Build America Bonds

What Are Build America Bonds?

Build America Bonds, or BABs, were taxable municipal bonds created under the American Recovery and Reinvestment Act of 2009 to help state and local governments finance public projects during the financial-crisis recovery period. Unlike traditional tax-exempt municipal bonds, BABs generally paid taxable interest to investors.

The program used federal tax benefits to lower borrowing costs for public issuers. In the most important version, called direct payment Build America Bonds, the issuer received a federal subsidy tied to interest costs rather than giving investors tax-exempt interest.

How the Program Worked

Traditional municipal bonds are often attractive to investors because the interest is exempt from federal income tax and sometimes state or local tax. That structure works best for investors who value the tax exemption. Build America Bonds took a different approach. They were taxable bonds, which meant they could appeal to investors who do not benefit as much from tax-exempt interest, including pension funds, foreign investors, and other institutional buyers.

For direct payment BABs, the federal government made a payment to the issuer equal to a percentage of the interest payable on the bond. That subsidy helped offset the higher taxable coupon the issuer might otherwise need to pay. The result was an attempt to connect municipal borrowers with a broader investor base while reducing net borrowing costs.

Why They Were Created

BABs were created during a period of stressed credit markets and weak public finances. State and local governments still needed to fund infrastructure, schools, transportation, utilities, and other public projects, but the municipal market was under pressure. A taxable subsidized bond structure was meant to stimulate borrowing capacity and investment activity.

The design also reflected a practical market issue: tax-exempt municipal bonds mainly appeal to investors with U.S. taxable income. Taxable BABs could reach investors less interested in the exemption, potentially increasing demand and improving financing options for issuers.

Investor and Issuer Tradeoffs

For investors, BABs behaved more like taxable fixed-income securities than traditional tax-exempt municipal bonds. Their after-tax return depended on coupon, price, credit quality, maturity, interest-rate movement, and the investor's tax situation. For issuers, the attraction was the federal subsidy and access to a deeper taxable-bond buyer base.

The tradeoff was program and subsidy risk. Direct federal payments depended on federal rules and budget treatment. Later reductions to certain direct-pay bond subsidies showed that issuers could face payment uncertainty even after bonds were issued. That made the net cost of borrowing less certain than the headline subsidy suggested.

Build America Bonds Versus Traditional Municipal Bonds

Why They Still Matter

Build America Bonds remain relevant because they show how federal tax policy can reshape municipal finance. A subsidy can change who buys the bonds, what yield the issuer must offer, and how public projects are financed. BABs also remain part of some investors' bond portfolios because outstanding bonds can continue trading long after new issuance authority ends.

The program is also a useful reference point in infrastructure-policy debates. Proposals to revive or redesign taxable subsidized municipal bonds often look back to the BAB experience: broader investor demand was useful, but subsidy reliability and federal budget treatment were major design concerns.

Investor Takeaway

Build America Bonds were a crisis-era municipal-finance tool that used taxable bond interest and federal issuer subsidies to support public borrowing. Investors should treat outstanding BABs like taxable municipal credit: analyze yield, maturity, credit quality, call features, liquidity, tax treatment, and whether any subsidy-related issues affect the issuer's economics.