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62–996 2011

TAX–EXEMPT AND 

TAXABLE GOVERNMENTAL BONDS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

OF THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

MAY 21, 2009 

Serial No. 111–22 

Printed for the use of the Committee on Ways and Means 

( 


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COMMITTEE ON WAYS AND MEANS 

CHARLES B. RANGEL, New York, Chairman 

FORTNEY PETE STARK, California 

SANDER M. LEVIN, Michigan 

JIM MCDERMOTT, Washington 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

JOHN S. TANNER, Tennessee 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

EARL POMEROY, North Dakota 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

EARL BLUMENAUER, Oregon 

RON KIND, Wisconsin 

BILL PASCRELL, JR., New Jersey 

SHELLEY BERKLEY, Nevada 

JOSEPH CROWLEY, New York 

CHRIS VAN HOLLEN, Maryland 

KENDRICK B. MEEK, Florida 

ALLYSON Y. SCHWARTZ, Pennsylvania 

ARTUR DAVIS, Alabama 

DANNY K. DAVIS, Illinois 

BOB ETHERIDGE, North Carolina 

LINDA T. SA ́ NCHEZ, California 

BRIAN HIGGINS, New York 

JOHN A. YARMUTH, Kentucky 

DAVE CAMP, Michigan 

WALLY HERGER, California 

SAM JOHNSON, Texas 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

ERIC CANTOR, Virginia 

JOHN LINDER, Georgia 

DEVIN NUNES, California 

PATRICK J. TIBERI, Ohio 

GINNY BROWN-WAITE, Florida 

GEOFF DAVIS, Kentucky 

DAVID G. REICHERT, Washington 

CHARLES W. BOUSTANY, JR., Louisiana 

DEAN HELLER, Nevada 

PETER J. ROSKAM, Illinois 

Janice Mays, Chief Counsel and Staff Director 

Jon Traub, Minority Staff Director 

SUBCOMMITTEE ON SELECT REVENUE MEASURES

RICHARD E. NEAL, Massachusetts, Chairman 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

ALLYSON Y. SCHWARTZ, Pennsylvania 

EARL BLUMENAUER, Oregon 

JOSEPH CROWLEY, New York 

KENDRICK B. MEEK, Florida 

BRIAN HIGGINS, New York 

JOHN A. YARMUTH, Kentucky 

PATRICK J. TIBERI, Ohio, Ranking Member 

JOHN LINDER, Georgia 

DEAN HELLER, Nevada 

PETER J. ROSKAM, Illinois 

GEOFF DAVIS, Kentucky 

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records 

of the Committee on Ways and Means are also published in electronic form. The printed 

hearing record remains the official version. Because electronic submissions are used to 

prepare both printed and electronic versions of the hearing record, the process of converting 

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process 

is further refined. 


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C O N T E N T S 

Page 

Advisory of May 14, 2009, announcing the hearing ............................................. 2 

WITNESSES 

The Honorable Alan B. Krueger, Assistant Secretary for Economic Policy, 

United States Department of the Treasury ....................................................... 5 

Robert L. Culver, President and Chief Executive Officer, MassDevelopment, 

Boston, Massachusetts ......................................................................................... 18 

Patrick J. McCoy, Director of Finance, NYS Metropolitan Transportation 

Authority, New York, New York ......................................................................... 21 

Michael Decker, Co-Chief Executive Officer, Regional Bond Dealers Association, Alexandria, Virginia .................................................................................... 28 

James P. Esposito, Managing Director, Goldman, Sachs & Co., New York, 

New York .............................................................................................................. 37 

Gary W. Bornholdt, Counsel, Nixon Peabody LLP, Washington, D.C. ............... 45 

SUBMISSIONS FOR THE RECORD 

Cadmus Hicks, Nuveen Investments, statement .................................................. 67 

Dean A. Spina, statement ....................................................................................... 70 

Peter B. Coffin, Breckinridge Capital Advisors, Inc., statement ......................... 71 

Seamus O’Neill, Liscarnan Solutions, statement .................................................. 72 


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(1) 

TAX–EXEMPT AND 

TAXABLE GOVERNMENTAL BONDS 

THURSDAY, MAY 21, 2009 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON WAYS AND MEANS, 

SUBCOMMITTEE ON SELECT REVENUE MEASURES, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 10:07 a.m., in 

Room 1100, Longworth House Office Building, Hon. Richard E. 

Neal (Chairman of the Subcommittee), presiding. 

[The advisory announcing the hearing follows:] 


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ADVISORY 

FROM THE COMMITTEE ON WAYS AND MEANS 

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

FOR IMMEDIATE RELEASE CONTACT: (202) 225–5522 

May 14, 2009 

Congressman Neal Announces a Hearing on 

Tax-Exempt and Taxable Governmental Bonds 

House Ways and Means Select Revenue Measures Subcommittee Chairman Richard E. Neal (D–MA) announced today that the Subcommittee on Select Revenue 

Measures will hold a hearing on issues involving tax-exempt and taxable governmental bonds. The hearing will take place on Thursday, May 21, 2009, in the 

main Committee hearing room, 1100 Longworth House Office Building, beginning at 10:00 a.m. 

Oral testimony at this hearing will be limited to invited witnesses. However, any 

individual or organization not scheduled for an oral appearance may submit a written statement for consideration by the Committee and for inclusion in the printed 

record of the hearing. 

FOCUS OF THE HEARING: 

The hearing will focus on issues relating to tax-exempt and taxable government 

bonds, and how the issuance of recently authorized taxable bonds may impact the 

demand for and supply of tax-exempt bonds. Other changes to State and local financing contained in recently passed legislation may also be discussed. 

BACKGROUND: 

Since the introduction of the Federal income tax, interest income from debt issued 

by State and local governments has been exempt from tax. The Federal tax exemption lowers the cost of borrowing for State and local governments so that State and 

local services can be efficiently and consistently provided where they might otherwise not be. State and local borrowing issued as bonds are generally classified either 

as governmental bonds, which finance governmental functions, or private activity 

bonds, which provide some benefit to private businesses and may or may not be taxexempt. 

Additionally, other alternative vehicles for State and local government financing 

have been authorized. For example, tax credit bonds, which allow the holders of 

such bonds to receive a tax credit instead of an interest payment. Recently, Congress passed H.R. 1, the ‘‘American Recovery and Reinvestment Act of 2009,’’ which 

was signed into law on February 17, 2009 (Pub. L. 111–5). This Act contains a number of changes impacting State and local government financing, including a new 

type of taxable government bond named ‘‘Build America Bonds.’’ These bonds allow 

State and local governments to elect to receive a direct payment from the Federal 

Government that approximates the subsidy that would have otherwise been delivered through the Federal tax credit for bonds issued in 2009 and 2010. To assist 

areas impacted by high unemployment, the bill also provides taxable government 

bonds with a greater subsidy and tax-exempt bonds, named Recovery Zone Economic 

Development Bonds and Recovery Zone Facility Bonds. 

