Municipal Bond Boggle

Trying to understand the economic impact of the president's latest "Jobs Bill" is a thankless and confusing task, especially for the average voter. A hat tip to former American Express CEO, Harvey Golub, who highlights one bill provision that clearly reflects the ineptitude that passes for public policy in the current administration. Writing in today's WSJ, Mr. Golub concludes, in part:

From green jobs to "cash for clunkers," many of us have suspected that economic illiterates were setting the economic policy of this administration

The article, entitled "A Jobs Bill That Boggles the Mind." does just that. It is widely known that states and municipalities are able to issue bonds at much lower rates than, say corporations, because the interest they pay is tax-exempt to the bondholders. This means that the state or city saves big on its debt service. Investors buy the bonds, accepting lower interest rates than they might get elsewhere because they don't have to pay taxes on the interest. Don't worry about the math, that's what we have CPA's for.

So now, the "Jobs Bill", in an attempt to close "loopholes" and make all those millionaires and billionaires pony up their fair share, would remove the tax-free status of municipal bonds. The first thing that happens, is that the rates on municipal bonds increases which jacks up the cities and towns cost to borrow. As for the bond investors, they will simply reevaluate their investment choices on the basis of net (after tax) yield. Let's ignore for the moment what happens to the value of previously issued bonds if this change is made retroactively, as the "Jobs Bill" calls for. Answer: big decline in value. But if we sort through the rubble, we realize that the real loser here is the issuer of municipal bonds. And that, dear reader, is us.

But don't worry folks, help is on the way for the municipalities. Half of the $475 billion from the "Jobs Bill" would be sent back to the states to help with the increased operating budgets, now inflated by increased debt-service costs. Why does this elicit a vision of Yogi Berra sitting in a barber's chair telling us that cash is just as good as money? No offense Yogi.

One of the more poignant questions raised by this article is:

The interesting questions for me are: Did anyone on his economic staff, at Treasury, or at the Office of Management and Budget tell him about this? Did he even ask?

To which we might add: As long suspected, these policy-makers don't seem to know what they don't know. Always a dangerous state of affairs.