[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



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                      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 
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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:]

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    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:]

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    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:]

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    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:]

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    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:]

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    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

                                 
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