NOT exceed a total of 10 pages,
including attachments. Witnesses and submitters are advised that the
Committee relies on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. All submissions must include a list of all clients, persons,
and/or organizations on whose behalf the witness appears. A
supplemental sheet must accompany each submission listing the name,
company, address, telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://democrats.waysandmeans.house.gov.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TDD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
Chairman NEAL. Let me call this meeting to order, and I
hope all will take their seats.
Today the Subcommittee will consider Federal tax incentives
for State and local financing needs. As a former Mayor of a
mid-sized city--I would like to point out, a real Mayor--I
personally know the value of tax-exempt financing for community
needs.
Our Federal Government has long recognized and acknowledged
the important role that cities play in our civilized society.
President Lyndon Johnson put it this way: ``The American city
should be a collection of communities, where every member has a
right to belong. It should be a place where each of us can find
the satisfaction and warmth which comes from being a member of
the community of man. This is what man sought at the dawn of
civilization. It is what we seek today.''
The economic downturn has been felt at every level of
government, but especially in our cities. The Ways and Means
Committee heard from Governors and Mayors at a hearing last
October, and responded with a stimulus package, including a
number of expansions and improvements for State and local
borrowing. Today, we welcome a number of experts to tell us how
these bond programs are working, and what remains to be done.
One of my proudest moments as Mayor of the City of
Springfield was the largest development ever in the history of
western Massachusetts, today known as Monarch Place. As those
of you involved in local government know, you scrape together
every dollar you can find for these projects from more sources
than you care to count. At the heart of these deals is always
municipal bonds.
Monarch Place spurred a revival of the downtown, and more
bonds were then used for housing and a local theater. It really
is a perfect example of how bonds can be utilized to rebuild a
community. From roads, bridges, and energy projects, our
witnesses will tell us today that Congress is on the right
track with some of the new and innovative ways for local
governments to build the kind of community that Lyndon Johnson
spoke of.
Let me at this moment recognize my friend, Mr. Tiberi, for
his opening statement.
Mr. TIBERI. Thank you, Mr. Chairman, and thank you for
calling this hearing today. If you would have asked me in 2001,
when I got sworn in, that I would be part of a hearing on
bonds, I would have thought of major league baseball, and not
what we're talking about today, Mr. Chairman. But it is so
important.
As we know, the principal ways that State and local
governments finance their activities is through issuance of
bonds to the public. It's generally agreed that the liquidity
crisis and the accompanying economic downturn have made it more
difficult for State and local governments to find ways for
buyers to buy their bonds.
Indeed, in 2008, total issuances of long-term State and
local bonds decreased in comparison to their levels in 2007. It
is important that we review this area of the tax law
periodically, and it is especially important now, given the
state of the economy, and in light of the dramatic changes we
have seen in bond programs with the enactment of last year's
TARP legislation and this year's stimulus package.
Thank you again, Mr. Chairman. I would like to also thank
the witnesses for being here today. We are looking forward to
your testimony. I yield back.
Chairman NEAL. Thank you, Mr. Tiberi. Let me welcome our
witnesses today.
First, I want to welcome Assistant Secretary for Economic
Policy, Alan Krueger. Secretary Krueger was only confirmed by
the Senate a few weeks ago, but has kindly agreed to come
before us today to discuss this important topic, and we are
most appreciative of his time. I also want to thank him for
agreeing to be on the panel format today, and allow him, at the
right time, to conclude promptly.
I also want to welcome Bob Culver, President and CEO of
MassDevelopment in Boston. I worked with Bob for many years,
and have always found his comments instructive. I would also
point out that he has been most helpful to me in the re-use of
the old Federal courthouse in Springfield because we have built
a new Federal courthouse in Springfield. And I thought that--
the financing, he figured it out, and was right there. So I am
indeed grateful for his presence, and we will hear from him
shortly, as well.
Let me next welcome Patrick McCoy, the Director of Finance
for the Metropolitan Transit Authority of New York. MTA is one
of the largest issuers of municipal debt in the country.
Next we will hear from Michael Decker, who is the Co-CEO of
the Regional Bond Dealers Association, a trade association
which represents security firms active in bond markets. We will
also hear from Jim Esposito, a Managing Director at Goldman
Sachs, in New York. Mr. Esposito leads the municipal and
corporate investment grade new issue financing business at
Goldman Sachs.
And finally, we will hear before the Committee from Gary
Bornholdt, who served this Committee as a tax advisor to joint
tax for many years, and now is a counsel at Nixon Peabody, here
in Washington.
We look forward to the testimony that we will hear today,
and we want to thank you all for your participation. Without
any objection, any other Members wishing to insert statements
as part of the record may do so. All written statements by the
witnesses will be inserted in the record, as well.
Let me recognize Secretary Krueger for his opening
statement.
STATEMENT OF THE HONORABLE ALAN B. KRUEGER, ASSISTANT SECRETARY
FOR ECONOMIC POLICY, UNITED STATES DEPARTMENT OF THE TREASURY
Mr. KRUEGER. Thank you. Good morning, Chairman Neal,
Ranking Member Tiberi, and other Members of the Subcommittee. I
appreciate the chance to appear before you today to discuss
changes in Federal tax subsidies to lower borrowing costs for
State and local governments and other public agencies.
State and local governments confront difficult challenges
in the current economic environment. The American Recovery and
Reinvestment Act of 2009 provides a number of new and expanded
bond financing subsidies for State and local governments. In
general, these bond financing tools will support infrastructure
investment, job creation, and economic recovery.
I commend this Committee for its work in leading the
successful legislative efforts for these bond financing tools
in the Recovery Act.
In my remarks, I will briefly compare the economic effects
of different ways of providing a Federal subsidy to reduce
State and local borrowing costs with a focus on the broadest
new bond program called ``Build America Bonds.'' And, finally,
I will highlight the Treasury's efforts to provide prompt
guidance for the new bond programs.
There are currently three different ways of providing
Federal subsidies to reduce State and local borrowing costs.
First, traditional tax-exempt bonds are an important financing
tool for State and local governments. There are over $2.7
trillion in outstanding tax-exempt bonds. Tax-exempt bonds
lower State and local borrowing costs by making the interest on
the bonds tax exempt for investors.
From an economic perspective, however, tax-exempt bonds can
be viewed as an inefficient subsidy in that the Federal revenue
costs of the tax exemption is often greater than the benefits
to State and local governments achieved through lower borrowing
costs.
This inefficiency arises because the bonds have a different
value to different investors. Investors in higher tax brackets
receive a greater tax benefit. The market interest rate of tax-
exempt bonds is determined by the tax rate of the marginal
investor. The marginal investor is the investor who is just
indifferent between buying a tax-exempt bond and buying a
taxable bond for another security.
To sell enough bonds, tax-exempt bonds often have marginal
investors who are below the highest tax bracket. As a result,
tax-exempt bonds tend to give excess benefits to investors in
higher tax brackets. This conclusion is consistent with the
fact that, since 1986, interest rates on long-term tax-exempt
bonds have been about 20 percent lower than the yields on high-
grade taxable bonds, whereas the Federal revenue cost has been
large enough to finance a 25 to 30-percent reduction in
interest rates.
Tax credit bonds are a second way of supporting State and
local government borrowing costs. With these bonds, investors
receive tax credits for a portion of their borrowing costs. The
Recovery Act expands the use of tax credit bonds significantly.
Tax credit bonds are more efficient than tax-exempt bonds, in
that tax credits have comparable value to all investors with
tax liabilities.
The third and most recent innovation in subsidizing State
and local government borrowing costs are Build America Bonds.
There are two types of Build America Bonds: Tax credit and
direct payment.
I will focus on the direct payment Build America Bonds.
They are fully taxable to investors, and the Federal Government
makes direct payments to issuers equal to 35 percent of the
coupon interest.
For example, if a State or local government were to issue
Build America Bonds at a 10 percent taxable interest rate, the
Treasury Department would make a direct payment to the
government of 3.5 percentage points of that interest, and the
issuers net borrowing cost would therefore be 6.5 percent.
Direct payment bonds offer four important advantages over
traditional tax-exempt bonds. First, they are a fully efficient
subsidy. Second, the amount of Federal support to bond issuers
can be varied by project type, offering the opportunity to
tailor Federal subsidies, to provide different levels of
support for different programs. Third, they are potentially
attractive to the entire universe of bond investors. And,
fourth, the benefits of participating is democratized in that
not only those in the highest tax brackets benefit the most.
Because Build America Bonds convey no tax benefits to
investors, they have yields comparable to taxable debt
instruments, and they should therefore appeal to all bond
investors, including pension funds and foreign investors, and
investors in lower tax brackets. Expanding the market should
result in lower borrowing costs.
The early market reception for Build America Bonds has been
very positive, as other Members of this panel can comment.
Guidance for Build America Bonds was released in early April of
this year. Between mid-April and mid-May, approximately 36
issues of Build America Bonds were made, totaling about $9.5
billion in volume. This represents about 20 percent of the
total issuance of tax-exempt bonds during this period.
Moreover, investor demand and sales orders for many of the
initial issues appears to have been strong.
Preliminary indications suggest that the significant sales
volume over the past month may have reduced the supply of tax-
exempt bonds somewhat, and possibly contributed to declining
interest rates on tax-exempt bonds. It is difficult, however,
to separate out the effects of other factors that also
influence tax-exempt bond rates.
The Build America Bonds program has just begun. But the
early signs are positive. The Treasury will track developments
to ascertain whether Build America Bonds can be an effective
additional tool to serve the diverse financing needs of State
and local governments.
Finally, I want to assure the Committee that the Treasury
Department is committed to providing prompt guidance to
implement the new bond financing tax incentives. A major part
of guidance was issued through five IRS notices released
publicly in early April. This guidance implemented the direct
payment procedures on the Build America Bond program, and
provided volume cap allocation guidance for four additional tax
credit bond programs for schools and energy projects.
In the next several weeks, we expect to provide priority
guidance on the bond volume cap allocations for the recovery
zone bond programs and the Indian tribal economic development
bonds. In the coming years, as we move forward beyond the
current economic challenges, the Administration is committed to
working closely with the Congress to determine how best to
provide Federal support for lower borrowing costs to State and
local governments in the most efficient, workable, uniform,
simple, and sustainable way. Thank you.
[The prepared statement of Mr. Krueger follows:]
[GRAPHIC] [TIFF OMITTED] T2996A.001
[GRAPHIC] [TIFF OMITTED] T2996A.002
[GRAPHIC] [TIFF OMITTED] T2996A.003
[GRAPHIC] [TIFF OMITTED] T2996A.004
[GRAPHIC] [TIFF OMITTED] T2996A.005
[GRAPHIC] [TIFF OMITTED] T2996A.006
[GRAPHIC] [TIFF OMITTED] T2996A.007
[GRAPHIC] [TIFF OMITTED] T2996A.008
[GRAPHIC] [TIFF OMITTED] T2996A.009
[GRAPHIC] [TIFF OMITTED] T2996A.010
Chairman NEAL. Thank you, Mr. Krueger.
Mr. Culver.
STATEMENT OF ROBERT L. CULVER, PRESIDENT AND
CHIEF EXECUTIVE OFFICER, MASSDEVELOPMENT, BOSTON, MASSACHUSETTS
Mr. CULVER. Chairman Neal, Ranking Member Tiberi, Members
of the Committee, thank you for inviting me to testify, and for
holding this hearing. I cannot overstate the importance of the
American Recovery and Reinvestment Act of 2009, but would
suggest that more can be done to maximize its impact.
I am Bob Culver, President and CEO of the Massachusetts
Development Finance Agency, a quasi-public finance and
development entity in the Commonwealth of Massachusetts. Having
issued private activity bonds that generated more than $2
billion in investment in Massachusetts last year,
MassDevelopment knows this market, which aids affordable
housing, higher education, manufacturing, and waste recovery.
I speak this morning as a representative of my agency,
only. I have submitted a written statement to the Committee
from which I will summarize six main topics. I call your
attention to two themes that run through my testimony. First,
standardizing allocation processes using the well-vetted and
understood volume cap method as a model. And, second, extending
allocations of special issuance capacity, and making permanent
enhancements to eligibility to allow more borrowers to use
these programs.
Briefly, the first of the six subjects I would like to
touch on concerns the expanded definition of manufacturing
facilities for qualified manufacturing bonds, to include the
production of intangible properties, such as software. ARRA
also eliminated the 25 percent limit on directly related and
ancillary property. Both of these provisions expire in 2011.
These enhancements are key to supporting modern manufacturing
facilities, thereby expanding the economy.
However, many companies will not use them today, but will
need them as the economy rebounds. MassDevelopment supports
making these enhancements permanent to bring manufacturing
bonds into the 21st century.
