Zach in the comments linked to this article from the Independent that mentioned the Obama Administration was looking into creating an EU-style bank for infrastructure development. I mentioned the idea briefly in this news round-up. The bank the idea is being modeled off of, the European Investment Bank, borrows money from capital markets and lends that money to development projects that further the EU’s long-term goals. The bank the Obama administration is investigating creating would have $60 billion to lend to infrastructure building projects.
The more I think about this, the better an idea it seems. The value in this system for agencies building infrastructure projects is that the Federal Government can borrow money much more cheaply than the agencies can. Even with a AAA rating, the interest rate Sound Transit can issue bonds at is usually 1% higher than the rate the US Treasury issues T-Bills at. Data for AAA municipal bonds from here, and for T-Bills from here.
The lower interest rate means lower payments, and it’s basically free money. Outside of the money it costs to operate the bank, lending money to agencies at the rate the Treasury borrows money won’t cost the Federal Government anything. In this $435 million worth of bonds issued in 2005, Sound Transit could have saved over $100 million in interest over the life of the bonds. This would basically be free money for the transit agencies, with one small exception.
The Treasury borrows money more cheaply because they are essentially guaranteed not to default on their debt, and while rare, other public agencies can default. A famous local example is the Washington Public Power Supply System which defaulted on $2.25 billion in 1982. The capital markets know this, and because of this they charge these agencies more interest. If the Federal Government became the lender to these agencies, when they default, it’d be the US tax payers stuck footing the bill. I don’t think this would be a huge problem, since the US tax payer is on the hook every time a bank or automaker runs into financial trouble, though politically this could be trouble for such a program.
Other snag in the implementation is that the European Investment Bank borrows money like a AAA rated government agency, which happens to be the same rate Sound Transit borrows at today. For Sound Transit to save money on a bank program like this, the program would have to be implemented so that the bank would borrow money at the same rate as the Treasury does. Even at the AAA rate, the program would still be very helpful for agencies that don’t have such a high credit rating, like Sound Transit before 2007.
It’s an interesting idea, and it could be a way that the Federal Government can provide a lot of financial help to agencies building infrastructure with very little cost to the taxpayer.
It’s an interesting idea. One benefit, if it could be implemented quickly would be to help free up the credit markets. If lenders don’t sell bonds to agencies like ST then they would have an inventive to loan it to corporations. Instead of bail out money going to banks to wall paper their corporate offices direct it to the borrowers.
If the net effect is the same as the Treasury issuing more T-bills won’t that drive up interest rates on all the money the government has to borrow? The more T-bills that are put on the market the higher the interest rate needs to be to attract enough investors.
Thanks for fleshing it out so well…
If a huge amount of bonds are issued it could drive the rate up, but the treasury has been borrowing a trillion a year or so, and this would be chump change compared to that.
AAA municipal bonds don’t “usually” carry higher rates than Treasuries. That’s really only been the case for the past year. Typically, transit agencies and other municipal issuers sell tax-exempt bonds — interest earned on the bonds is tax-exempt for the investor. Interest on Treasury bonds isn’t tax-exempt. Yes, the US Treasury is less likely to default, but in a typical market, the tax exemption (which is itself a form of federal subsidy) outweighs the additional credit risk of municipal bonds, and borrowers like ST actually borrow at rates lower than the Treasury.
BTW, your link to AAA bond data is for corporate (taxable) bonds, not municipal (tax-exempt) bonds.
That’s true