Already, some jurisdictions have issued new bonds under the Build America 

Bonds program, while the two Recovery Zone Bond programs are awaiting initial 

Treasury guidance. 


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In announcing the hearing, Chairman Neal stated, ‘‘As we begin to move this 

economy forward, Congress should review these innovative financing options for State and local governments as well as the impact on their traditional methods of borrowing. I look forward to hearing the comments from 

the government issuers as well as from private sector capital market experts.’’ 

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS: 

Please Note: Any person(s) and/or organization(s) wishing to submit for the hearing record must follow the appropriate link on the hearing page of the Committee 

website and complete the informational forms. From the Committee homepage, 

http://democrats.waysandmeans.house.gov, select ‘‘Committee Hearings.’’ Select the 

hearing for which you would like to submit, and click on the link entitled, ‘‘Click 

here to provide a submission for the record.’’ Once you have followed the online instructions, complete all informational forms and click ‘‘submit’’ on the final page. 

ATTACH your submission as a Word or WordPerfect document, in compliance with 

the formatting requirements listed below, by close of business Thursday, June 4, 

2009. Finally, please note that due to the change in House mail policy, the U.S. 

Capitol Police will refuse sealed-package deliveries to all House Office Buildings. 

For questions, or if you encounter technical problems, please call (202) 225–1721. 

FORMATTING REQUIREMENTS: 

The Committee relies on electronic submissions for printing the official hearing record. As always, submissions will be included in the record according to the discretion of the Committee. 

The Committee will not alter the content of your submission, but we reserve the right to format 

it according to our guidelines. Any submission provided to the Committee by a witness, any supplementary materials submitted for the printed record, and any written comments in response 

to a request for written comments must conform to the guidelines listed below. Any submission 

or supplementary item not in compliance with these guidelines will not be printed, but will be 

maintained in the Committee files for review and use by the Committee. 

1. All submissions and supplementary materials must be provided in Word or WordPerfect 

format and MUST NOT exceed a total of 10 pages, including attachments. Witnesses and submitters are advised that the Committee relies on electronic submissions for printing the official 

hearing record. 

2. Copies of whole documents submitted as exhibit material will not be accepted for printing. 

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material 

not meeting these specifications will be maintained in the Committee files for review and use 

by the Committee. 

3. All submissions must include a list of all clients, persons, and/or organizations on whose 

behalf the witness appears. A supplemental sheet must accompany each submission listing the 

name, company, address, telephone and fax numbers of each witness. 

Note: All Committee advisories and news releases are available on the World 

Wide Web at http://democrats.waysandmeans.house.gov. 

The Committee seeks to make its facilities accessible to persons with disabilities. 

If you are in need of special accommodations, please call 202–225–1721 or 202–226– 

3411 TDD/TTY in advance of the event (four business days notice is requested). 

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above. 

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Chairman NEAL. Let me call this meeting to order, and I hope 

all will take their seats. 

Today the Subcommittee will consider Federal tax incentives for 

State and local financing needs. As a former Mayor of a mid-sized 

city—I would like to point out, a real Mayor—I personally know 

the value of tax-exempt financing for community needs. 

Our Federal Government has long recognized and acknowledged 

the important role that cities play in our civilized society. President 


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Lyndon Johnson put it this way: ‘‘The American city should be a 

collection of communities, where every member has a right to belong. It should be a place where each of us can find the satisfaction 

and warmth which comes from being a member of the community 

of man. This is what man sought at the dawn of civilization. It is 

what we seek today.’’ 

The economic downturn has been felt at every level of government, but especially in our cities. The Ways and Means Committee 

heard from Governors and Mayors at a hearing last October, and 

responded with a stimulus package, including a number of expansions and improvements for State and local borrowing. Today, we 

welcome a number of experts to tell us how these bond programs 

are working, and what remains to be done. 

One of my proudest moments as Mayor of the City of Springfield 

was the largest development ever in the history of western Massachusetts, today known as Monarch Place. As those of you involved 

in local government know, you scrape together every dollar you can 

find for these projects from more sources than you care to count. 

At the heart of these deals is always municipal bonds. 

Monarch Place spurred a revival of the downtown, and more 

bonds were then used for housing and a local theater. It really is 

a perfect example of how bonds can be utilized to rebuild a community. From roads, bridges, and energy projects, our witnesses will 

tell us today that Congress is on the right track with some of the 

new and innovative ways for local governments to build the kind 

of community that Lyndon Johnson spoke of. 

Let me at this moment recognize my friend, Mr. Tiberi, for his 

opening statement. 

Mr. TIBERI. Thank you, Mr. Chairman, and thank you for calling this hearing today. If you would have asked me in 2001, when 

I got sworn in, that I would be part of a hearing on bonds, I would 

have thought of major league baseball, and not what we’re talking 

about today, Mr. Chairman. But it is so important. 

As we know, the principal ways that State and local governments 

finance their activities is through issuance of bonds to the public. 

It’s generally agreed that the liquidity crisis and the accompanying 

economic downturn have made it more difficult for State and local 

governments to find ways for buyers to buy their bonds. 

Indeed, in 2008, total issuances of long-term State and local 

bonds decreased in comparison to their levels in 2007. It is important that we review this area of the tax law periodically, and it is 

especially important now, given the state of the economy, and in 

light of the dramatic changes we have seen in bond programs with 

the enactment of last year’s TARP legislation and this year’s stimulus package. 

Thank you again, Mr. Chairman. I would like to also thank the 

witnesses for being here today. We are looking forward to your testimony. I yield back. 

Chairman NEAL. Thank you, Mr. Tiberi. Let me welcome our 

witnesses today. 

First, I want to welcome Assistant Secretary for Economic Policy, 

Alan Krueger. Secretary Krueger was only confirmed by the Senate 

a few weeks ago, but has kindly agreed to come before us today to 

discuss this important topic, and we are most appreciative of his 


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time. I also want to thank him for agreeing to be on the panel format today, and allow him, at the right time, to conclude promptly. 

I also want to welcome Bob Culver, President and CEO of 

MassDevelopment in Boston. I worked with Bob for many years, 

and have always found his comments instructive. I would also 

point out that he has been most helpful to me in the re-use of the 

old Federal courthouse in Springfield because we have built a new 

Federal courthouse in Springfield. And I thought that—the financing, he figured it out, and was right there. So I am indeed grateful 

for his presence, and we will hear from him shortly, as well. 

Let me next welcome Patrick McCoy, the Director of Finance for 

the Metropolitan Transit Authority of New York. MTA is one of the 

largest issuers of municipal debt in the country. 

Next we will hear from Michael Decker, who is the Co-CEO of 

the Regional Bond Dealers Association, a trade association which 

represents security firms active in bond markets. We will also hear 

from Jim Esposito, a Managing Director at Goldman Sachs, in New 

York. Mr. Esposito leads the municipal and corporate investment 

grade new issue financing business at Goldman Sachs. 