Second, ARRA creates recovery zone facility bonds, a new
PAB category with a national limit of $15 billion. Uses include
acquisition and construction of property in designated recovery
zones. The provision expires on December 31, 2011. After
Treasury allocates cap amounts, each State must implement a
process and identify projects. And large scale redevelopment
projects may take more than a year to be ready for permanent
financing.
To maximize this program's potential, MassDevelopment urges
Treasury to give State governments control of allocating
issuance capacity among eligible projects, and asks Congress to
allow unexpended capacity to be carried forward through 2015.
Third, ARRA increased the national issuance capacity for
clean renewable energy bonds, but reduced the allowable tax
credit. Issuance capacity is awarded by the IRS, and favors
smaller issues over larger, less costly ones. MassDevelopment
used its entire allocation in 2006 to support 12 solar projects
at State facilities, but may not be able to do so again because
of the constrained tax credit market and reduced tax credit.
Giving States a pro-rata share of the overall issuance
capacity and the ability to select projects could save time and
money. Giving the program a direct pay option from the Federal
Government could speed use of the program and deliver more
benefits by eliminating structuring costs.
Fourth, ARRA increases the issuance capacity of qualified
energy conservation bonds. These bonds are also dependent on a
vibrant tax credit market. Giving States control over where to
allocate issuance capacity could enhance the program. And
because these projects take years to advance, unused issuance
capacity should be carried forward to 2015.
While MassDevelopment applauds Congress for providing this
option, creating a new category of private equity activity,
tax-exempt facility bonds would give renewable energy
developers the certainty of a permanent Tax Code provision.
Next, ARRA increases the bank-qualified bond provisions to
apply to issuers of less than $30 million a year, and include
501(c)(3)'s that borrow through a conduit issuer like
MassDevelopment. This provision will increase the market for
tax-exempt bonds by enlisting more banks as potential
purchasers, while allowing them to pass through lower interest
rates.
MassDevelopment supports these provisions, but recommends
eliminating the 2011 expiration date, and extending them to
other types of private activity bonds, in particular
manufacturing.
Finally, in 2008 Congress authorized the Federal home loan
banks to confirm bank-issued letters of credit on tax-exempt
private activity bonds beyond affordable housing. This levels
the playing field for smaller and mid-sized banks to support
tax-exempt bonds, and helps offset the collapse of bond issuers
and credit ratings of some larger banks. We support this
program, and recommend it be made permanent, so that a market
can develop. It comes with no significant cost to the Federal
Government, makes the market more efficient, and puts more
banks to work.
I appreciate the opportunity to speak to the Committee, and
look forward to your questions. Thank you, Mr. Chairman.
[The prepared statement of Mr. Culver follows:]
Prepared Statement of Robert L. Culver, President and
Chief Executive Officer, MassDevelopment, Boston, Massachusetts
Chairman Neal, Ranking Member Tiberi, Members of the Committee:
Thank you for inviting me to testify before you this morning and for
holding this hearing. One cannot overstate the importance of the
American Recovery and Reinvestment Act of 2009, but more can be done to
maximize the impact of ARRA.
I am President and CEO of the Massachusetts Development Finance
Agency (MassDevelopment), a quasi-public finance and development entity
established by the Legislature in the Commonwealth of Massachusetts.
Having issued private activity bonds that generated more than $2
billion in investment in Massachusetts in fiscal year 2008,
MassDevelopment knows this market, which aids affordable housing,
higher education, manufacturing, and waste recovery.
I speak this morning as a representative of my agency, only.
In particular, I call your attention to two general themes that run
through my testimony:
First, standardize allocation processes using the already
well-vetted and well-understood volume cap method as a model, and
Second, extend allocations of special issuance capacity
and make permanent certain enhancements to eligibility to allow more
borrowers to take advantage of these programs.
Expanded Definition of Manufacturing Facility
The first topic that I want to address has to do with ARRA's
expansion of the definition of manufacturing facilities for qualified
manufacturing bonds to include facilities used in the production of
intangible property such as software and biotech. ARRA also eliminates
the 25% limit on directly related and ancillary property so that such
property may be financed if it is functionally related and subordinate
to the manufacturing facility. Both of these provisions expire on
January 1, 2011.
These enhancements are important to supporting modern manufacturing
and production facilities, and expanding the economy. Crucially, these
bonds are subject to States' annual allocations of volume cap, which
was not expanded. For that reason, the expansions of the applications
should not be seen as an additional cost to the government. Notably,
many manufacturing companies will not take advantage of these
provisions in the current economic climate but will need them for
expansions as the economy rebounds. MassDevelopment strongly supports
making these enhancements permanent to bring manufacturing bonds into
the 21st century.
Recovery Zone Facility Bonds
Second, ARRA creates Recovery Zone Facility Bonds, a new category
of tax-exempt private activity bonds subject to a national limit of $15
billion. Eligible uses include acquisition and construction of property
in designated Recovery Zones.
As of the writing of this testimony, guidance from the U.S.
Department of the Treasury has not yet been released on how the cap
would be allocated among the States. After guidance is issued, further
work must be done in each State to implement the allocation process and
identify projects. While the interest rate savings on a tax-exempt bond
is not enough of a subsidy to make or break large-scale projects, the
savings can still be useful in steering development to underserved
areas. These types of projects may take more than a year to be ready
for permanent financing, which means that the December 31, 2010
expiration date may prove problematic.
To maximize the potential of this new bond program, MassDevelopment
urges Treasury to give State governments control of allocating issuance
capacity among eligible projects and asks Congress to provide for the
carrying forward of unexpended issuance capacity for 5 years beyond
December 31, 2010.
Clean Renewable Energy Bonds
Third, ARRA increased the national issuance capacity for clean
renewable energy bonds, which are tax-credit bonds that governmental
entities can use to finance eligible renewable energy projects.
These bonds are dependent on a vibrant tax credit market that does
not exist at this time. This concern is exacerbated because the
expanded program is limited to 70% of the tax credit allowed by the
original program. The issuance capacity is awarded to governmental
borrowers by the Internal Revenue Service by ranking applications from
smallest to largest. This approach favors small issues that tend
to be less efficient than larger ones because of the proportionately
larger cost of issuance.
MassDevelopment used its entire allocation in 2006 to support 12
solar projects at State facilities. We are concerned, however, that we
may not be able to use the program as successfully again because of the
constrained tax-credit market and the reduced tax credit. The potential
of the program would be greatly enhanced by giving States a pro-rata
share of the overall issuance capacity along with the ability to select
projects, rather than leaving the application process with the IRS,
which takes more time and favors less efficient projects.
We would also favor giving the program a ``direct pay'' option from
the Federal Government (as with Build America Bonds) instead of tax
credits. Doing so would speed the use of the program and possibly
deliver more benefits to the projects by eliminating some of the
structuring costs and investor yield requirements.
Qualified Energy Conservation Bonds
Fourth, ARRA increases the issuance capacity for Qualified Energy
Conservation Bonds. These are tax-credit bonds that can be used for
both governmental and private purposes and can finance a broad range of
energy conservation and renewable energy generation projects.
MassDevelopment fully supports the objectives of this program. Like
the Clean Renewable Energy Bonds, however, the energy conservation
bonds are dependent on a vibrant tax credit market. In line with our
prior recommendation for the Recovery Zone Facility Bond program, to
enhance the program's health States should have control over where to
allocate issuance capacity. And unused issuance capacity should be able
to be carried forward to 2015.
While MassDevelopment applauds the Congress for making tax-
advantaged financing available for renewable energy projects, an
efficient way to support this sector would be to create a new category
of private activity, tax-exempt facility bonds. Doing so would allow
the sector to benefit from the same tax-exempt bonding programs
currently available to waste recovery projects. This new category would
also give renewable energy developers the certainty of a permanent
provision of the Tax Code. These projects--which involve financing,
permitting, and site-control issues--take years to advance, a process
that could be short-circuited if the necessary incentives expire in the
short term without certainty of renewal.
Bank Deductibility of Interest Expense
Next, ARRA increases the ``bank-qualified'' bond provisions to
apply to issuers of less than $30 million per year, up from $10 million
per year, and to include 501(c)3 borrowers that borrow through a
conduit issuer such as MassDevelopment.
This provision will increase the market for tax-exempt bonds by
enlisting more banks as potential purchasers while allowing them to
pass through lower interest rates. MassDevelopment places many of its
smaller issues directly with banks, which handle the transactions much
like commercial loans. These borrowings benefit from the discipline of
having a bank lender instead of the capital markets and also from
having smaller costs of issuance.
MassDevelopment supports the increased bank-qualified provisions,
but recommends that they be extended to other types of private activity
bonds other than 501(c)3 borrowings, in particular manufacturing. The
Agency also recommends eliminating the expiration date of 2011.
Federal Home Loan Bank Confirming Letters of Credit
Finally, in 2008, Congress authorized the Federal Home Loan Banks
to confirm bank-issued letters of credit on tax-exempt private activity
bonds beyond affordable housing only. This authorization will be
tremendously useful in providing investment grade rated credit to
guarantee private activity bonds issued by conduit issuers such as
MassDevelopment. This authorization levels the playing field for
smaller and mid-sized banks to support tax exempt bonds, and helps to
offset the collapse of bond insurers and the investment grade credit
ratings of some of the larger banks.
We fully support this program and recommend that it be made
permanent beyond 2010 so that a market can develop. MassDevelopment
believes this program comes with no significant cost to the Federal
Government: The program does not increase the eligible uses of tax-
exempt bonds, but simply makes the market more efficient and puts more
banks to work. In fact, MassDevelopment recently held seminars across
Massachusetts that banks enthusiastically attended. Our agency closed
its first issue under this expanded capacity in March.
Thank you for the opportunity to submit this testimony.
Chairman NEAL. Thank you, Mr. Culver.
Mr. McCoy.
STATEMENT OF PATRICK J. MCCOY, DIRECTOR OF FINANCE, NYS
METROPOLITAN TRANSPORTATION AUTHORITY, NEW YORK, NEW YORK
Mr. MCCOY. Good morning, Mr. Chairman, Ranking Member
Tiberi, and Members of the Subcommittee. I want to thank you
for the opportunity to testify today on taxable and tax-exempt
municipal government bonds and, in particular, the newly
created Build America Bonds program.
Mr. Chairman, as you know, the MTA transportation network
is one of the largest in the world. MTA provides 8.7 million
subway, bus and commuter railroad rides daily, or 2.7 billion
rides per year, accounting for nearly one-third of all transit
riders in the United States. MTA also operates seven bridges
and two tunnels that carry nearly 300 million vehicles per
year, the most heavily trafficked bridge and tunnel system in
the Nation. MTA accomplishes this mission with over 69,000
dedicated employees.
Investment in this vast regional transportation network has
resulted in MTA being one of the largest issuers of municipal
debt in the United States, with over $26 billion in debt
outstanding at this time.
Since 1982, MTA has invested over $72 billion in capital
improvements through a series of 5-year capital programs that
are funded from city, State, and Federal grants, as well as our
bond financing program. MTA has replaced or overhauled nearly
the entire system, including restoration of Grand Central
Terminal, and Long Island Railroad's Penn Station.
The need to maintain our extensive transportation
infrastructure and keep it in a state of good repair requires
stable and predictable capital investment. But dramatic
ridership growth over the past 10 years, nearly 50 percent
across the board, has also required us to undertake the first
major expansion of our service in over 60 years through the
construction of the Second Avenue Subway, Number Seven Line
extension, and connecting Long Island Railroad with Grand
Central Terminal.
Our existing current 2005 through 2009 capital program,
which covers both maintenance and state-of-good-repair
investment, as well as expansion needs, is over $22 billion.
Like many other issuers, MTA uses a variety of funding
sources to meet its capital program requirements, including
bond financing, which accounts for about 40 percent of our
current capital funding needs. Bond financing for large capital
expenditures matches the funding of the asset with the useful
life of the asset. If a subway car, for example, lasts for 30
years, we like to finance that with a 30-year debt.
MTA is slated to issue roughly $2 billion per year in the
foreseeable future to continue these investments, just our bond
financing portion of the funding.
The ongoing global credit crisis has had a devastating
effect on the municipal bond market over the past year, and
that has hampered State and local governments across the
country from being able to access the market affordably. For
example, State and local governments, including the MTA, have
seen their access to liquidity severely constrained at
increasing cost. This is a trend that appears to be continuing
for the foreseeable future.
While, however, it does appear, though, that the credit
markets are slowly recovering, ensuring long-term stability
should be a vital priority for Congress and the Administration.
