In anticipation of the end of Bush-era tax cuts, investors are considering the tax shelter offered by municipal bonds and related exchange traded funds (ETFs). One of the more interesting products to come out of the financial crisis is the Build America Bond ETF, which give investors a direct way to play the recovery of the domestic economy.

What Are BABs?

The Build America Bond program was created to help ease the liquidity crisis found in the bond markets after the financial crisis had wreaked havoc. When a state or local government issues a Build America Bond, it receives a cash subsidy from the federal government equal to 35% of the coupon interest rate on the bond. Interest payments are subsidized by the U.S. Treasury, making them attractive to cash-strapped municipalities and states. Yields are comparable to those found in corporate bonds.

More than $125 billion in Build America Bonds has been issued. The appeal is easy to see: interest rates are declining and Bush tax cuts are expiring, and it’s all contributing to a rush for tax-free municipal debt.

Build America Bonds have been so popular, in fact, that demand has outpaced supply – they’ve accounted for 21% of all municipal bond issuances since April 2009. The credit-strapped markets pushed municipalities to hike up their interest rates to attract buyers, and the buyers flocked to the high yields.

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