And finally, we will hear before the Committee from Gary 

Bornholdt, who served this Committee as a tax advisor to joint tax 

for many years, and now is a counsel at Nixon Peabody, here in 

Washington. 

We look forward to the testimony that we will hear today, and 

we want to thank you all for your participation. Without any objection, any other Members wishing to insert statements as part of 

the record may do so. All written statements by the witnesses will 

be inserted in the record, as well. 

Let me recognize Secretary Krueger for his opening statement. 

STATEMENT OF THE HONORABLE ALAN B. KRUEGER, ASSISTANT SECRETARY FOR ECONOMIC POLICY, UNITED STATES 

DEPARTMENT OF THE TREASURY 

Mr. KRUEGER. Thank you. Good morning, Chairman Neal, 

Ranking Member Tiberi, and other Members of the Subcommittee. 

I appreciate the chance to appear before you today to discuss 

changes in Federal tax subsidies to lower borrowing costs for State 

and local governments and other public agencies. 

State and local governments confront difficult challenges in the 

current economic environment. The American Recovery and Reinvestment Act of 2009 provides a number of new and expanded bond 

financing subsidies for State and local governments. In general, 

these bond financing tools will support infrastructure investment, 

job creation, and economic recovery. 

I commend this Committee for its work in leading the successful 

legislative efforts for these bond financing tools in the Recovery 

Act. 

In my remarks, I will briefly compare the economic effects of different ways of providing a Federal subsidy to reduce State and 

local borrowing costs with a focus on the broadest new bond program called ‘‘Build America Bonds.’’ And, finally, I will highlight 

the Treasury’s efforts to provide prompt guidance for the new bond 

programs. 


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There are currently three different ways of providing Federal 

subsidies to reduce State and local borrowing costs. First, traditional tax-exempt bonds are an important financing tool for State 

and local governments. There are over $2.7 trillion in outstanding 

tax-exempt bonds. Tax-exempt bonds lower State and local borrowing costs by making the interest on the bonds tax exempt for 

investors. 

From an economic perspective, however, tax-exempt bonds can be 

viewed as an inefficient subsidy in that the Federal revenue costs 

of the tax exemption is often greater than the benefits to State and 

local governments achieved through lower borrowing costs. 

This inefficiency arises because the bonds have a different value 

to different investors. Investors in higher tax brackets receive a 

greater tax benefit. The market interest rate of tax-exempt bonds 

is determined by the tax rate of the marginal investor. The marginal investor is the investor who is just indifferent between buying 

a tax-exempt bond and buying a taxable bond for another security. 

To sell enough bonds, tax-exempt bonds often have marginal investors who are below the highest tax bracket. As a result, taxexempt bonds tend to give excess benefits to investors in higher tax 

brackets. This conclusion is consistent with the fact that, since 

1986, interest rates on long-term tax-exempt bonds have been 

about 20 percent lower than the yields on high-grade taxable 

bonds, whereas the Federal revenue cost has been large enough to 

finance a 25 to 30-percent reduction in interest rates. 

Tax credit bonds are a second way of supporting State and local 

government borrowing costs. With these bonds, investors receive 

tax credits for a portion of their borrowing costs. The Recovery Act 

expands the use of tax credit bonds significantly. Tax credit bonds 

are more efficient than tax-exempt bonds, in that tax credits have 

comparable value to all investors with tax liabilities. 

The third and most recent innovation in subsidizing State and 

local government borrowing costs are Build America Bonds. There 

are two types of Build America Bonds: Tax credit and direct payment. 

I will focus on the direct payment Build America Bonds. They 

are fully taxable to investors, and the Federal Government makes 

direct payments to issuers equal to 35 percent of the coupon interest. 

For example, if a State or local government were to issue Build 

America Bonds at a 10 percent taxable interest rate, the Treasury 

Department would make a direct payment to the government of 3.5 

percentage points of that interest, and the issuers net borrowing 

cost would therefore be 6.5 percent. 

Direct payment bonds offer four important advantages over traditional tax-exempt bonds. First, they are a fully efficient subsidy. 

Second, the amount of Federal support to bond issuers can be varied by project type, offering the opportunity to tailor Federal subsidies, to provide different levels of support for different programs. 

Third, they are potentially attractive to the entire universe of bond 

investors. And, fourth, the benefits of participating is democratized 

in that not only those in the highest tax brackets benefit the most. 

Because Build America Bonds convey no tax benefits to investors, they have yields comparable to taxable debt instruments, and 


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they should therefore appeal to all bond investors, including pension funds and foreign investors, and investors in lower tax brackets. Expanding the market should result in lower borrowing costs. 

The early market reception for Build America Bonds has been 

very positive, as other Members of this panel can comment. Guidance for Build America Bonds was released in early April of this 

year. Between mid-April and mid-May, approximately 36 issues of 

Build America Bonds were made, totaling about $9.5 billion in volume. This represents about 20 percent of the total issuance of taxexempt bonds during this period. Moreover, investor demand and 

sales orders for many of the initial issues appears to have been 

strong. 

Preliminary indications suggest that the significant sales volume 

over the past month may have reduced the supply of tax-exempt 

bonds somewhat, and possibly contributed to declining interest 

rates on tax-exempt bonds. It is difficult, however, to separate out 

the effects of other factors that also influence tax-exempt bond 

rates. 

The Build America Bonds program has just begun. But the early 

signs are positive. The Treasury will track developments to ascertain whether Build America Bonds can be an effective additional 

tool to serve the diverse financing needs of State and local governments. 

Finally, I want to assure the Committee that the Treasury Department is committed to providing prompt guidance to implement 

the new bond financing tax incentives. A major part of guidance 

was issued through five IRS notices released publicly in early 

April. This guidance implemented the direct payment procedures 

on the Build America Bond program, and provided volume cap allocation guidance for four additional tax credit bond programs for 

schools and energy projects. 

In the next several weeks, we expect to provide priority guidance 

on the bond volume cap allocations for the recovery zone bond programs and the Indian tribal economic development bonds. In the 

coming years, as we move forward beyond the current economic 

challenges, the Administration is committed to working closely 

with the Congress to determine how best to provide Federal support for lower borrowing costs to State and local governments in 

the most efficient, workable, uniform, simple, and sustainable way. 

Thank you. 

[The prepared statement of Mr. Krueger follows:] 


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Chairman NEAL. Thank you, Mr. Krueger. 

Mr. Culver. 

STATEMENT OF ROBERT L. CULVER, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, MASSDEVELOPMENT, BOSTON, 

MASSACHUSETTS 

Mr. CULVER. Chairman Neal, Ranking Member Tiberi, Members of the Committee, thank you for inviting me to testify, and for 

holding this hearing. I cannot overstate the importance of the 

American Recovery and Reinvestment Act of 2009, but would suggest that more can be done to maximize its impact. 

