Build America Bonds, or BABs, are government bonds that are earmarked to help fund and encourage necessary capital projects, such as construction and repairs on public buildings, courthouses, energy projects, schools, roads, bridges, transportation infrastructure, government hospitals, environmental projects, public safety facilities and equipment, water and sewer projects, public utilities and governmental housing projects. Implemented under the American Recovery and Reinvestment Act of 2009 by President Obama, Build America Bonds are basically federal tax subsidies that allow local and state governments to borrow money at a much lower rate in order to stimulate the economy and encourage infrastructure development in capital projects in 2009 and 2010. They will expire at the end of the 2010 fiscal calendar.

Under Build America Bonds, the government will assume 35% of the interest on any approved bond measures. BABs can operate one of two ways. The state or agency issuing the bonds can choose to pay out a higher rate to bondholders. Then, the Fed will rebate 35% of the interest paid back to the issuer. Or, the issuer can pay a lower interest rate to the borrower, in which 35% of the interest received by investors is tax-free. The bonds are taxable in either case (at least partially), and most agencies have opted for the first method.

Advantages of Investing in Build America Bonds

These bonds are being utilized all over the country. In California, $5.23 billion in 25 and 30-year BABs has already been established at an annualized rate of 7.4%. Since the Fed reimburses 35% of this amount the state of California will only be responsible for 4.8% of that interest, however. This lower rate decreases the chances for default, thus strengthening your investment and reducing your risk in these bonds.

The New Jersey Turnpike Authority is another local entity using Build America Bonds for infrastructure initiatives. With an original goal of raising $250 million, enthusiasm for these bonds (they borrowed 30-year bonds at the same 7.4%/4.8% rate) garnered a whopping $1.32 billion in municipal revenue. On average, these bonds are yielding 3.6 percentage points higher than U.S. Treasuries.

Disadvantages of Investing in Build America Bonds

You’re not likely going to become a billionaire from investments in BABs, but you can see significant and steady return on your investment in many cases. Also, keep in mind that the federal government does not back these bonds like Treasury notes. These are locally funded and dispersed, so if a state defaults, you could be in trouble. However, if a state defaults – we could all be in trouble. In general, bonds are low-risk investments, though, that should be considered carefully with your investment professional as a part of a well-balanced financial portfolio.

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