One of the more positive developments that has taken hold
of the market this year are the many bond provisions that were
included in the American Recovery and Reinvestment Act of 2009,
especially the newly created Build America Bonds program. We
were one of the first issuers to take advantage of this
program, and I would like to talk a little bit about that now.
In April, we announced plans to issue $200 million in Build
America Bonds under our dedicated tax fund rated AA by S&P and
A+ by Fitch. We plan to enter the market at the same time, with
$400 million in tax-exempt bonds. And, as you know, these
markets that we issue into, the taxable and the tax-exempt
markets, are different, and they are structured and priced
differently.
Traditional tax-exempt bonds are structured with serial
maturities, or with part of the principal amount due each year,
much like a mortgage. And often there are larger maturities,
referred to as term bonds, at the end of the amortization
schedule, similar to a balloon payment on a mortgage. Serial
and term bond structure allows the issuer to repay part of the
principal and interest each year until the bond is repaid.
Traditional tax-exempt bonds are generally priced relative to
an index of AAA-rated municipal bonds.
Tax credit bonds, including Build America Bonds, generally
need to be issued with long-dated, bullet maturities, which are
common in the corporate taxable bond market. In other words,
the entire principal amount would be due in one lump-sum
payment. Build America Bonds are--like corporate taxable
bonds--priced relative to the 30-year Treasury, and we express
that as a spread to Treasuries. MTA was optimistic that this
structure would expand the pool of investors, increase market
access for our debt.
Other issuers that came the same week as the MTA were the
State of California and the New Jersey Turnpike. We all priced
our bonds on different days, and we watched how these other
issuers came to market and worked aggressively to price our
bonds as efficiently as possible at that time. Our initial
offer of $200 million was increased to $750 million, due to
very strong investor interest at the time of the issue.
I will sum up now. The Build America Bond program has
expanded the investor base for municipal bonds. And there were
approximately 35 new investors that came into the MTA deal that
had never participated in our borrowings before. By attracting
these new investors, MTA was able to expand and diversify the
investor base, which we believe will help achieve more
efficient pricings in the future.
The rest of my testimony is on record, and I will be happy
to take questions at that time, after concluding. Thank you.
[The prepared statement of Mr. McCoy follows:]
[GRAPHIC] [TIFF OMITTED] T2996A.011
[GRAPHIC] [TIFF OMITTED] T2996A.012
[GRAPHIC] [TIFF OMITTED] T2996A.013
[GRAPHIC] [TIFF OMITTED] T2996A.014
Chairman NEAL. Thank you, Mr. McCoy.
Mr. Decker.
STATEMENT OF MICHAEL DECKER, CO-CHIEF EXECUTIVE OFFICER,
REGIONAL BOND DEALERS ASSOCIATION, ALEXANDRIA, VIRGINIA
Mr. DECKER. Thank you, Chairman Neal, Ranking Member
Tiberi, and other Members of the Subcommittee. I appreciate the
opportunity to be here today.
Like all other sectors of the capital markets, the
municipal bond market has been acutely affected by the global
financial crisis. Last fall, for a time at the height of the
crisis, it became nearly impossible for most States and
localities to access the capital markets to finance investment
projects.
The market has recovered significantly since then, in part
with the help of legislation advanced by the Ways and Means
Committee. But now, State and local governments are dealing
with the sometimes severe fiscal stress brought about by the
recession and the downturn in real estate markets.
The American Recovery and Reinvestment Act includes a
number of provisions that have helped States and localities
weather the financial crisis. My written statement offers
comments on all the municipal finance provisions included in
the law. In the interest of time, I will focus my comments here
on three provisions that have had the most positive effect:
Build America Bonds, expansion of bank investment, and the tax-
exempt bond market, and the AMT relief.
I am going to admit, Mr. Chairman, that when I first heard
about Build America Bonds, I was skeptical that they would
offer real benefits for States and localities. However, based
on the experience of the last 2 months, I am now a believer. By
allowing State and local governments to tap the taxable bond
market without losing the generous interest subsidy associated
with tax-preferred financing, Build America Bonds offer State
and local governments a tool that often provides lower-cost
financing than they could obtain through any other means.
Moreover, Build America Bonds have had the unanticipated
effect of lowering borrowing costs in the tax-exempt bond
market, as well. They are, in short, a huge hit.
That is not to say that Build America Bonds haven't raised
some questions among market participants. They are challenging
some of the standard structures that have been popular among
municipal bond issuers for decades, like serial maturities and
10-year call provisions.
Also, there are doubts about whether Build America Bonds
will be as effective for State and local governments when the
interest subsidy rebate expires at the end of 2010, and the tax
credit on the bonds accrues to investors, rather than issuers.
While we don't think Build America Bonds can or should displace
tax-exempt bonds as the dominant way for States and localities
to finance capital investment, they're a great tool to help
bond issuers weather the crisis.
Two other provisions of the stimulus legislation that have
helped States and localities are expanding bank investment in
tax-exempt bonds and exempting bond interest from the AMT. The
bank investment provisions have helped restore the role of
commercial banks as tax-exempt bond investors.
Before the 1986 Tax Reform Act, banks were dominant buyers
of tax-exempt debt. The 1986 Act included tax law changes that
effectively took banks out of the market for all but a small
number of bonds. By bringing banks back, and thereby increasing
demand for bonds, you have made it easier for States and
localities to find investors for their debt at good terms.
Lifting the AMT on tax-exempt bond interest has helped
reopen an important sector of the market that had been
effectively closed since last year. It had become exceedingly
difficult for issuers of private activity bonds for facilities
like airports and economic development projects to obtain bond
financing.
The spread, or difference in interest rates between AMT and
non-AMT bonds, had increased to historical levels. The AMT
holiday has addressed these issues, and made it possible for
private activity bonds to be issued once again.
With respect to another set of provisions from the stimulus
bill, authority for targeted tax credit bonds, such as clean
renewable energy bonds and qualified energy conservation bonds,
I think it is useful to point out to the Subcommittee that, in
many cases, borrowers have had a hard time using this authority
to raise financing. The Subcommittee may want to consider
diverting all or a portion of the revenue cost associated with
some tax credit bond authority to other more conventional types
of financing, such as private activity tax-exempt bonds for
energy facilities.
Also, I would like to bring to the Subcommittee's attention
legislation that, even as we speak, is being discussed in the
Financial Services Committee. Two bills under consideration
there to help State and local bond issuers include provisions
to exempt some new proposed programs from the section 149 Tax
Code prohibition on Federal guarantees of tax-exempt bonds.
While these proposals--when these proposals come before the
Ways and Means Committee, we urge you to approve them quickly.
The stimulus bill has certainly been successful in
providing tools to State and local governments to continue to
raise capital in a distressed market. We appreciate the work
you all did in ensuring that State and local finance received
meaningful attention in the stimulus legislation.
Thank you, again, for the opportunity to be here. I look
forward to your questions.
[The prepared statement of Mr. Decker follows:]
[GRAPHIC] [TIFF OMITTED] T2996A.015
[GRAPHIC] [TIFF OMITTED] T2996A.016
[GRAPHIC] [TIFF OMITTED] T2996A.017
[GRAPHIC] [TIFF OMITTED] T2996A.018
[GRAPHIC] [TIFF OMITTED] T2996A.019
[GRAPHIC] [TIFF OMITTED] T2996A.020
[GRAPHIC] [TIFF OMITTED] T2996A.021
Chairman NEAL. Thank you very much, Mr. Decker. The AMT
holiday that you referenced was my amendment, and I was amazed
at how quickly it appeared in advertising.
Mr. DECKER. Absolutely.
Chairman NEAL. Mr. Esposito.
STATEMENT OF JAMES P. ESPOSITO, MANAGING DIRECTOR, GOLDMAN,
SACHS & CO., NEW YORK, NEW YORK
Mr. ESPOSITO. Chairman Neal, Ranking Member Tiberi, and
Members of the Committee, my name is Jim Esposito, and I lead
the municipal and corporate financing business at Goldman
Sachs.
Given my leadership role across both the taxable and tax-
exempt capital markets business, I have a broad perspective on
the new programs enacted by Congress as a part of the American
Recovery and Reinvestment Act.
Build America Bonds have had a positive impact in three
specific areas. First, they have lowered borrowing costs for
State and local governments. Second, they have provided issuers
a needed source of capital to fund infrastructure projects.
And, third, they are improving the functionality of the capital
markets for issuers and investors, alike.
Historically, the $2.5 trillion municipal debt market had
provided States and municipalities access to capital at
affordable borrowing rates. The capital market deterioration
during 2008 created an exceptionally challenging environment
where only the highest-rated municipalities and corporations
had access to the capital markets.
Certain institutional investors exited the market
permanently, and others sat on the sidelines, simply willing to
ride out the storm. It became clear that expanding the
traditional tax-exempt buyer base was needed to restore
stability and long-term viability to the municipal market.
The Build America program has provided municipal issuers
access to a separate and distinct buyer base. Access to this
new taxable investor base has helped municipal issuers lower
their overall borrowing costs, and diversify their funding
streams. Build America Bonds have not eliminated the need for a
tax-exempt market, but rather have provided an alternative
through 2010.
A positive effect to the BABs program to date is the
visible resurgence of the traditional tax-exempt market. As
taxable investors grow more comfortable analyzing municipal
credits, we are starting to see signs of an increased amount of
structuring flexibility and pricing power.
The other large taxable program recently created is the
qualified school construction bonds, otherwise known as QSCBs.
The size of this program, as well as the ability for large
school districts to fund education capital needs on an
interest-free basis, will be two key components that will drive
the ultimate success of this program.
If I can turn your attention for a second to the monitors,
I appended an exhibit to my testimony. And they say a picture
is worth 1,000 words. And I think this exhibit is rather
powerful, and really speaks to the success of the Build America
Bond program.
And just a brief explanation as to what you see in this
exhibit. If you follow along the horizontal axis, those navy
blue bar charts are tax-exempt issuance volumes, dating back to
September 2008 on a weekly basis. If you move all the way to
the right of the horizontal axis, the lightish blue color is
issuance volumes under the Build America Bond program. And, to
date, we have seen 9.25 billion issued under the Build America
program in the past month, alone.
Now, more importantly on this chart is the red line. The
red line represents the cost of borrowings to States and local
governments. That is a AAA-rated composite of municipal bond
yields, as a percentage of overall Treasury yields.
Historically, municipal yields have traded at about 80 to 90
percent of Treasury yields.
And, as you can see, if you go back to the time of the
Lehman Brothers bankruptcy filing in September of 2008,
issuance volumes from municipal clients started to really dry
up. And, just as importantly, borrowing costs really spiked,
reaching a peak at year-end 2008. And we saw municipal yields
trading at almost two times the rate of underlying Treasury
yields. So, market access really seized up, and borrowing costs
spiked.
Now, as we get into the new calendar year, you can see
borrowing costs starting to fall significantly. I think it's
important to point out, as a part of the market anticipating
the positive impact of the American Recovery and Reinvestment
Act, yields started to fall. And they continued to fall during
the period in which the Build America program actually got
rolled out.
It is not just issuers who have financed debt under the
Build America program who have benefitted. With borrowing costs
falling in a taxable market, whether you use the program or
not, all municipal clients have been beneficiaries of this
program.
In conclusion, the taxable bond options recently enacted
have had the immediate effect of lowering borrowing costs to
State and local governments, while providing investors with a
compelling opportunity to diversify their portfolio holdings.
Congress, and this Committee specifically, should be commended
for providing municipalities access to new liquidity sources
during these challenging times. We encourage Congress to
monitor the stimulus-related financing programs to determine
if, at the end of 2010, any or all of these programs warrant
extension or even expansion.
On behalf of Goldman Sachs, I appreciate the opportunity to
appear before the Committee today, and I look forward to taking
your questions.
[The prepared statement of Mr. Esposito follows:]
[GRAPHIC] [TIFF OMITTED] T2996A.022
[GRAPHIC] [TIFF OMITTED] T2996A.023
[GRAPHIC] [TIFF OMITTED] T2996A.024
[GRAPHIC] [TIFF OMITTED] T2996A.025
[GRAPHIC] [TIFF OMITTED] T2996A.026
[GRAPHIC] [TIFF OMITTED] T2996A.027
Chairman NEAL. Thank you very much, Mr. Esposito.
Mr. Bornholdt.
STATEMENT OF GARY W. BORNHOLDT, COUNSEL,
NIXON PEABODY LLP, WASHINGTON, D.C.
Mr. BORNHOLDT. Good morning, Mr. Chairman, Ranking Member
Tiberi, and Members of the Subcommittee. Thank you for holding
this important hearing today, and thank you for giving me the
opportunity to testify.