I am Bob Culver, President and CEO of the Massachusetts Development Finance Agency, a quasi-public finance and development 

entity in the Commonwealth of Massachusetts. Having issued private activity bonds that generated more than $2 billion in investment in Massachusetts last year, MassDevelopment knows this 

market, which aids affordable housing, higher education, manufacturing, and waste recovery. 

I speak this morning as a representative of my agency, only. I 

have submitted a written statement to the Committee from which 

I will summarize six main topics. I call your attention to two 

themes that run through my testimony. First, standardizing allocation processes using the well-vetted and understood volume cap 

method as a model. And, second, extending allocations of special 

issuance capacity, and making permanent enhancements to eligibility to allow more borrowers to use these programs. 

Briefly, the first of the six subjects I would like to touch on concerns the expanded definition of manufacturing facilities for qualified manufacturing bonds, to include the production of intangible 

properties, such as software. ARRA also eliminated the 25 percent 

limit on directly related and ancillary property. Both of these provisions expire in 2011. These enhancements are key to supporting 

modern manufacturing facilities, thereby expanding the economy. 

However, many companies will not use them today, but will need 

them as the economy rebounds. MassDevelopment supports making 

these enhancements permanent to bring manufacturing bonds into 

the 21st century. 

Second, ARRA creates recovery zone facility bonds, a new PAB 

category with a national limit of $15 billion. Uses include acquisition and construction of property in designated recovery zones. The 

provision expires on December 31, 2011. After Treasury allocates 

cap amounts, each State must implement a process and identify 

projects. And large scale redevelopment projects may take more 

than a year to be ready for permanent financing. 

To maximize this program’s potential, MassDevelopment urges 

Treasury to give State governments control of allocating issuance 

capacity among eligible projects, and asks Congress to allow unexpended capacity to be carried forward through 2015. 

Third, ARRA increased the national issuance capacity for clean 

renewable energy bonds, but reduced the allowable tax credit. 

Issuance capacity is awarded by the IRS, and favors smaller issues 

over larger, less costly ones. MassDevelopment used its entire allocation in 2006 to support 12 solar projects at State facilities, but 


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may not be able to do so again because of the constrained tax credit 

market and reduced tax credit. 

Giving States a pro-rata share of the overall issuance capacity 

and the ability to select projects could save time and money. Giving 

the program a direct pay option from the Federal Government 

could speed use of the program and deliver more benefits by eliminating structuring costs. 

Fourth, ARRA increases the issuance capacity of qualified energy 

conservation bonds. These bonds are also dependent on a vibrant 

tax credit market. Giving States control over where to allocate 

issuance capacity could enhance the program. And because these 

projects take years to advance, unused issuance capacity should be 

carried forward to 2015. 

While MassDevelopment applauds Congress for providing this 

option, creating a new category of private equity activity, taxexempt facility bonds would give renewable energy developers the 

certainty of a permanent Tax Code provision. 

Next, ARRA increases the bank-qualified bond provisions to 

apply to issuers of less than $30 million a year, and include 

501(c)(3)’s that borrow through a conduit issuer like MassDevelopment. This provision will increase the market for tax-exempt bonds by enlisting more banks as potential purchasers, while 

allowing them to pass through lower interest rates. 

MassDevelopment supports these provisions, but recommends 

eliminating the 2011 expiration date, and extending them to other 

types of private activity bonds, in particular manufacturing. 

Finally, in 2008 Congress authorized the Federal home loan 

banks to confirm bank-issued letters of credit on tax-exempt private activity bonds beyond affordable housing. This levels the playing field for smaller and mid-sized banks to support tax-exempt 

bonds, and helps offset the collapse of bond issuers and credit ratings of some larger banks. We support this program, and recommend it be made permanent, so that a market can develop. It 

comes with no significant cost to the Federal Government, makes 

the market more efficient, and puts more banks to work. 

I appreciate the opportunity to speak to the Committee, and look 

forward to your questions. Thank you, Mr. Chairman. 

[The prepared statement of Mr. Culver follows:] 

Prepared Statement of Robert L. Culver, President and 

Chief Executive Officer, MassDevelopment, Boston, Massachusetts 

Chairman Neal, Ranking Member Tiberi, Members of the Committee: Thank you 

for inviting me to testify before you this morning and for holding this hearing. One 

cannot overstate the importance of the American Recovery and Reinvestment Act 

of 2009, but more can be done to maximize the impact of ARRA. 

I am President and CEO of the Massachusetts Development Finance Agency 

(MassDevelopment), a quasi-public finance and development entity established by 

the Legislature in the Commonwealth of Massachusetts. Having issued private activity bonds that generated more than $2 billion in investment in Massachusetts in 

fiscal year 2008, MassDevelopment knows this market, which aids affordable housing, higher education, manufacturing, and waste recovery. 

I speak this morning as a representative of my agency, only. 

In particular, I call your attention to two general themes that run through my 

testimony: 

• First, standardize allocation processes using the already well-vetted and wellunderstood volume cap method as a model, and 


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• Second, extend allocations of special issuance capacity and make permanent 

certain enhancements to eligibility to allow more borrowers to take advantage 

of these programs. 

Expanded Definition of Manufacturing Facility 

The first topic that I want to address has to do with ARRA’s expansion of the definition of manufacturing facilities for qualified manufacturing bonds to include facilities used in the production of intangible property such as software and biotech. 

ARRA also eliminates the 25% limit on directly related and ancillary property so 

that such property may be financed if it is functionally related and subordinate to 

the manufacturing facility. Both of these provisions expire on January 1, 2011. 

These enhancements are important to supporting modern manufacturing and production facilities, and expanding the economy. Crucially, these bonds are subject to 

States’ annual allocations of volume cap, which was not expanded. For that reason, 

the expansions of the applications should not be seen as an additional cost to the 

government. Notably, many manufacturing companies will not take advantage of 

these provisions in the current economic climate but will need them for expansions 

as the economy rebounds. MassDevelopment strongly supports making these enhancements permanent to bring manufacturing bonds into the 21st century. 

Recovery Zone Facility Bonds 

Second, ARRA creates Recovery Zone Facility Bonds, a new category of tax-ex- empt private activity bonds subject to a national limit of $15 billion. Eligible uses 

include acquisition and construction of property in designated Recovery Zones. 

As of the writing of this testimony, guidance from the U.S. Department of the 

Treasury has not yet been released on how the cap would be allocated among the 

States. After guidance is issued, further work must be done in each State to implement the allocation process and identify projects. While the interest rate savings on 

a tax-exempt bond is not enough of a subsidy to make or break large-scale projects, 

the savings can still be useful in steering development to underserved areas. These 

types of projects may take more than a year to be ready for permanent financing, 

which means that the December 31, 2010 expiration date may prove problematic. 

To maximize the potential of this new bond program, MassDevelopment urges 

Treasury to give State governments control of allocating issuance capacity among 

eligible projects and asks Congress to provide for the carrying forward of unexpended issuance capacity for 5 years beyond December 31, 2010. 

