Looming under the somewhat Byzantine headline name, Sequestration, are automatic cuts to government spending that may include planned reimbursements to state and local issuers of Build America Bonds (BABs).
BABs are taxable municipal bonds, authorized as a stimulus program under the 2009 American Recovery and Reinvestment Act.
The federal government promised rebates to the issuers equal to 35% of their interest costs as an incentive to raise capital for “shovel ready” projects. Many market participants considered it to be a highly successful program.
In the lawyer-crafted pages of the Act, however, is language that permits Congress to take away or reduce the 35% rebate at its discretion. [Muni Bond ETFs: January Rebound]
If that should happen, I believe city and state issuers will be obligated to make up the difference, likely forcing some of these issuers to reconfigure their budgets to accommodate these additional obligations.
Ultimately, the extra burden, in my opinion, will rest with taxpayers who may have thought that certain needs and benefits coming out of the recession were already accounted for, but now find the hand of government back in their pockets.
Market Vectors Long Municipal Index (NYSEArca: MLN)
James Colby is a portfolio manager and senior municipal strategist at Market Vectors ETFs.