While I was with joint counsel a little over a year ago, I
had the opportunity to work on many of the tax-exempt and tax
bond provisions that we are discussing here today. In my
current position as a tax-exempt bond attorney with Nixon
Peabody, I now have the opportunity to assist State and local
governments in their efforts to utilize many of these new
programs.
But the past year has certainly presented challenges in
that regard. As we have heard from other witnesses today, the
global credit crisis and the economic downturn has made it
significantly difficult for State and local governments to
access the capital markets. This, in turn, has had a
significant impact on the ability of State and local
governments to finance essential governmental services and
facilities.
We are seeing some improvements for higher-rated municipal
issuers. However, access to the bond market continues to be a
problem for many State and local governments.
The American Recovery and Reinvestment Act provided State
and local governments with a number of new financing tools and
modifications to existing programs that have the potential to
increase the demand for bonds and improve the overall
efficiency of the markets. And, as we have heard from the other
witnesses today, we are already seeing improvements due to some
of the provisions that have been enacted.
Yet, not all of the bond provisions have been fully
utilized as of yet. For example, the Recovery Act authorized a
$25 billion bond program for economically distressed areas that
cannot be used until initial guidance is issued by Treasury.
More generally, because many of the bond programs in the
Recovery Act are so innovative, issuers would benefit from
additional guidance clarifying that the existing regulatory
framework that applies to tax-exempt bonds, and that has been
in place for more than 20 years, would also apply to many of
the new bonds that have been established under the Recovery
Act. This would also help to remove some of the uncertainties,
with respect to the new programs.
That said, I would like to note that Treasury and IRS chief
counsel have been incredibly responsive to issues that have
developed regarding implementation of these new programs. The
ability of Treasury to respond to these questions on a prompt
basis is obviously of critical importance, given the temporary
nature of many of these programs, and I am confident that the
open dialogue the Treasury and IRS have had with the industry
can continue.
As we have heard, the tax exclusion that is provided under
the Internal Revenue Code for State and local government bonds
helps to lower borrowing costs. And traditionally, this has
provided State and local governments with an efficient source
of capital for their financing needs.
In contrast, recent tax credit bond programs, which date
back to about 1997, have--tend to be illiquid, and a market has
not--an efficient market has not yet developed for these
programs. And I think this is for a number of points that I
would just like to summarize briefly.
For one, most of the tax credit bonds under present law
share a common feature, in that the credit rate is set by the
Department of the Treasury, and it is generally intended to be
set at a level that provides deeper subsidy than provided for
tax-exempt bonds.
However, as Treasury has acknowledged, it has not always
managed to set the credit rate at the intended subsidy level,
which has required tax credit bonds to go out at a discount,
which lessens the value of the intended subsidy.
In addition, there has been a lack of demand for tax
credits in general. Currently, a liquid market for tax credits
does not exist. In the current economic climate, there has not
been a strong demand for tax credits among taxable investors.
In addition, rules that would allow investors to sell the
underlying tax credits separately from the principal component
of the bond, which should, in theory, improve the marketability
of the tax credit bonds, have not yet been released by the
Department of the Treasury.
In addition, all of the existing tax credit bonds have been
temporary or limited in size. The Clean Renewable Energy Bond
program, for example, was initially capped at 800 million, when
enacted in 2005. This amount has been increased over the years,
and is currently at 2.4 billion, after the Recovery Act. But
this is still a relatively small program, when contrasted with
the approximately 19 billion of tax-exempt debt that was issued
for public power in 2007 alone.
In addition, some of the tax credit bond programs have
expired over time. For example, the QZAB program, Qualified
Zone Academy Bonds, has expired, only to be reauthorized on a
retroactive basis. These issues have made it difficult for
efficient markets to develop, with respect to the existing tax
credit bond programs.
Recently, Congress has enacted standardized rules for many
of these existing tax credit bonds, which should help to
address some of these issues regarding efficiencies. But
Treasury guidance will probably need to be issued with respect
to many of the new rules before the market can get comfortable
with respect to the standardized rules that would apply to all
tax credit bonds.
With regard to the Recovery Act, we see some of the most
significant changes to the tax rules relating to municipal
bonds since the Tax Reform Act of 1986. The Recovery Act
contains provisions that should help improve the demand for tax
and financing, such as the temporary elimination of the
application of the AMT to bonds issued in 2009 and 2010, and
the relaxation of deductibility restrictions, also for bonds
issued in 2009 and 2010. These demand-side incentives are
already providing benefits to the market, and there are sound
policy reasons for making these provisions permanent.
The biggest program, from the standpoint of State and local
governments, is probably the Build America Bond program, which
we have heard about here today. And, as we have heard, there
are two types of Build America bonds: The tax credit bond
version, which operates similar to existing tax credit
structures; as well as the direct pay version.
I am not going to go through the technical details of the
two types of the program. But as we have heard here today, we
have seen significant interest in the direct pay version of the
Build America bonds. And I think this is, in part, due to the
fact that, in some cases, there may, in fact, be a deeper
subsidy for the Build America Bonds direct pay than associated
with tax-exempt bonds.
But I think it's also due to the fact that, for this new
product, investors have not had to digest many of the new rules
that would apply to tax credit bonds, generally. Rather, the
market is purchasing a taxable bond, and it is the issuer that
is receiving the direct benefit from the Federal Government in
this case.
Finally, in conclusion, I would like to say that, due to
the temporary nature of these programs, it may be difficult for
robust markets to develop in the short period of time we have
to issue bonds under the Recovery Act programs. So I think it
is necessary to extend many of these programs in order for
Congress to get a full sense of the value that they could
provide, as a complement to tax-exempt bond financing,
generally.
In addition, I would like to mention that today the results
that we're hearing going on in the Financial Services Committee
address some of the liquidity issues that still remain in the
tax-exempt bond market, and some of these issues will also
impact tax-exempt bond requirements. For example, there are
issues relating to Federal guarantees, which are generally
prohibited under the Internal Revenue Code. Some of the
proposals that are being considered by the Financial Services
Committee, for example, would require amending these Federal
guarantee prohibitions, in order for these new liquidity
proposals to operate efficiently.
Thank you for the opportunity to testify. I look forward to
your questions.
[The prepared statement of Mr. Bornholdt follows:]
[GRAPHIC] [TIFF OMITTED] T2996A.028
[GRAPHIC] [TIFF OMITTED] T2996A.029
[GRAPHIC] [TIFF OMITTED] T2996A.030
[GRAPHIC] [TIFF OMITTED] T2996A.031
[GRAPHIC] [TIFF OMITTED] T2996A.032
[GRAPHIC] [TIFF OMITTED] T2996A.033
[GRAPHIC] [TIFF OMITTED] T2996A.034
Chairman NEAL. Thank you, Mr. Bornholdt.
Secretary Krueger, I am interested in the guidance you have
referenced for the recovery zone bond program. We have heard
from some witnesses that we should consider extending the time
for these programs. Do you expect this initial guidance will be
comprehensive, especially for those jurisdictions which may be
receiving a direct allocation, such as Springfield?
Mr. KRUEGER. Our goal is to produce the guidance as quickly
as we can, which I think will be in a matter of a small number
of weeks, and to make the program as administratively easy as
possible for Springfield and other communities.
Chairman NEAL. Thank you. And, Mr. Culver, let me follow up
on the line of questioning with you. I understand
MassDevelopment has issued bonds on behalf of smaller
jurisdictions in Massachusetts. As you know, the recovery zone
bond program will not only have allocations for States, but for
large cities and counties with severe job losses.
Do you expect MassDevelopment to assist with the recovery
zone bond offerings? And, if so, what preparations have you
made for the pending Treasury guidance that could come in a
small number of weeks?
Mr. CULVER. Right. We are--as you know, we work with all
351 of the cities and towns in the Commonwealth of
Massachusetts, as well as smaller banks. And we are really,
right now, working with them to make them aware of the new
programs, how they might use them, and how we can assist them,
in fact, in making filings to take advantage of them, and also
expressing to them their need to get their projects ready to
go, if, in fact, they're going to use this type of debt
financing.
Chairman NEAL. Right. And, Mr. McCoy, we have heard from
other witnesses that the Build America Bonds may have been
priced inefficiently, perhaps due to the fact that they were a
new product on the market. As someone who has issued the Build
America Bonds, what is your experience, in terms of pricing
your bonds?
Mr. MCCOY. We went into the pricing of our bonds, again,
both taxable and tax-exempt, on the same day, and evaluated
significant amounts of information, market data from our
financial advisor, as well as from our underwriters. And we
felt that, given the fact that we were improving pricing
relative to tax-exempt bonds, the Build America Bonds were--
delivered the kind of savings we needed and wanted.
We have certainly heard those criticisms about particularly
secondary market trading, and how that has improved the
pricing, relative to the primary issuance. I think, given our
experience, we were satisfied with the outcome, and would
evaluate the issuance of BABs again in the future, with the
same process and the same methodology that we used the first
time.
Chairman NEAL. And, Mr. Decker, your testimony highlights
support for the safe harbor provision, allowing banks to invest
in tax-exempt bonds. You stated that many banks have not
followed through. And, as you know, I pushed hard for this
provision in the stimulus bill.
It is disappointing to hear what you have suggested. And
can you explain to me why more banks have not increased their
holdings?
Mr. DECKER. I think part of it is inertia. I think bank--
many bank investment officers are used to buying bonds that
have an explicit opinion, tax opinion, associated with the
bonds, that they're bank-qualified.
And in expanding the eligibility for bank investment to
non-bank-qualified bonds--to any bonds that are available in
the market, I think it's just going to take a little time for
bank investment officers and tax directors to get used to the
idea that they can buy non-bank-qualified bonds and still not
take a tax hit. Forums like this I think are good for
publicizing that.
Chairman NEAL. This is very informative, just listening to
your testimony, all of you, this morning. Very, very helpful.
Mr. Esposito, I was interested in the chart you presented.
It shows a peak at the end of 2008 for municipal yields, as a
percentage of the 30-year Treasuries. You refer to this as a
dislocation.
And, first, have you seen this sort of dislocation before?
And what amount of municipal borrowing usually occurs in the
last quarter of the year? And what happened at the end of 2008?
Mr. ESPOSITO. Yes, let me start by saying that the
dislocation that we saw in the capital markets was not specific
to the tax-exempt market. There was a dislocation, globally,
across all asset classes, other parts of the debt markets, the
equity markets. So, this was a dislocation and a severe lack of
liquidity. Liquidity left the system through a very violent de-
leveraging process.
While, over the years, volume certainly slipped into year-
end, the end of 2008, for the municipal market, were some of
the thinnest volumes we have seen in the past decade. In terms
of the success of the Build America program, and what that
meant for issuance volumes and lowering the cost of borrowing
for municipal clients, I think the graph is very telling. And,
bear in mind, the markets were anticipating the passage of the
Act.
So, while the lines started to fall at the beginning of the
year, at that point in time market participants were already
expecting the passage of the Build America program. So I think,
in a lot of ways, the program should get credit for the
decrease in yields, starting at the beginning of the year.
Chairman NEAL. Okay, thank you. Mr. Bornholdt, you suggest
that Congress should look to extend the Build America Bond's
direct payment model to other types of tax credit programs.
Others have suggested that private activity bonds might be
expanded to include these tax credit programs.
Mr. Houghton, a former Member of this Committee, we worked
hard on that very issue, and we were very successful. What
approach do you think would be better?
Mr. BORNHOLDT. Regarding either expanding the direct pay--
--
Chairman NEAL. Yes.
Mr. BORNHOLDT [continuing]. Version, or expanding the Build
America Bonds to private activity bonds?
Chairman NEAL. Yes.
Mr. BORNHOLDT. Well, that is a good question. I mean, I
think Congress has identified certain priorities in authorizing
the Clean Renewable Energy Bond programs and the School
Construction Bond programs, by providing these particular
programs with a deeper subsidy than provided generally through
tax-exempt bonds, or even provided through the direct pay for
Build America Bond programs.
For example, with the clean renewable energy bonds,
Congress provides a subsidy that is approximately equivalent to
70 percent of the interest costs.
So, to the extent Congress continues to view renewable
energy as a priority, school construction as a priority, and
worthy of deeper subsidies than some other types of programs,
the direct pay, which would provide a direct pay equivalent to
the intended subsidy under the tax credit rate, would probably
be preferable, in terms of delivering that deeper subsidy.
In terms of long-term--with respect to just general purpose
activities, for example, we have seen programs similar to the
Recovery Act facility bonds, which are essentially a type of
private activity bond for any type of business purpose--that
is, any depreciable property. We have seen those programs
successful in other recovery areas, such as the New York
Liberty Zone and the Gulf Opportunity Zone.