Clean Renewable Energy Bonds 

Third, ARRA increased the national issuance capacity for clean renewable energy 

bonds, which are tax-credit bonds that governmental entities can use to finance eligible renewable energy projects. 

These bonds are dependent on a vibrant tax credit market that does not exist at 

this time. This concern is exacerbated because the expanded program is limited to 

70% of the tax credit allowed by the original program. The issuance capacity is 

awarded to governmental borrowers by the Internal Revenue Service by ranking 

applications from smallest to largest. This approach favors small issues that tend 

to be less efficient than larger ones because of the proportionately larger cost of 

issuance. 

MassDevelopment used its entire allocation in 2006 to support 12 solar projects 

at State facilities. We are concerned, however, that we may not be able to use the 

program as successfully again because of the constrained tax-credit market and the 

reduced tax credit. The potential of the program would be greatly enhanced by giving States a pro-rata share of the overall issuance capacity along with the ability 

to select projects, rather than leaving the application process with the IRS, which 

takes more time and favors less efficient projects. 

We would also favor giving the program a ‘‘direct pay’’ option from the Federal 

Government (as with Build America Bonds) instead of tax credits. Doing so would 

speed the use of the program and possibly deliver more benefits to the projects by 

eliminating some of the structuring costs and investor yield requirements. 

Qualified Energy Conservation Bonds 

Fourth, ARRA increases the issuance capacity for Qualified Energy Conservation 

Bonds. These are tax-credit bonds that can be used for both governmental and private purposes and can finance a broad range of energy conservation and renewable 

energy generation projects. 

MassDevelopment fully supports the objectives of this program. Like the Clean 

Renewable Energy Bonds, however, the energy conservation bonds are dependent on 

a vibrant tax credit market. In line with our prior recommendation for the Recovery 

Zone Facility Bond program, to enhance the program’s health States should have 


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control over where to allocate issuance capacity. And unused issuance capacity 

should be able to be carried forward to 2015. 

While MassDevelopment applauds the Congress for making tax-advantaged financing available for renewable energy projects, an efficient way to support this sector would be to create a new category of private activity, tax-exempt facility bonds. 

Doing so would allow the sector to benefit from the same tax-exempt bonding programs currently available to waste recovery projects. This new category would also 

give renewable energy developers the certainty of a permanent provision of the Tax 

Code. These projects—which involve financing, permitting, and site-control issues— 

take years to advance, a process that could be short-circuited if the necessary incentives expire in the short term without certainty of renewal. 

Bank Deductibility of Interest Expense 

Next, ARRA increases the ‘‘bank-qualified’’ bond provisions to apply to issuers of less than $30 million per year, up from $10 million per year, and to include 501(c)3 

borrowers that borrow through a conduit issuer such as MassDevelopment. 

This provision will increase the market for tax-exempt bonds by enlisting more 

banks as potential purchasers while allowing them to pass through lower interest 

rates. MassDevelopment places many of its smaller issues directly with banks, 

which handle the transactions much like commercial loans. These borrowings benefit from the discipline of having a bank lender instead of the capital markets and 

also from having smaller costs of issuance. 

MassDevelopment supports the increased bank-qualified provisions, but recommends that they be extended to other types of private activity bonds other than 

501(c)3 borrowings, in particular manufacturing. The Agency also recommends 

eliminating the expiration date of 2011. 

Federal Home Loan Bank Confirming Letters of Credit 

Finally, in 2008, Congress authorized the Federal Home Loan Banks to confirm 

bank-issued letters of credit on tax-exempt private activity bonds beyond affordable 

housing only. This authorization will be tremendously useful in providing investment grade rated credit to guarantee private activity bonds issued by conduit 

issuers such as MassDevelopment. This authorization levels the playing field for 

smaller and mid-sized banks to support tax exempt bonds, and helps to offset the 

collapse of bond insurers and the investment grade credit ratings of some of the 

larger banks. 

We fully support this program and recommend that it be made permanent beyond 

2010 so that a market can develop. MassDevelopment believes this program comes 

with no significant cost to the Federal Government: The program does not increase 

the eligible uses of tax-exempt bonds, but simply makes the market more efficient 

and puts more banks to work. In fact, MassDevelopment recently held seminars 

across Massachusetts that banks enthusiastically attended. Our agency closed its 

first issue under this expanded capacity in March. 

Thank you for the opportunity to submit this testimony. 

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Chairman NEAL. Thank you, Mr. Culver. 

Mr. McCoy. 

STATEMENT OF PATRICK J. MCCOY, DIRECTOR OF FINANCE, 

NYS METROPOLITAN TRANSPORTATION AUTHORITY, NEW 

YORK, NEW YORK 

Mr. MCCOY. Good morning, Mr. Chairman, Ranking Member 

Tiberi, and Members of the Subcommittee. I want to thank you for 

the opportunity to testify today on taxable and tax-exempt municipal government bonds and, in particular, the newly created Build 

America Bonds program. 

Mr. Chairman, as you know, the MTA transportation network is 

one of the largest in the world. MTA provides 8.7 million subway, 

bus and commuter railroad rides daily, or 2.7 billion rides per year, 

accounting for nearly one-third of all transit riders in the United 

States. MTA also operates seven bridges and two tunnels that 

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ficked bridge and tunnel system in the Nation. MTA accomplishes 

this mission with over 69,000 dedicated employees. 

Investment in this vast regional transportation network has resulted in MTA being one of the largest issuers of municipal debt 

in the United States, with over $26 billion in debt outstanding at 

this time. 

Since 1982, MTA has invested over $72 billion in capital improvements through a series of 5-year capital programs that are 

funded from city, State, and Federal grants, as well as our bond 

financing program. MTA has replaced or overhauled nearly the entire system, including restoration of Grand Central Terminal, and 

Long Island Railroad’s Penn Station. 

The need to maintain our extensive transportation infrastructure 

and keep it in a state of good repair requires stable and predictable 

capital investment. But dramatic ridership growth over the past 10 

years, nearly 50 percent across the board, has also required us to 

undertake the first major expansion of our service in over 60 years 

through the construction of the Second Avenue Subway, Number 

Seven Line extension, and connecting Long Island Railroad with 

Grand Central Terminal. 

Our existing current 2005 through 2009 capital program, which 

covers both maintenance and state-of-good-repair investment, as 

well as expansion needs, is over $22 billion. 

Like many other issuers, MTA uses a variety of funding sources 

to meet its capital program requirements, including bond financing, 

which accounts for about 40 percent of our current capital funding 

needs. Bond financing for large capital expenditures matches the 

funding of the asset with the useful life of the asset. If a subway 

car, for example, lasts for 30 years, we like to finance that with a 

30-year debt. 

MTA is slated to issue roughly $2 billion per year in the foreseeable future to continue these investments, just our bond financing 

portion of the funding. 

