A Better Way to Pay for Infrastructure Investments

by Scott Minerd of Guggenheim Investments, 7/26/21

There’s plenty to like about the Biden Administration’s proposed infrastructure plan: who doesn’t want better roads, clean water and faster broadband to binge on Netflix? But while the ends are laudable, it’s the means to get there that are more politically contentious. As in, how to pay for the $1tn wish list?

There are only so many wealthy people and corporations to tax, as the left would prefer, and many have access to smart accountants. With bouts of inflation scares in the markets, and rising prices already walloping consumers at the grocery store and on car lots, printing money will not go over well.

Others can argue over the specifics of the president’s plan. My concern, and that of many taxpayers who will foot the bill, is where the money comes from. Buried in the Biden’s proposal is a passing reference to “direct pay bonds”, which I believe is the single best way to finance much of the plan.

Despite the generic name, these are essentially juiced-up municipal bonds issued by state and local governments. The interest payments are subsidized by the federal government, and they are taxable, which expands the potential market to pension funds, endowments and sovereign-wealth funds. Tax-exempt munis are of little use to that type of investor which prefers to have the higher yields on offer for taxable equivalents.

The president should be familiar with the bonds since they’re an updated version of the Obama-era Build America Bonds. The American Recovery and Reinvestment act of 2009 introduced BABs, taxable debt securities that were issued by states and municipalities to finance capital expenditures.

The coupon paid by the issuer of each bond carried a 35 per cent subsidy provided by the federal government, which lowered the cost of borrowing for state and local governments. More than $180bn of them were sold before the program lapsed at the end of 2010.

A more recent, bipartisan, version was introduced in April as the American Infrastructure Bonds Act of 2021. This would create a new bond with a flat 28 per cent reimbursement rate to the issuers.

The advantage of BABs, as opposed to Treasuries, is that they finance spending at the local level, which effectively makes cities, states and investors partners in infrastructure investments, instead of passive bystanders to the Feds.

Not that deficits seem to matter anymore, but BABs also would not add to the bulging national debt like Treasuries. State and local governments already supply almost 60 per cent of the capital costs and a whopping 90 per cent of the operation and maintenance expenses of the nation’s infrastructure, according to the Congressional Budget Office.