So, for more general programs, the private activity bond
program which allows issuers to issue tax-exempt bonds for
basically any purpose that the State or local government
determines is a worthy financing opportunity, the private
activity bond program may provide a better general purpose
program. But with respect to those programs that Congress has
specifically identified as worthy of a deeper subsidy, the
direct pay is probably the more direct approach.
Chairman NEAL. Thank you. Mr. Tiberi is recognized to
inquire.
Mr. TIBERI. Thank you, Mr. Chairman. Starting with Mr.
Krueger, over the last 20 years we have seen an expansion on
the use of tax-preferred bond financing through incentives in
the amount of private activity bonds that the States can issue,
and the addition of activities, as well, that qualify for tax-
preferred bond financing.
In your view, what impact has that had for State and local
governments in financing what we would all look at as
traditional functions, like building bridges and roads, if any?
Mr. KRUEGER. I'm sorry, I'm not sure I understand the
question. The question is how has the balance with private
activity----
Mr. TIBERI. Yes. How has the expansion of activities and
the use of these bonds for State and local governments impacted
the building of roads and bridges by the whole government?
Mr. KRUEGER. I--this is not an area that I have studied
directly.
Mr. TIBERI. We can go to other panelists and come back to
you. Mr. Culver.
Mr. KRUEGER. But I would just emphasize that the private
activity bonds are subject to the volume cap, which is going
to, you know, often be a constraint on the amount of private
activity that--private activity bonds that are issued, and that
take place.
Mr. TIBERI. Thank you. Mr. Culver, any thoughts?
Mr. CULVER. I agree. I mean, the--they are a good addition
to the debt that is already--needs to be incurred for these. If
you look at our issue of the big dig and other issues that we
deal with, they will not affect us in that financing, per se,
if you will. I mean, we are still subject to a lot of other
financing mechanisms.
But the--what is happening right now, in terms of the new
issuance that you are considering, is really going to help us,
in terms of what I deal with, small businesses, and assisting
cities and towns, by giving them access to tax-exempt debt that
they have not heretofore had. It will take some time, as has
been noted, for the markets to get used to this. And it will
also take time for these businesses and the smaller cities and
towns to believe that they have the cashflow to pay the debt
service, even though it is becoming more efficient and the cost
of issuance is becoming less for them.
And that is why we're basically asking please extend this.
Give us a little bit more time with this, because this--these
new products will be more effective in the areas that we deal
with, as the economy begins to pick up, and the markets begin
to understand how to use these.
Mr. TIBERI. Mr. McCoy.
Mr. MCCOY. You know, I think our experience with the Build
America Bonds issuance that we had last month was very
successful. We improved our cost of financing, relative to tax-
exempt financing, on a present-value basis. We saved
approximately $46 million using the Build America Bonds,
relative to doing that in a tax-exempt market.
At the end of the day, we used both tax-exempt and taxable,
because we want to have flexibility, we want to be able to
enter the market in ways that continue to tap into these
different investor pools. I think, to the extent that we will
come back to the market later in the year, and certainly next
year--again, with heavy issuance--we're going to continue to
look at this program as a tool that we would absolutely look to
use.
Chairman NEAL. Mr. Decker.
Mr. DECKER. There are some uses for private activity bonds
that are traditional infrastructure-type projects, not roads
and bridges, but projects like water and sewer systems or
airports, that are eligible for private activity bond
financing. And I think that that--those provisions in the Code
allow State and local governments to use public-private
partnership arrangements, which are sometimes very efficient
ways of financing traditional infrastructure projects when you
have an element of private participation.
So, in that regard, I think the private activity bond
authority has been helpful, in some cases, in helping get those
kinds of projects financed.
Mr. TIBERI. Mr. Esposito.
Mr. ESPOSITO. I have nothing additional to add.
Mr. TIBERI. Okay. Mr. Bornholdt.
Mr. BORNHOLDT. Just with respect to private activity bonds,
generally, I would note that, again, in the cases of the New
York Liberty Zone and the Gulf Opportunity Zone, we saw a
pretty rapid utilization of the additional 30 that was provided
in those particular cases. And I think it was more than just
because of the economic distress those areas were under. It was
also because Congress provided fairly open-ended definitions of
the type of property that could be financed.
For example, State and local governments could decide what
type of private property could be financed. We see this again
in the Recovery Act with the recovery zone bonds. It is
basically any depreciable property. I think that has certain
elements of efficiency that are more advantageous than the
current structure of many of the private activity bonds.
For one example, solid waste facilities, which are a
defined type of private activity bond, the IRS and the industry
have spent years and countless dollars arguing over what is the
definition of a solid waste facility. And this is a definition
that was established under regulations dating back to the early
1970s. And obviously, as times have changed, we have different
needs with respect to solid waste and recycling facilities,
generally, but the Code and the regulations have not kept up.
To the extent Congress provides more of these open-ended
definitions of economic purposes that can be financed in State
and local governments, I think that has real advantages.
Mr. TIBERI. Thank you. I yield back.
Chairman NEAL. Thank you, Mr. Tiberi. Mr. Thompson is
recognized to inquire.
Mr. THOMPSON. Thank you, Mr. Chairman. Thanks to all the
witnesses for being here. I would like to carry on the
discussion about the private activity bonds, and based upon
what we did in the Recovery Act, and the success that the
expansion of the private activity bonds have had in regard to
renewable green projects.
I am pursuing legislation that would even expand that--I
plan to drop the bill here as soon as we get back from the
break--that would allow the use of the private activity bonds
to fund, to a greater extent, renewable energy-type of
projects.
In my home State of California, our treasurer came to me
and said, you know, ``I can use these to fund traditional
energy facilities.'' But at a time when we are trying to
decrease the amount of money we are paying for foreign oil and
to move toward more renewable energy, he believes it would be
advantageous to extend that ability over to the green
technologies.
And I would like to hear what you think about that in
regard to two issues: One, what would it mean, from an economic
stimulus perspective; and, two, any comments you might have on
how this will help expedite our move to a renewable energy
society. And we can start wherever you would like.
Mr. ESPOSITO. Well, why don't I start by trying to frame
some guiding principles, as you think about any changes or
tweaks you make to existing programs, as well as think about
what has been successful with what's been rolled out to date.
I think we can glean some very important learning lessons
from the Build America program. We at Goldman Sachs are also
confident that the qualified school construction program will
ultimately prove successful.
So, what is it about these two programs that are going to
lead to success and a lot of investor receptivity in the
capital markets? I think the first guiding principle that you
need to bear in mind, that the size of the program matters. And
I'm not just talking about the overall size of eligible debt
that can be issued under it, but I am talking about the actual
issuance amounts by any one entity.
What we have seen to date is that investors are willing to
embrace programs that either have a lot of eligible size behind
it, or at least individual issuance that will be of reasonable
size that will merit their time, energy, and intention. So this
is a place where size does matter.
Mr. THOMPSON. And doesn't size differ between projects?
Mr. ESPOSITO. It does, and that will be one of the issues
that Congress will have to grapple with. And maybe there are
other thoughtful ways that, together, we can think about
efficiency gains by thinking about ways to roll up various
issuance strategies into more liquid debt issuances.
Because, clearly, the marketplace is demonstrating a
propensity to want to invest in more liquid alternatives. So
that is point one. Second----
Mr. THOMPSON. Before----
Mr. ESPOSITO. Sorry.
Mr. THOMPSON [continuing]. You drill down too deep on the
specifics, maybe I could get a commitment from you to work with
my office to try and define some of these specifics that would
make this bill an even better tool for what it is we want to
do. And, because we're limited in time, maybe just hear,
generally, what people think about the idea of whether or not
the expansion will create economic activities and get us to
where we need to go quicker.
Mr. ESPOSITO. We would be delighted to follow up with your
office.
Mr. THOMPSON. Thank you.
Mr. DECKER. I think that would be a very welcome piece of
legislation, Congressman. Members of ours tell me that--bond
dealers that work with State and local governments tell me that
they have projects that are ready to go that are related to
energy generation or energy conservation, retrofitting
buildings for energy conservation, or alternative energy-
generating projects that are ready to go that don't make sense
if the borrowing is taking place at 6 or 7 or 8 percent, but do
if the borrowing is taking place at 2 or 3 or 4 percent.
And so, I think your idea would result in some very quick
and meaningful investment activity.
Mr. KRUEGER. I would highlight that the Administration has
made renewable energy a priority. And the President, you know,
has strongly supported cap and trade policy. And the budget
would use much of that revenue--I think it was $15 billion a
year--for renewable energy research and development and
implementation projects. So, we very much agree with the goal
of trying to expand renewable energy.
As far as private activity bonds, I think a very important
issue has to do with the revenue costs, which would have to be
considered, how it relates to the current volume caps, and so
on, which are issues that we would very much like to look at
and work with after you do develop the bill.
The last question you raised about the economic recovery, I
think, as an economist, I would say that it depends upon the
speed in which the programs are put in place. And----
Mr. THOMPSON. Now, with the support of you and Goldman's, I
think we can move it out pretty quick.
[Laughter.]
Mr. KRUEGER. Yes.
Mr. THOMPSON. Thank you.
Mr. CULVER. If I may, in the spirit of the size does
matter, especially when you are on the little side of size
matters--and for those of us who come from the New England
States, there are many smaller entities that will be seeking to
issue under this. And they may have a different experience in
the markets than the larger issuers would. And I hope that they
would not be discriminated against, because of their size.
Mr. BORNHOLDT. And I would just like to briefly add that
Congress has recently authorized two tax credit bond programs
for renewable energy: the Clean and Renewable Energy Bond
program, which is a $2.4 billion program, as well as the
recently enacted Energy Conservation Bond program, which is a
$3.2 billion program.
And, to the extent that Congress is considering providing
additional financing for these types of projects, I would urge
Congress to continue to look at the existing programs, and ways
to enhance those tax credit bond programs. For example, given
the success with the Build America Bond programs, and the lack
of a liquid market for tax credit bonds, generally, additional
refinements to both the CREBs, as well as the Clean Energy
Conservation Bond program might be warranted.
In addition, to echo the point regarding size, as I said,
you know, there is $2.4 billion of clean renewable energy bonds
authorized for the entire program, but public power, you know,
in 1 year, issues approximately $19 billion. And that $2.4
billion for clean renewable energy bonds is actually divided
into three parts for both State and local governments, which
has been used primarily, for example, to put solar panels on
top of courthouses, one-third for cooperative entities, and
one-third for public powers.
All of those are, obviously, worthy goals. But, by
splitting that $2.4 billion among the three different classes
of issuers, it has obviously diluted some of the benefits of
the program.
Chairman NEAL. Mr. Linder, the gentleman from Georgia, is
recognized to inquire.
Mr. LINDER. Thank you, Mr. Chairman. Mr. Bornholdt,
California's bond rating has recently been reduced to the
lowest in the country of any State, from A+ to A. What kind of
difference does that make in their interest payments, the
cost----
Mr. BORNHOLDT. Well, as I said--and I think most of the
witnesses said this morning--we are seeing some improvements in
the markets, but that has generally been at the higher end of
the ratings scale, for example, at the AA level.
When we get into the A level and the BBB level, and even
lower, we are still seeing some difficulties accessing the
market, which has impacted across. But I probably have other
witnesses here who are more qualified to testify today
regarding the pricing, with respect to California's----
Mr. LINDER. Mr. Esposito.
Mr. ESPOSITO. Sure. I would just point out that investors
rely upon a lot of different factors and judgments to make a
decision whether to purchase a bond or not. And, while clearly
ratings are one of the important variables that go into that
decision, investors do a lot of their own credit work.
And many of the investors had already factored into their
analysis the credit conditions prior to the actual----
Mr. LINDER. Maybe somebody could try and answer the
question. Would anybody like to take a shot at this? What
difference would it make, in the savings or cost to a State, if
their bond rating went from AA to A?
Mr. MCCOY. At the MTA, we have been looking at this issue,
as our existing credits--we have had stability over the past
few years.
But, as we look forward and look at stress in our own
system, we have looked at the scenarios that we would confront.
And a simple 1-notch downgrade for the MTA could cost us
approximately 25 basis points. A 2-notch downgrade could--we
estimate--could cost us approximately 75 basis points. And
these are estimates, but obviously we are very sensitive to
that, and work very closely with the rating agencies to
maintain those ratings.
But given all the economic pressure that our revenue
streams are under, you know, it is one of those scenarios that
we have to be aware of and sensitive to.
Mr. LINDER. What would happen if the Federal Government
decided--and this is just a matter of discussion right now; the
Fed says no--but if our government decided to back-stop or
guarantee California's bonds, would it raise the rating? Would
it just lower the interest rate? What would happen?
Mr. Bornholdt, do you want to take a shot at that?