The ongoing global credit crisis has had a devastating effect on 

the municipal bond market over the past year, and that has hampered State and local governments across the country from being 

able to access the market affordably. For example, State and local 

governments, including the MTA, have seen their access to liquidity severely constrained at increasing cost. This is a trend that appears to be continuing for the foreseeable future. 

While, however, it does appear, though, that the credit markets 

are slowly recovering, ensuring long-term stability should be a vital 

priority for Congress and the Administration. 

One of the more positive developments that has taken hold of the 

market this year are the many bond provisions that were included 

in the American Recovery and Reinvestment Act of 2009, especially 

the newly created Build America Bonds program. We were one of 

the first issuers to take advantage of this program, and I would 

like to talk a little bit about that now. 

In April, we announced plans to issue $200 million in Build 

America Bonds under our dedicated tax fund rated AA by S&P and 

A+ by Fitch. We plan to enter the market at the same time, with 

$400 million in tax-exempt bonds. And, as you know, these markets 


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that we issue into, the taxable and the tax-exempt markets, are 

different, and they are structured and priced differently. 

Traditional tax-exempt bonds are structured with serial maturities, or with part of the principal amount due each year, much 

like a mortgage. And often there are larger maturities, referred to 

as term bonds, at the end of the amortization schedule, similar to 

a balloon payment on a mortgage. Serial and term bond structure 

allows the issuer to repay part of the principal and interest each 

year until the bond is repaid. Traditional tax-exempt bonds are 

generally priced relative to an index of AAA-rated municipal bonds. 

Tax credit bonds, including Build America Bonds, generally need 

to be issued with long-dated, bullet maturities, which are common 

in the corporate taxable bond market. In other words, the entire 

principal amount would be due in one lump-sum payment. Build 

America Bonds are—like corporate taxable bonds—priced relative 

to the 30-year Treasury, and we express that as a spread to Treasuries. MTA was optimistic that this structure would expand the 

pool of investors, increase market access for our debt. 

Other issuers that came the same week as the MTA were the 

State of California and the New Jersey Turnpike. We all priced our 

bonds on different days, and we watched how these other issuers 

came to market and worked aggressively to price our bonds as efficiently as possible at that time. Our initial offer of $200 million 

was increased to $750 million, due to very strong investor interest 

at the time of the issue. 

I will sum up now. The Build America Bond program has expanded the investor base for municipal bonds. And there were approximately 35 new investors that came into the MTA deal that 

had never participated in our borrowings before. By attracting 

these new investors, MTA was able to expand and diversify the investor base, which we believe will help achieve more efficient 

pricings in the future. 

The rest of my testimony is on record, and I will be happy to 

take questions at that time, after concluding. Thank you. 

[The prepared statement of Mr. McCoy follows:] 


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Chairman NEAL. Thank you, Mr. McCoy. 

Mr. Decker. 

STATEMENT OF MICHAEL DECKER, CO–CHIEF EXECUTIVE 

OFFICER, REGIONAL BOND DEALERS ASSOCIATION, ALEXANDRIA, VIRGINIA 

Mr. DECKER. Thank you, Chairman Neal, Ranking Member 

Tiberi, and other Members of the Subcommittee. I appreciate the 

opportunity to be here today. 

Like all other sectors of the capital markets, the municipal bond 

market has been acutely affected by the global financial crisis. Last 

fall, for a time at the height of the crisis, it became nearly impossible for most States and localities to access the capital markets to 

finance investment projects. 

The market has recovered significantly since then, in part with 

the help of legislation advanced by the Ways and Means Committee. But now, State and local governments are dealing with the 

sometimes severe fiscal stress brought about by the recession and 

the downturn in real estate markets. 

The American Recovery and Reinvestment Act includes a number 

of provisions that have helped States and localities weather the financial crisis. My written statement offers comments on all the 

municipal finance provisions included in the law. In the interest of 

time, I will focus my comments here on three provisions that have 

had the most positive effect: Build America Bonds, expansion of 

bank investment, and the tax-exempt bond market, and the AMT 

relief. 

I am going to admit, Mr. Chairman, that when I first heard 

about Build America Bonds, I was skeptical that they would offer 

real benefits for States and localities. However, based on the experience of the last 2 months, I am now a believer. By allowing State 

and local governments to tap the taxable bond market without losing the generous interest subsidy associated with tax-preferred financing, Build America Bonds offer State and local governments a 

tool that often provides lower-cost financing than they could obtain 

through any other means. 

Moreover, Build America Bonds have had the unanticipated effect of lowering borrowing costs in the tax-exempt bond market, as 

well. They are, in short, a huge hit. 

That is not to say that Build America Bonds haven’t raised some 

questions among market participants. They are challenging some of 

the standard structures that have been popular among municipal 

bond issuers for decades, like serial maturities and 10-year call 

provisions. 

Also, there are doubts about whether Build America Bonds will 

be as effective for State and local governments when the interest 

subsidy rebate expires at the end of 2010, and the tax credit on the 

bonds accrues to investors, rather than issuers. While we don’t 

think Build America Bonds can or should displace tax-exempt 

bonds as the dominant way for States and localities to finance capital investment, they’re a great tool to help bond issuers weather 

the crisis. 

Two other provisions of the stimulus legislation that have helped 

States and localities are expanding bank investment in tax-exempt 


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bonds and exempting bond interest from the AMT. The bank investment provisions have helped restore the role of commercial 

banks as tax-exempt bond investors. 

Before the 1986 Tax Reform Act, banks were dominant buyers of 

tax-exempt debt. The 1986 Act included tax law changes that effectively took banks out of the market for all but a small number of 

bonds. By bringing banks back, and thereby increasing demand for 

bonds, you have made it easier for States and localities to find investors for their debt at good terms. 

Lifting the AMT on tax-exempt bond interest has helped reopen 

an important sector of the market that had been effectively closed 

since last year. It had become exceedingly difficult for issuers of 

private activity bonds for facilities like airports and economic development projects to obtain bond financing. 

The spread, or difference in interest rates between AMT and 

non-AMT bonds, had increased to historical levels. The AMT holiday has addressed these issues, and made it possible for private activity bonds to be issued once again. 

With respect to another set of provisions from the stimulus bill, 

authority for targeted tax credit bonds, such as clean renewable energy bonds and qualified energy conservation bonds, I think it is 

useful to point out to the Subcommittee that, in many cases, borrowers have had a hard time using this authority to raise financing. The Subcommittee may want to consider diverting all or a portion of the revenue cost associated with some tax credit bond authority to other more conventional types of financing, such as private activity tax-exempt bonds for energy facilities. 

Also, I would like to bring to the Subcommittee’s attention legislation that, even as we speak, is being discussed in the Financial 

Services Committee. Two bills under consideration there to help 

State and local bond issuers include provisions to exempt some new 

proposed programs from the section 149 Tax Code prohibition on 

Federal guarantees of tax-exempt bonds. 

While these proposals—when these proposals come before the 

Ways and Means Committee, we urge you to approve them quickly. 

