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Muni bond market roiled by possible end of 'Build America' program

Market prices of tax-free municipal bonds took a hit on Tuesday, hurt by uncertainty over the fate of a federal subsidy program for muni issuers and by another general rise in interest rates.

The Build America Bond program, which for the last two years has allowed state and local governments to issue taxable muni bonds with interest partly paid by Uncle Sam, may not be extended beyond Dec. 31. The program wasn’t included in the compromise tax-cut agreement reached between President Obama and Republican leaders.

If the BAB program is terminated, it could mean that muni issuers that would otherwise have borrowed via the bonds in 2011 would be forced to issue conventional tax-free bonds instead -- boosting the supply of those securities.

Reacting to that possibility, some investors dumped longer-term tax-free muni issues on Tuesday, driving prices down and yields up. That showed in prices of popular muni bond mutual funds.

Shares of the Vanguard California Long-Term Tax-Exempt bond fund fell 0.5% to $10.92 from $10.98 on Monday. The iShares S&P National AMT-Free exchange-traded muni fund slumped 1.5% for the day.

Muniyield The annualized yield on the Bond Buyer index of 40 long-term muni bonds nationwide (charted at left) jumped to 5.40% from 5.32% on Monday and 5.24% a week ago.

Munis also were hurt as interest rates rose sharply in the Treasury bond market, reacting to expectations that the tax-cut deal will boost economic growth next year.

The end of BABs could be costly for California, which has been the single biggest issuer of the bonds. The state has sold $14 billion of BABs since the program began early in 2009, using the proceeds to fund voter-approved infrastructure projects.

The federal government picks up the tab for 35% of the interest cost of Build America Bonds. That has made it cheaper for muni issuers to borrow via BABs than conventional munis.

“We’ve saved California taxpayers millions of dollars” via the BAB program, said Tom Dresslar, a spokeman for state Treasurer Bill Lockyer. Ending the program “would be counterproductive to California’s efforts to recover.”

Some Republicans, however, have viewed the BAB program as an unnecessary subsidy and want it to expire as scheduled on Dec. 31. (The subsidy would continue on previously issued BABs.)

It’s still possible that the program will get a new lease on life: Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committeee and a BAB supporter, told Bloomberg News that “there are provisions [in tax discussions] that are not yet negotiated, and that’s one of them.”

Tuesday’s muni sell-off follows a tough November for the bonds, as the market choked early in the month on a heavy supply of conventional bonds and of BABs, driving prices down and yields up. The market had calmed down over the last two weeks -- before Tuesday's eruption.

-- Tom Petruno

 
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