Mr. BORNHOLDT. Well, it wouldn't raise California's rating,
per se, but it would certainly raise the rating on the
underlying debt that the issuer--because, obviously, investors
in that case are looking through to the ultimate guarantor on
the bonds, which would be the Federal Government.
Mr. LINDER. So it would save California money?
Mr. BORNHOLDT. It would save money.
Mr. LINDER. The equivalent of 75 basis points?
Mr. BORNHOLDT. I don't know that I can testify regarding
the pricing element----
Mr. LINDER. Mr. Decker, do you want to----
Mr. DECKER. I would say, based on where California is now,
versus where they would issue if they got a full faith in
credit Federal guarantee on their debt, it would be
significantly more than 75 basis points.
The credit spreads in the market now, the difference in
borrowing costs between different rating categories, are some
of the widest that I have ever seen, as a result of the credit
crisis, and de-leveraging, and illiquidity in the market. So
there are big differences between rating categories now, much
bigger than there had been for a long time.
Mr. ESPOSITO. You can also look to the FDIC, TLGP program
as a proxy for what happened when the government started to
guarantee individual commercial bank's debt. The savings to the
banking system was more than 200 basis points in that example.
And I think that's a pretty good place to borrow for what the
impact would be on the State of California, as a place to look
at for a judgment.
Mr. LINDER. Thank you. Mr. Esposito, I just can't--this is
not on the subject of our hearing, but I can't resist asking
you, from Goldman Sachs.
When the face value of credit default swaps exceeded the
total economic output of all of this planet's nations, why
didn't somebody say, ``What the hell is going on?''
Mr. ESPOSITO. One thing I would point out is when you read
about the amount of credit default swaps outstanding, bear in
mind those are notional amounts. Many investors, many
commercial banks, many Wall Street marketmakers, have
offsetting positions. So, while that headline number is
obviously enormous----
Mr. LINDER. $62 trillion.
Mr. ESPOSITO. Absolutely. If we were to net out the actual
economic counterparty exposures, it would be significantly less
than the number you just referenced.
Mr. LINDER. How is that hedging working so far?
Mr. ESPOSITO. I think it depends on each instance. There
have been places where credit default swaps have been an
effective hedging tool. And, clearly, there have been other
places where it has worked far less well.
Mr. LINDER. Thank you, Mr. Chairman.
Chairman NEAL. Thank you very much, Mr. Linder. The
gentleman from Connecticut, Mr. Larson, is recognized to
inquire.
Mr. LARSON. Thank you, Mr. Chairman, and thank you for
holding this hearing. I thank the witnesses for their
testimony.
My question is for Mr. Krueger. Both Mr. Culver and Mr.
Bornholdt stated in their testimony that the direct payment
approach employed by the--that class of Build America Bonds has
resulted in strong demand, and both favor extending the direct
pay option to other tax credit bonds.
Could you please discuss Treasury's thinking on this
matter?
Mr. KRUEGER. Well, the program, as I say in my testimony,
is only in place for about a month. And while we're very
pleased by the initial response, it is premature to say how
successful the program will ultimately be.
The characteristics of the municipal bond market, tax-
exempt market, tend to be different from the corporate taxable
bond market. So, going forward, we need to study the reception
of the bonds to reach a more informed judgment about the
program after it's set to expire. What----
Mr. LARSON. What would you guesstimate that to be, in terms
of time?
Mr. KRUEGER. How much time do we need?
Mr. LARSON. Yes.
Mr. KRUEGER. You know, I don't think I could put a figure
on that. I think, as I said, the initial reports that we're
getting, and as you heard on this panel, have all been very
enthusiastic, and it seems to be very successful. But the
financial markets are going through a serious evolution right
now. And it's just very difficult to give you a precise
timetable.
One thing I would point out, which is also, I think, worth
paying attention to, is that the way that the Treasury has been
computing the credit for tax credit bonds has changed. In
January 2009, IRS implemented a new approach, which changed the
tax credit bonds from being linked to AA corporate bonds to a
blend of A, BBB ratings, in order to adjust the rates so that
the bonds sell at par, as opposed to a discount. So, hopefully
going forward, one of the issues which Mr. Bornholdt raised
would be a less serious concern.
Mr. LARSON. Now, are you referring to Mr. Bornholdt's
notion that with--the demand in liquidity in this market could
be increased if Treasury were to rule that underlying tax
credits may be sold separately from a principal component of
the bonds?
Mr. KRUEGER. Well, my comment was just on how the tax
credits were established, and how the rates were----
Mr. LARSON. Well, would you agree with that? Would that
work?
Mr. KRUEGER. I agree that allowing investors to strip the
credits would broaden the market for the bonds.
Mr. LARSON. So, what can we determine will Treasury have
for rulemaking with respect to that, with this notion? And----
Mr. KRUEGER. Treasury has been working, together with IRS,
to develop accounting rules and tax compliance rules to permit
the stripping of the credits. And that is something that is a
priority within the Department.
Mr. LARSON. How long a timeframe on that, do you think?
Mr. KRUEGER. I would--you know, if I were forced to give
you--as an economist, I try not to answer questions about
timeframe. But if I were forced to, I would probably say within
the next few months.
Mr. LARSON. Well, as legislators, you can understand why--
--
Mr. KRUEGER. Yes.
Mr. LARSON [continuing]. With the economy being where it
is, we are interested in time. And that is why it is always
distressing when everything seems open-ended, and we go back to
our districts and people are looking for--just a--thank you--a
followup with Mr. Esposito on Mr. Linder's question, as well.
With regard to credit default swaps and derivatives, et
cetera, the 60 Minutes piece that was out there, et cetera,
some have noted with great interest that maybe those numbers
are true and maybe they're not. How do we ascertain those
numbers?
And would taxing those things be of interest, in terms of
revenue, or a way of limiting the positions that are taken?
Mr. ESPOSITO. Well, we at Goldman Sachs are supportive of
some of the initiatives to establish a clearinghouse by which
credit default swaps will be settled, and it will be a very
simple mechanism by which we can reduce the counterparty
exposure between those that are engaging in trading of CDS, and
legitimate hedging activities.
In regards to your point about taxing the trading of CDS,
clearly any form of taxation will limit and reduce the
activity. And I think it would just be a decision by Congress
as to whether or not that is in the best interest of the
marketplace. There are plenty of counterparties that require
legitimate use of CDS for hedging and other purposes. And any
form of a taxation will clearly limit the trading activity of
those securities.
Mr. LARSON. How do you distinguish between those that are
regulated, and those that have no regulation?
And is this--what would you put on a number? If it's not
the 40 to 60 trillion that Mr. Linder talked, where do you
think the ballpark is? You said it wasn't there, but where do
you think it is?
Mr. ESPOSITO. I think it is significantly less, but it is
just not my----
Mr. LARSON. It is significantly less than 30 to 40
trillion. Is it 20 trillion?
Mr. ESPOSITO. It is just not my area of expertise at
Goldman Sachs, so it is difficult for me to give you an
estimate on that.
Mr. LARSON. Who could give me an estimate on that?
Mr. ESPOSITO. I will work with my colleagues back in New
York, and see if we can't come up with a netting number, which
is, I think, what you're after, not the notional amount of CDS
outstanding, but what we think the real exposure is, and see if
we can't come up with that----
Mr. LARSON. Thank you, Mr. Esposito, and thank you, Mr.
Chairman.
Chairman NEAL. Thank you, Mr. Larson. Perhaps we could get
an answer in writing from Goldman. If we inquire, they could
help us with that detail.
Mr. ESPOSITO. We will do our best to provide that.
Chairman NEAL. Sure, sure. Mr. Heller, the gentleman from
Nevada, is recognized to inquire.
Mr. HELLER. Thank you very much, Mr. Chairman. And I want
to thank you for putting this panel of experts together. I
have--it has been a very interesting hearing.
I wanted to move back to this chart that you showed
recently, and I guess if there was a comment to be made on
that, I would say that it looks pretty volatile, and--going
back from September of 2008 through this month.
I guess, with the dislocations and everything that you
spoke of on this particular chart, I guess my question is, as I
look at something like this, I am more concerned about where
we're going to be a year from now, or 2 years from now. Is
there any work that is being done, in trying to anticipate,
with our current economic conditions, what that red line is
going to look like, as opposed to where it is today?
And the reason that I bring that up is that, you know, I
think there is going to be an economic recovery. And I think
most people agree that within--perhaps by the end of the year,
first part of next year, but they are also talking the impact
of inflation and higher rates, because of some of the
activities in this Congress.
I would like to know what is going to be the long-term
impact of this red line by decisions that are made in this
Congress, as it pertains to unemployment, inflation, and
perhaps higher rates--if that is a fair question?
Mr. ESPOSITO. It is a fair question, and I think part of
the answer to your question will also depend upon whether or
not Congress considers expanding and extending a program like
the Build America Bond program. You have successfully addressed
the demand side of the equation. You have allowed States and
local governments to tap into a much broader and larger pool of
liquidity.
In a world where supply has remained somewhat static, at
least into 2009, by addressing the demand side of the equation,
you have helped lower that red line that represents the
borrowing cost to municipalities. If you consider extending
that program, as we look out into 2010 and 2011, I think we
would be much more optimistic that that red line can continue
to trend lower, and remain that way almost regardless of what
the economic backdrop plays out to be.
That demand side of the equation is incredibly powerful.
The investment grade corporate market is deep, and it is
liquid. And so, if we can consider extending the program, I
think you will be much more successful, regardless of the
economic backdrop, to keep borrowing rates low for States and
local governments.
Mr. HELLER. I don't know if there is anybody else that
wants to comment on that.
But I just wanted to bring up one other question, and that
is we seem to have an interest in what's going on in California
right now. Based on the activities just this week, their
inability to balance their budget, what impact does that--and,
keep in mind, I'm from Nevada, so we are right next door--what
impact is this lack of--the financial crisis in California
right now going to have in their municipal bond ratings, and
perhaps long-term impact, nationally?
Mr. ESPOSITO. Well, one thing I would say about California,
it is simply too big not to cause any knock-on effects to the
broader credit markets, and specifically to the municipal
market.
Mr. HELLER. I would agree.
Mr. ESPOSITO. And so, that is just something I think
Congress will need to bear in mind. We are not just talking
specifically about California. There is no way we can isolate
the credit situation in California from the broader markets.
And we think that is going to be a very important consideration
as we play forward over the coming months.
Mr. HELLER. Thank you. Any other comments?
[No response.]
Mr. HELLER. If not, I will yield back, Mr. Chairman.
Chairman NEAL. Thank you very much, Mr. Heller. Just a
couple of thoughts.
Certainly the use of referendum questions comes to mind in
the current crisis in California, and how they have been
utilized. At the same time, I think that Mr. Esposito touched
on a very key point. That was the whole idea of stimulus, to
address the issue of demand. And slowly, but surely, I think
that we are making some progress on that front.
As panelists, you were terrific. And I think this is very,
very helpful. You reminded me of my work with Mr. Houghton on
private activity bonds, the AMT holiday, things that a
Subcommittee can accomplish. I am very pleased with the
dialogue today.
Are there other Members of the panel who would like to ask
additional questions?
[No response.]
Chairman NEAL. If not, I want to thank you for your good
time and good work today. We will, perhaps, have some followup
questions. And you will hear from Members, and we hope that you
will respond promptly.
And, if there are no further comments, the hearing stands
adjourned.
[Whereupon, at 11:22 a.m., the Subcommittee was adjourned.]
[Submissions for the Record follow:]
Statement of Cadmus Hicks, Nuveen Investments
Over the years, some have argued that tax-exemption is an
inefficient way for the Federal Government to help State and local
governments lower their borrowing costs, because tax-exempt bonds may
be held by people in the highest tax brackets, even though they are
priced to produce the same after-tax returns as taxable bonds held by
investors in lower tax brackets. For example, during 2006 and 2007
(before turmoil in the credit markets caused Treasury yields to plummet
as investors became extremely averse to risk), the average yield of 10-
year, triple-A rated, tax-exempt general obligation bonds was 81% of
the average yield of 10-year Treasury notes, which implies that an
investor with a marginal tax rate of 19% would have the same after-tax
return from either security (based on the Thomson Reuters, Municipal
Market Data scale, ignoring differences in credit quality, call
provisions, etc.). However, if the investor were in the 35% tax
bracket, the tax-exempt bond would produce a much higher after-tax
return than the Treasury note. If a Treasury note yielded 5.00% before
tax, its net yield after paying taxes at a 35% rate would be only
3.25%, which is well below the 4.05% yield of a tax-exempt bond that
yielded 81% of the Treasury yield.