The stimulus bill has certainly been successful in providing tools 

to State and local governments to continue to raise capital in a distressed market. We appreciate the work you all did in ensuring 

that State and local finance received meaningful attention in the 

stimulus legislation. 

Thank you, again, for the opportunity to be here. I look forward 

to your questions. 

[The prepared statement of Mr. Decker follows:] 


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Chairman NEAL. Thank you very much, Mr. Decker. The AMT 

holiday that you referenced was my amendment, and I was amazed 

at how quickly it appeared in advertising. 

Mr. DECKER. Absolutely. 

Chairman NEAL. Mr. Esposito. 

STATEMENT OF JAMES P. ESPOSITO, MANAGING DIRECTOR, 

GOLDMAN, SACHS & CO., NEW YORK, NEW YORK 

Mr. ESPOSITO. Chairman Neal, Ranking Member Tiberi, and 

Members of the Committee, my name is Jim Esposito, and I lead 

the municipal and corporate financing business at Goldman Sachs. 

Given my leadership role across both the taxable and tax-exempt 

capital markets business, I have a broad perspective on the new 

programs enacted by Congress as a part of the American Recovery 

and Reinvestment Act. 

Build America Bonds have had a positive impact in three specific 

areas. First, they have lowered borrowing costs for State and local 

governments. Second, they have provided issuers a needed source 

of capital to fund infrastructure projects. And, third, they are improving the functionality of the capital markets for issuers and investors, alike. 

Historically, the $2.5 trillion municipal debt market had provided 

States and municipalities access to capital at affordable borrowing 

rates. The capital market deterioration during 2008 created an exceptionally challenging environment where only the highest-rated 

municipalities and corporations had access to the capital markets. 

Certain institutional investors exited the market permanently, 

and others sat on the sidelines, simply willing to ride out the 

storm. It became clear that expanding the traditional tax-exempt 

buyer base was needed to restore stability and long-term viability 

to the municipal market. 

The Build America program has provided municipal issuers access to a separate and distinct buyer base. Access to this new taxable investor base has helped municipal issuers lower their overall 

borrowing costs, and diversify their funding streams. Build America Bonds have not eliminated the need for a tax-exempt market, 

but rather have provided an alternative through 2010. 

A positive effect to the BABs program to date is the visible resurgence of the traditional tax-exempt market. As taxable investors 

grow more comfortable analyzing municipal credits, we are starting 

to see signs of an increased amount of structuring flexibility and 

pricing power. 

The other large taxable program recently created is the qualified 

school construction bonds, otherwise known as QSCBs. The size of 

this program, as well as the ability for large school districts to fund 

education capital needs on an interest-free basis, will be two key 

components that will drive the ultimate success of this program. 

If I can turn your attention for a second to the monitors, I appended an exhibit to my testimony. And they say a picture is worth 

1,000 words. And I think this exhibit is rather powerful, and really 

speaks to the success of the Build America Bond program. 

And just a brief explanation as to what you see in this exhibit. 

If you follow along the horizontal axis, those navy blue bar charts 

are tax-exempt issuance volumes, dating back to September 2008 


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on a weekly basis. If you move all the way to the right of the horizontal axis, the lightish blue color is issuance volumes under the 

Build America Bond program. And, to date, we have seen 9.25 billion issued under the Build America program in the past month, 

alone. 

Now, more importantly on this chart is the red line. The red line 

represents the cost of borrowings to States and local governments. 

That is a AAA-rated composite of municipal bond yields, as a percentage of overall Treasury yields. Historically, municipal yields 

have traded at about 80 to 90 percent of Treasury yields. 

And, as you can see, if you go back to the time of the Lehman 

Brothers bankruptcy filing in September of 2008, issuance volumes 

from municipal clients started to really dry up. And, just as importantly, borrowing costs really spiked, reaching a peak at year-end 

2008. And we saw municipal yields trading at almost two times the 

rate of underlying Treasury yields. So, market access really seized 

up, and borrowing costs spiked. 

Now, as we get into the new calendar year, you can see borrowing costs starting to fall significantly. I think it’s important to 

point out, as a part of the market anticipating the positive impact 

of the American Recovery and Reinvestment Act, yields started to 

fall. And they continued to fall during the period in which the 

Build America program actually got rolled out. 

It is not just issuers who have financed debt under the Build 

America program who have benefitted. With borrowing costs falling 

in a taxable market, whether you use the program or not, all municipal clients have been beneficiaries of this program. 

In conclusion, the taxable bond options recently enacted have 

had the immediate effect of lowering borrowing costs to State and 

local governments, while providing investors with a compelling opportunity to diversify their portfolio holdings. Congress, and this 

Committee specifically, should be commended for providing municipalities access to new liquidity sources during these challenging 

times. We encourage Congress to monitor the stimulus-related financing programs to determine if, at the end of 2010, any or all 

of these programs warrant extension or even expansion. 

On behalf of Goldman Sachs, I appreciate the opportunity to appear before the Committee today, and I look forward to taking your 

questions. 

[The prepared statement of Mr. Esposito follows:] 


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Chairman NEAL. Thank you very much, Mr. Esposito. 

Mr. Bornholdt. 

STATEMENT OF GARY W. BORNHOLDT, COUNSEL, 

NIXON PEABODY LLP, WASHINGTON, D.C. 

Mr. BORNHOLDT. Good morning, Mr. Chairman, Ranking 

Member Tiberi, and Members of the Subcommittee. Thank you for 

holding this important hearing today, and thank you for giving me 

the opportunity to testify. 

While I was with joint counsel a little over a year ago, I had the 

opportunity to work on many of the tax-exempt and tax bond provisions that we are discussing here today. In my current position as 

a tax-exempt bond attorney with Nixon Peabody, I now have the 

opportunity to assist State and local governments in their efforts 

to utilize many of these new programs. 

But the past year has certainly presented challenges in that regard. As we have heard from other witnesses today, the global 

credit crisis and the economic downturn has made it significantly 

difficult for State and local governments to access the capital markets. This, in turn, has had a significant impact on the ability of 

State and local governments to finance essential governmental 

services and facilities. 

We are seeing some improvements for higher-rated municipal 

issuers. However, access to the bond market continues to be a problem for many State and local governments. 

The American Recovery and Reinvestment Act provided State 

and local governments with a number of new financing tools and 

modifications to existing programs that have the potential to increase the demand for bonds and improve the overall efficiency of 

the markets. And, as we have heard from the other witnesses 

today, we are already seeing improvements due to some of the provisions that have been enacted. 

Yet, not all of the bond provisions have been fully utilized as of yet. For example, the Recovery Act authorized a $25 billion bond 

program for economically distressed areas that cannot be used 

until initial guidance is issued by Treasury. 

More generally, because many of the bond programs in the Recovery Act are so innovative, issuers would benefit from additional 

guidance clarifying that the existing regulatory framework that applies to tax-exempt bonds, and that has been in place for more than 

20 years, would also apply to many of the new bonds that have 

been established under the Recovery Act. This would also help to 

remove some of the uncertainties, with respect to the new programs. 

