Arbing the Global Savings Glut

I blogged recently about how foreign capital continues to invest at elevated levels in US federal debt, even as private debt instruments fall out of favor. I mused that one thing Obama could do to arb this would be to issue credit cards to Americans.

So I was very interested when I heard about Build America Bonds. These are municipal bonds, but unlike typical municipal bonds they are not US federal tax-free. Instead, the federal government subsidizes 35% of the interest rate payments, i.e., the issuer of the bond offers a higher yield to compensate for paying taxes. This might seem like a tortured dance until you realize foreign investors are not subject to US federal tax on their bond income. Therefore, up to now, they have avoided tax-free municipal bonds with higher "effective pre-tax yields". Clearly Build America Bonds were designed to attract their attention, and sure enough a recent auction by California was gangbusters. (Ok, a less cynical possible design rationale is that domestic investors from the lower marginal tax rate brackets will find these bonds more attractive than tax-free bonds; somehow I don't think that was the aha moment behind these.)

Given that the domestic personal savings rate is trending higher, and marginal tax rates are almost certainly going up in the next few years, classical tax-free municipal bonds will have more domestic money chasing them with a higher effective pre-tax yield. In addition, the Build America Bonds provide an alternative market competing for yield which attracts foreign interest. It's a good time to be a local issuer of debt: Obama has handed you a federally subsidized credit card!