To the extent that tax-exempt bonds are held by investors in the
highest tax brackets, it would appear that the reduction in State and
local borrowing costs made possible by tax-exemption is less than the
loss of tax revenue to the U.S. Treasury. By this reasoning, in our
earlier example, the Federal Government's tax reve-
nues are reduced by an amount equal to 35% of the interest that would
be paid on a taxable bond, but the municipal issuer's costs are only
19% lower than they would be if the bond were taxable. This lost
Federal tax revenue is viewed by some as a ``subsidy'' from the Federal
Government to municipal issuers. However, this paper argues that such
reasoning fails to allow for the fact that taxable municipal bonds may
be purchased for tax-deferred and other accounts that have lower
effective tax rates. Consequently, the amount of tax revenue that the
Federal Government forgoes due to tax-exemption is considerably lower
than it would be if the only alternative to buying a tax-exempt bond
was to purchase a bond whose interest is fully taxable in the year it
is received. This paper also shows that the relative pricing of tax-
exempt bonds reasonably reflects the benefit of tax-deferral on taxable
bonds.
The issuance of taxable Build America Bonds (BABs) illustrates the
dynamics at work in the relative pricing of tax-exempt securities. On
Wednesday, April 22, the State of California sold $3 billion of BABs,
maturing in 2039 with a yield of 7.40%, which was approximately 3.60%
above the yield on 30-year Treasury securities. Because the State chose
to retain the tax credit rather than pass it on to investors, the State
will receive payments from the U.S. Treasury equal to 35% of each
interest payment, which lowers the State's net cost from 7.40% to 4.81%
(7.40% (1 - 0.35) = 4.81%). This effective interest rate was
well below the yield of 5.47% that the State's outstanding tax-exempt,
30-year bonds were offering at the time of the sale. The after-tax
return of the BAB and the tax-exempt bond would be the same if someone
had a 26% marginal tax rate (1 - (5.47 / 7.40) = 0.261), which means
that tax-exemption reduces that State's interest cost by 26%. (Unlike
the State's BABs, the tax-exempt bonds are subject to optional
redemption at par in 10 years. Without that call provision, the yield
would have been 0.10% to 0.15% lower.)
This discrepancy between tax-exempt yields and the net borrowing
costs of BABs raises several questions. Is the State's tax-exempt
borrowing rate higher than it should be? Is the Federal Government
giving up more in potential tax revenue than the municipal issuers are
saving through tax-exemption? Is the amount of tax revenue the Federal
Government will collect on taxable BABs at least as great as the amount
of the payments it will make to the issuers of BABs? For tax receipts
to equal payments to issuers, all BABs would need to be held by
investors in the 35% tax bracket, which is clearly not the case, since
many of the BABs have been sold to pension plans and foreign investors.
This implies that the amount of tax revenue that would be lost if the
bonds were tax-exempt will not be as great as the cost of the tax
credits paid to issuers.
Tax-exemption is efficient if the savings enjoyed by municipal
issuers are at least equal to the amount of tax revenue the Federal
Government would receive if the bonds were taxable. In such an
analysis, the tax generated by BABs is a measure of how much Federal
revenue would be lost if the bonds were tax-exempt. Thus, the reason
why net borrowing costs are lower on BABs than on tax-exempt bonds is
likely to be because the U.S. Treasury has agreed to pay more to
issuers than it will collect in tax revenue. To the extent that taxable
municipal bonds are held by investors with effective tax rates of less
than 35%, tax-exemption is a more efficient way of supporting State and
local issuers than might appear at first glance. In the case of the
California bonds discussed earlier, the effective tax rate on its BABs
must be at least 26% in order for Federal tax revenue from BABs to
exceed what the State would save if it sold tax-exempt bonds instead.
The Ratio Curve
From the time when BABs were first proposed, market participants
recognized that issuers would enjoy the greatest cost savings on bonds
with the longest maturities, because tax-exempt bonds with longer
maturities tend to have yields that are higher as a percentage of
taxable yields than do shorter maturities. The question is whether the
upward slope of the ``ratio curve'' implies that tax-exemption is less
efficient for longer maturities. Various factors have been cited to
explain the upward slope of the ratio curve:
(1) Compared to most taxable debt, municipal issues tend to be
structured with multiple serial and term bonds, which are more heavily
weighted toward the long end in order to produce level debt service
(with principal payments increasing and interest payments declining
over time). The added supply of long bonds causes their yields to rise
relative to taxable bonds.
(2) Investors want to be compensated for the possibility that tax
policy could change over time in a way that makes tax-exempt bonds less
attractive.
(3) Yield quotes on municipal bonds generally are based on bonds that
can be redeemed, or ``called,'' at the option of the issuer many years
before their stated maturity date. In exchange for this option, issuers
pay higher interest rates than they would on noncallable bonds, which
are more common in taxable markets.
(4) Relative to Treasuries, municipals have more credit risk, and the
longer the maturity, the more time in which negative developments could
occur.
The Benefits of Tax-Deferral
Another factor that may affect the tax-exempt/taxable ratio curve
is the fact that tax-exempt bonds do not just compete with fully
taxable securities, but also with what might be termed ``tax-deferred
investments,'' i.e. bonds held in vehicles where the income is not
immediately taxed in the year it is earned. Furthermore, since the
benefit of tax-deferral increases with longer time horizons, and since
tax-deferred vehicles are typically used to fund long-term liabilities
(such as pension obligations and individual retirement plans), one
would expect bonds with longer maturities to be favored for such
vehicles.
The longer a security is held on a tax-deferred basis, the lower
the effective tax rate on that security. For example, suppose that
someone places into an Individual Retirement Account a taxable bond
that cost $100,000, matures in 30 years, and yields 7%. Suppose further
that the investor expects to be in the 35% tax bracket when he or she
withdraws bond principal and accumulated interest from the account. If
interest on the bond were reinvested at 7% and allowed to accumulate
tax-deferred, at the end of 30 years that investment would be worth
$761,226, of which $100,000 was the original principal and $661,226 was
the amount of interest earned. Tax on the interest earnings would be:
$231,429
(0.35 $661,226 = $231,429).
The ending value of the investment after the payment of taxes would
be $529,797, which represents an annual rate of return of:
5.72%
((529,797 / 100,000) (1/30) = 1.0572).
This return of 5.72% is 81.6% of the 7.00% pretax return, which
implies an effective tax rate of 18.4%. The following table shows the
calculation of the implied effective tax rate for bonds held on a tax-
deferred basis for different periods of time.
After-Tax Rate of Return and Implied Tax Rate on a Tax-Deferred Investment of $100,000 Yielding 7% With Earnings
Reinvested
----------------------------------------------------------------------------------------------------------------
Ending Tax After-Tax After-Tax After-Tax Implied
Number of Years Value Liability Value Rate Ratio Tax Rate
----------------------------------------------------------------------------------------------------------------
1 107,000 2,450 104,550 4.55% 65.0% 35.0%
----------------------------------------------------------------------------------------------------------------
2 114,490 5,072 109,419 4.60% 65.8% 34.2%
----------------------------------------------------------------------------------------------------------------
5 140,255 14,089 126,166 4.76% 68.0% 32.0%
----------------------------------------------------------------------------------------------------------------
10 196,715 33,850 162,865 5.00% 71.4% 28.6%
----------------------------------------------------------------------------------------------------------------
15 275,903 61,566 214,337 5.21% 74.5% 25.5%
----------------------------------------------------------------------------------------------------------------
20 386,968 100,439 286,529 5.40% 77.2% 22.8%
----------------------------------------------------------------------------------------------------------------
25 542,743 154,960 387,783 5.57% 79.6% 20.4%
----------------------------------------------------------------------------------------------------------------
30 761,226 231,429 529,797 5.72% 81.6% 18.4%
----------------------------------------------------------------------------------------------------------------
Past performance is no guarantee of future results. This
hypothetical example has been provided for illustration only. Other
methods may produce different results, and the results for individual
portfolios may vary depending on market conditions.
The table demonstrates that the longer the maturity, the greater
the potential benefit to the investor from deferring taxes on the
security, and, therefore, the greater the potential present value loss
of tax revenue to the U.S. Treasury from tax deferral. When estimating
how much potential revenue the Treasury loses when municipalities sell
tax-exempt bonds, one should deduct the amount of revenue that could be
lost if the municipalities sold taxable bonds that were bought held in
tax-deferred accounts.
Tax-Deferral and the Ratio of Tax-Exempt to Taxable Yields
As it happens, the ratios of after-tax to pretax returns on
investments held in a tax-deferred account for various lengths of time
resemble the ratio curve of tax-exempt to Treasury yields. The
following table shows the average ratio of municipal to Treasury yields
during 2006 and 2007, and compares those ratios to the after-tax ratios
from the preceding table.
------------------------------------------------------------------------
Muni/ After-Tax
Years to Maturity Treasury Ratio
------------------------------------------------------------------------
2 77% 66%
------------------------------------------------------------------------
10 81% 71%
------------------------------------------------------------------------
30 88% 82%
------------------------------------------------------------------------
Sources: Federal Reserve Board constant maturity Treasury series,
Thomson Reuters Municipal Market Data.
While the ratio of municipal to Treasury yields is generally higher
than the after-tax ratio (owing to differences in credit quality, call
provisions, liquidity, etc.), the differences between the ratios for
different maturities are comparable. For example, the 10-year
municipal/Treasury ratio is four percentage points higher than the 2-
year ratio, while the 10-year after-tax ratio is five points higher
than the 2-year after-tax ratio.
The effect of tax-deferral on the relative yields of tax-exempt
bonds has important implications for tax policy. Congress has estimated
that the BAB provision will cost the Federal Government $4.35 billion
over 10 years. Given the fact that over $7.5 billion of BABs were
issued in just the last 2 weeks of April, and that most of these issues
had maturities as long as 30 years, the Federal Government may find
that the cost of making direct payments to issuers is considerably
higher than the ``subsidy'' produced by tax-exemption. If the Treasury
Department and Congress were to compare the costs of payments made
under the BABs program with the Federal tax revenue derived from such
bonds, we would not be surprised if they concluded that taxable bonds
with tax credits are not really any more efficient than tax-exemption
as a means of lowering the borrowing costs of State and local
governments, and may even be more costly in the long run.
Cadmus Hicks,
Nuveen Investments
Statement of Dean A. Spina
I propose that Congress eliminate the current penalty on religious
organizations that results from application of the Federal tax-exempt
bond laws. Religious organizations, from churches to religious colleges
and schools, are denied the low rates of interest available through
tax-exempt bond financing. This is because tax-exemption is derived
from the issuance of bonds by a State or local issuer and the loan of
bond proceeds to the borrower.
The First Amendment is an obstacle to the use of tax-exempt bond
financing for religious organizations. As a result, religious
organizations, and some related organizations such as schools, are
denied tax-exempt bond financing that is available under Internal
Revenue Code Section 145 to all other 501(c)(3) organizations.
A direct exemption of religious organization debt would not violate
the Constitution. A direct tax exemption is different than the use of
the State or local governmental power to issue debt and loan the
proceeds to a religious organization.
Amending the Internal Revenue Code to exempt interest on debt
incurred by a religious organization (to the same extent it would be so
recognized for debt issued by a State or local unit of government for a
501(c)(3) organization under IRC Section 145) would remove the penalty
on religious organizations without the necessity of the involvement of
any unit of State or local government.
Following this statement is a draft of legislation to enable a
religious organization to elect to be covered by certain tax-exempt
bond provisions and thus have tax-exempt debt and substantially lower
interest cost. Borrowing $1,000,000 for 20 years at a taxable interest
rate of 8.5% requires payment of $370,000 more interest than the same
loan at a tax-exempt rate of 5.95%.
This proposal will benefit tax revenues. Tax revenues should be
increased if lower borrowing costs enable religious entities to proceed
with projects that might not otherwise be undertaken. More construction
generates a demand for goods and services, and creates more taxable
income. Moreover, Federal and State tax revenues could be positively
impacted by lower borrowing costs. If religious organizations need
smaller charitable contributions to finance a project, charitable tax
deductions should be smaller. Most church financing is ultimately paid
for by deductible charitable contributions.
I am an attorney and I am active in the use of tax exempt bonds for
501(c)(3) organizations. This proposal is not made on behalf of any
client. This proposal is driven by the belief that Congress should act
to rectify the current tax-exempt bond laws to enable religious
organizations to enjoy the same rates of interest enjoyed by all other
501(c)(3) organizations.
Thank you.
Dean A. Spina
__________
DRAFT LEGISLATION--TITLE 26--INTERNAL REVENUE CODE
PART IV-TAX EXEMPTION REQUIREMENTS FOR STATE AND LOCAL BONDS
Subpart A--Private Activity Bonds
Sec. 145. Qualified 501(c)(3) bond
Add to Section 145 of the Internal Revenue Code the following:
(f) Election by religious organization
This section shall apply to a religious organization obligation
if--
the religious organization elects to have this section apply to
such obligation, and
the religious organization reports the election in such form as
the Secretary may
require.
For purposes of this subsection, the following shall apply to the
religious organization obligation: Subsection 147(b),\1\ Subsection
147(e),\2\ Paragraph (1) of Subsection 147(g),\3\ Paragraphs 2 and 3 of
Subsection 147(h)(2),\4\ Section 148,\5\ Subsection 149(e) \6\ and
Subsections (b) and (c) of Section 150 \7\ and in applying the
foregoing, the religious organization shall be deemed to be an issuer.
---------------------------------------------------------------------------
\1\ Bond maturity.
\2\ Prohibited uses.
\3\ Limit on costs of issuance from obligation proceeds.
\4\ 501(c)(3) bonds are exempt from certain limitations.
\5\ Arbitrage.
\6\ Reporting requirement.
\7\ Change of use.
---------------------------------------------------------------------------
For purposes of this subsection a ``religious organization'' means
a 501(c)(3) organization which is exempt from tax under section 501(a)
as a religious or religious education \8\ organization and a
``religious organization obligation'' is any debt obligation of a
religious organization incurred by the religious organization on or
after the date of enactment of this subsection and prior to January 1,
2019, for
---------------------------------------------------------------------------
\8\ Educational organizations affiliated with a religion have been
able to use tax-exempt bond financing. This provision would overcome
concerns about entanglement.
-- the religious organization's financing or refinancing of the
acquisition,\9\ construction, reconstruction, or renovation of a
facility to serve the needs of its members \10\ for appropriate objects
of the religious organization and to serve the community (including
providing services such as preschools, daycare and assistance \11\ to
the needy through the religious organization or an organization
controlled by or affiliated \12\ with the religious organization,
provided such use of the facility does not result in an organization
having income subject to tax \13\ under this Subtitle A) or
---------------------------------------------------------------------------
\9\ Acquisition includes an existing facility without a requirement
of rehabilitation.
\10\ For example, religious worship and education.
\11\ Food pantries, clothing and household distribution, shelters
and education and training for the poor and distressed.
\12\ This would allow a separate organization to be formed to
operate a preschool program or summer program for disadvantaged youth
and use the facility.
\13\ Avoids tax-exempt debt being used to build ``Sunday school''
classes that are used throughout the week for non-affiliated daycares
or preschools, some of which may be for profit entities.
---------------------------------------------------------------------------
-- to make one or more loans to an affiliated religious
organization for such a facility.\14\
---------------------------------------------------------------------------
\14\ Church extension funds oftentimes borrow from church members
to fund loans to churches within the denomination.
The religious organization that makes the election under this
subsection with respect to its obligations for a facility (but not for
an obligation to fund loans to affiliated organizations) shall be a
qualified small issuer for purposes of subclause I of Section
265(b)(3)(B)(i), provided that in any calendar year the religious
organization designates no more than the amount that may be designated
under subparagraph (C) of Section 265(b)(3) and the designation is
reported by the religious organization in the manner required by the
---------------------------------------------------------------------------
Secretary.
Statement of Peter B. Coffin, Breckinridge Capital Advisors, Inc.
Breckinridge Capital Advisors, Inc. strongly supports the new Build
America Bond program, but we are concerned that institutional investors
are unlikely to make a meaningful long-term allocation to these issues
if the program expires on December 31, 2010. We firmly believe that to
ensure the continued success of the Build America Bond program, its
term must be extended. The sooner this extension takes place, the
sooner Build America Bonds will be established as a credible asset
class for institutional investors.
A Registered Investment Advisor, Breckinridge Capital Advisors
manages over $9 billion in municipal bond portfolios on behalf of
institutions and high-net-worth individuals. We believe the Build
America Bond program provides much-needed depth to the municipal market
by broadening demand beyond the traditional buyers of tax-free bonds.
This has already significantly lowered municipal borrowing costs while
improving secondary market liquidity.
To date, Build America Bonds have been attractively priced as new
issues, and are performing well in the secondary market. As such, they
have been a good ``trade'' for investors and the appetite for the bonds
has been solid, reflecting positive momentum from early success.
However, sustainable demand cannot be based on short-term profits.
Eventually, Build America Bonds need to be recognized as an important
core allocation in an institutional fixed income portfolio.
Institutional investors prize the safety, reliability and the
relatively long duration of Build America Bonds. This is especially
true after the recent difficulties in other sectors of the fixed-income
markets. Moreover, many public pension funds and charitable endowments
will welcome the opportunity to invest in communities through Build
America Bonds, but only if the current expiration date of December 2010
is extended.
The Federal Government has long seen value in subsidizing State and
local government borrowing. Today we understand that the traditional
form of that subsidy--exempting municipal interest from taxes--is not
always completely effective in reducing a municipality's borrowing
costs and maintaining its access to capital. The Build America Bond
program introduces a new form of subsidy that has had early success in
broadening municipal demand thus, improving the overall effectiveness
of the Federal subsidy. Breckinridge believes an extension of the Build
America Bond program will ensure even greater and more sustainable
success for the future.
Statement of Seamus O'Neill, Liscarnan Solutions
Mr. Chairman, Members of the Subcommittee--Good morning, I am
Seamus O'Neill of Liscarnan Solutions, LLC based in McLean, Virginia. I
have more than 28 years experience as an investment banker and
financial advisor. For the past 20 years, I have been a financial
advisor and project consultant to the student loan industry, including
the nonprofit lenders in California, Ohio and Montana, who have a
combined debt outstanding of approximately $4.5 billion.
While this hearing is aimed at addressing issues facing government
issuers of both tax-exempt and taxable debt, I would like to discuss
very similar issues concerning nonprofit and State agency student loan
issuers.
Nonprofit and State agency student loan providers, who combined
have more than $30 billion of outstanding taxable and tax-exempt debt
financings, are facing two significant issues caused by the financial
markets meltdown. The first issue concerns their outstanding tax-exempt
financings, which have been damaged by the financial crisis, and what
needs to be done to make these financings marketable. The other issue
concerns the ability of nonprofit and State agency issuers to access
financing for new student loans.
Unmarketable Outstanding Financings
In February 2008, the financial markets meltdown impacted the tax-
exempt student loan sector. This meltdown has produced two results--(1)
it has destroyed much of the balance sheet value of the student loan
non-profits and State agencies due to the failed financing structures;
and (2) it has prevented such issuers from refinancing these failed
bond issues because their access to the tax-exempt bond market has been
cut off.
When the variable rate market for student loan notes froze,
billions of dollars of tax-exempt variable rate student loan financings
became unmarketable. Investors, including pension funds, institutional
investors and individuals, were no longer willing to buy or sell
student loan securities. In addition, the interest rate on these
financings went to a maximum rate, meaning that these financings have
been paying the maximum rate of interest allowable under their
financing documents--a rate that was never contemplated for the life of
the bonds and is unsustainable in the long-term.
One of the important reasons for our inability to restructure
failed tax-exempt financings is the lack of variable interest rate
financing in the tax-exempt bond market. The tax-exempt student loan
bond market is primarily a fixed interest rate market, while our
Federal student loan assets earn floating interest rates. Thus, we have
a mismatch between the interest earned and interest expense. This
mismatch was solved in the past by creating tax-exempt variable
interest bonds synthetically, either by using a bank liquidity facility
or an auction mechanism. However, in today's dysfunctional financial
markets, these options are no longer available, meaning that the rates
cannot be matched. As a result, tax-exempt financings for Federal
student loans are unmarketable and the frozen financings cannot be
restructured.
Fortunately, there are solutions. Tax-exempt student loan bonds
have already been temporarily relieved of the Alternative Minimum Tax.
Unfortunately, this benefit does not solve the mismatch between
interest earned on loans and interest expense on bonds. Our proposed
solution is to expand the availability of the Taxable Bond Option to
student loans. We believe that our solution should produce a neutral
budget score given that we are substituting Taxable Bond Option bonds
for existing tax-exempt bond authorization.
Expansion of Build America Bonds
The subject of this hearing involves the ``Build America Bond''
included in the American Recovery and Reinvestment Act. The ``Build
America Bond'' is essentially an idea referred to as the ``taxable bond
option.'' The ARRA allowed for the use of this bond by State and local
governments to help these governments restructure existing debt, as
well as issue new debt. As student loan debt is facing many of the same
problems as State and local government debt, it would be consistent to
extend the ability to issue these bonds to tax-exempt student loan
issuers.
By extending this bond, issuers of tax-exempt student loan bonds
would be permitted to issue taxable bonds and then receive a rebate of
35 percent of the interest they pay to investors. This credit would
have the effect of reducing the taxable bond interest rate down to a
tax-exempt rate while permitting the issuer to access the taxable
market. The issuance of these taxable bonds would be subject to all
Federal and State limitations currently affecting the issuance of tax-
exempt bonds.
The taxable bond market is much more accommodating to the issuance
of variable interest rate bonds; thus, permitting issuers of student
loan bonds to better match the interest rates on their loans and
liabilities. Access to these bonds will remarkably improve the
potential for restructuring the damaged balance sheets of student loan
non-profits and State agencies. In the end, the marketability of these
bonds would be restored and billions of dollars of frozen financings
could be restructured saving hundreds of millions of dollars for the
benefit of students and their families.
Access to New Financing for Loans
This hearing is concerned with the taxable bond option but there
are other issues that can be addressed in this area that would greatly
impact the availability of funds from tax-exempt financings for the
benefit of schools and students.
While the taxable bond option would greatly help tax-exempt issuers
in restructuring existing financings, steps can be taken to permit tax-
exempt issuers to utilize the tax-exempt market for new loans, most
notably in the area of private loans.
Even with the increase in Pell Grants and Federal loan limits,
there is still a great need for private loans, i.e. those loans not
guaranteed by the Federal Government. Historically, these loans have
been provided by banks, for-profit lenders and some State agencies.
However, lenders have pulled back in offering these loans. The
remaining loans are costly for students to borrow. The only bright spot
for students is in the 13 States that have a private loan product
offered by a State agency.
In addition, other sources of college funding are scaling back.
Parents are less likely to be able to tap their diminished home equity;
529 education savings plans have taken significant investment losses;
college endowments have been similarly damaged; institutional aid has
become strained; and State government resources and tax revenues are in
decline.
Students are finding it harder to come up with the resources
necessary to fund the gap in their education expenses (i.e. the gap
between what they can get from the Federal Government and what they owe
their college).
Nonprofit lenders would like to help fill this gap by providing
low-cost private loans. However, nonprofit lenders have been unable to
utilize its tax-exempt financing for these loans because of the
restrictions of Section 150(d) of the Internal Revenue Code.
Students would be greatly served if nonprofit lenders had access to
tax-exempt financing for private loans. As such, the restrictions in
150(d) should be modified to permit nonprofit tax-exempt issuers to
utilize its tax-exempt financing for private student loans. In making
these loans, the nonprofit issuers would work in partnership with their
respective States to ensure that these loans are providing a benefit to
the State's students. The nonprofit status of the lender and the tax-
exempt nature of the financings would result in a reasonable, fair,
affordable and low-cost private loan to help students fill the gap in
their college financing.
Other Changes to 150(d)
Section 150(d) should also be reformed to more easily permit
nonprofit, tax-exempt issuers to better serve its State's students and
schools by permitting it to directly engage in origination and
servicing activities, as well as other charitable activities. Current
150(d) organizations set up an affiliate or similar entity to handle
these activities, leaving the 150(d) entity to issue debt, and acquire
and hold Federal loans. This wall was created in a different time and
for a Federal student loan program that has been greatly transformed.
There is really no good reason for the wall to exist in the student
loan program of 2009.
By removing this wall and allowing one entity to serve as the
issuer, originator, servicer, and charitable organization, nonprofits
can better serve students and schools in the same way that State
agencies do. There is a need for this change even if the Federal
Government transitions to the financing of 100% of the Federal loans
directly from Federal financing. This change would help nonprofits meet
the needs associated with the financing and servicing of loans already
made, the potential servicing of loans going forward, and the resources
needed for charitable activities; in addition to the efforts of
nonprofits to meet the private loan demands of students and schools.
Conclusion
The above three reforms would go a long way in repairing the
balance sheets of nonprofit lenders, freeing up capital and other
resources for student loans and related activities for the benefit of
students and their families, at little if any cost to the Federal
Government. They are commonsense changes to the Internal Revenue Code
to meet today's needs.
Thank you for this opportunity to submit this testimony.
Seamus O'Neill,
Liscarnan Solutions, LLC
7424 Eldorado St., McLean, Virginia 22102