That said, I would like to note that Treasury and IRS chief counsel have been incredibly responsive to issues that have developed 

regarding implementation of these new programs. The ability of 

Treasury to respond to these questions on a prompt basis is obviously of critical importance, given the temporary nature of many of 

these programs, and I am confident that the open dialogue the 

Treasury and IRS have had with the industry can continue. 

As we have heard, the tax exclusion that is provided under the 

Internal Revenue Code for State and local government bonds helps 

to lower borrowing costs. And traditionally, this has provided State 


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and local governments with an efficient source of capital for their 

financing needs. 

In contrast, recent tax credit bond programs, which date back to 

about 1997, have—tend to be illiquid, and a market has not—an 

efficient market has not yet developed for these programs. And I 

think this is for a number of points that I would just like to summarize briefly. 

For one, most of the tax credit bonds under present law share a 

common feature, in that the credit rate is set by the Department 

of the Treasury, and it is generally intended to be set at a level 

that provides deeper subsidy than provided for tax-exempt bonds. 

However, as Treasury has acknowledged, it has not always managed to set the credit rate at the intended subsidy level, which has 

required tax credit bonds to go out at a discount, which lessens the 

value of the intended subsidy. 

In addition, there has been a lack of demand for tax credits in 

general. Currently, a liquid market for tax credits does not exist. 

In the current economic climate, there has not been a strong demand for tax credits among taxable investors. 

In addition, rules that would allow investors to sell the underlying tax credits separately from the principal component of the 

bond, which should, in theory, improve the marketability of the tax 

credit bonds, have not yet been released by the Department of the 

Treasury. 

In addition, all of the existing tax credit bonds have been temporary or limited in size. The Clean Renewable Energy Bond program, for example, was initially capped at 800 million, when enacted in 2005. This amount has been increased over the years, and 

is currently at 2.4 billion, after the Recovery Act. But this is still 

a relatively small program, when contrasted with the approximately 19 billion of tax-exempt debt that was issued for public 

power in 2007 alone. 

In addition, some of the tax credit bond programs have expired 

over time. For example, the QZAB program, Qualified Zone Academy Bonds, has expired, only to be reauthorized on a retroactive 

basis. These issues have made it difficult for efficient markets to 

develop, with respect to the existing tax credit bond programs. 

Recently, Congress has enacted standardized rules for many of 

these existing tax credit bonds, which should help to address some 

of these issues regarding efficiencies. But Treasury guidance will 

probably need to be issued with respect to many of the new rules 

before the market can get comfortable with respect to the standardized rules that would apply to all tax credit bonds. 

With regard to the Recovery Act, we see some of the most significant changes to the tax rules relating to municipal bonds since 

the Tax Reform Act of 1986. The Recovery Act contains provisions 

that should help improve the demand for tax and financing, such 

as the temporary elimination of the application of the AMT to 

bonds issued in 2009 and 2010, and the relaxation of deductibility 

restrictions, also for bonds issued in 2009 and 2010. These demandside incentives are already providing benefits to the market, and 

there are sound policy reasons for making these provisions permanent. 


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The biggest program, from the standpoint of State and local governments, is probably the Build America Bond program, which we 

have heard about here today. And, as we have heard, there are two 

types of Build America bonds: The tax credit bond version, which 

operates similar to existing tax credit structures; as well as the direct pay version. 

I am not going to go through the technical details of the two 

types of the program. But as we have heard here today, we have 

seen significant interest in the direct pay version of the Build 

America bonds. And I think this is, in part, due to the fact that, 

in some cases, there may, in fact, be a deeper subsidy for the Build 

America Bonds direct pay than associated with tax-exempt bonds. 

But I think it’s also due to the fact that, for this new product, 

investors have not had to digest many of the new rules that would 

apply to tax credit bonds, generally. Rather, the market is purchasing a taxable bond, and it is the issuer that is receiving the 

direct benefit from the Federal Government in this case. 

Finally, in conclusion, I would like to say that, due to the temporary nature of these programs, it may be difficult for robust markets to develop in the short period of time we have to issue bonds 

under the Recovery Act programs. So I think it is necessary to extend many of these programs in order for Congress to get a full 

sense of the value that they could provide, as a complement to taxexempt bond financing, generally. 

In addition, I would like to mention that today the results that 

we’re hearing going on in the Financial Services Committee address some of the liquidity issues that still remain in the tax-exempt bond market, and some of these issues will also impact taxexempt bond requirements. For example, there are issues relating 

to Federal guarantees, which are generally prohibited under the Internal Revenue Code. Some of the proposals that are being considered by the Financial Services Committee, for example, would require amending these Federal guarantee prohibitions, in order for 

these new liquidity proposals to operate efficiently. 

Thank you for the opportunity to testify. I look forward to your 

questions. 

[The prepared statement of Mr. Bornholdt follows:] 


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Chairman NEAL. Thank you, Mr. Bornholdt. 

Secretary Krueger, I am interested in the guidance you have referenced for the recovery zone bond program. We have heard from 

some witnesses that we should consider extending the time for 

these programs. Do you expect this initial guidance will be comprehensive, especially for those jurisdictions which may be receiving a direct allocation, such as Springfield? 

Mr. KRUEGER. Our goal is to produce the guidance as quickly 

as we can, which I think will be in a matter of a small number of 

weeks, and to make the program as administratively easy as possible for Springfield and other communities. 

Chairman NEAL. Thank you. And, Mr. Culver, let me follow up 

on the line of questioning with you. I understand MassDevelopment has issued bonds on behalf of smaller jurisdictions in Massachusetts. As you know, the recovery zone bond program will not 

only have allocations for States, but for large cities and counties 

with severe job losses. 

Do you expect MassDevelopment to assist with the recovery zone 

bond offerings? And, if so, what preparations have you made for 

the pending Treasury guidance that could come in a small number 

of weeks? 

Mr. CULVER. Right. We are—as you know, we work with all 351 

of the cities and towns in the Commonwealth of Massachusetts, as 

well as smaller banks. And we are really, right now, working with 

them to make them aware of the new programs, how they might 

use them, and how we can assist them, in fact, in making filings 

to take advantage of them, and also expressing to them their need 

to get their projects ready to go, if, in fact, they’re going to use this 

type of debt financing. 

Chairman NEAL. Right. And, Mr. McCoy, we have heard from 

other witnesses that the Build America Bonds may have been 

priced inefficiently, perhaps due to the fact that they were a new 

product on the market. As someone who has issued the Build 

America Bonds, what is your experience, in terms of pricing your 

bonds? 

Mr. MCCOY. We went into the pricing of our bonds, again, both 

taxable and tax-exempt, on the same day, and evaluated significant 

amounts of information, market data from our financial advisor, as 

well as from our underwriters. And we felt that, given the fact that 

we were improving pricing relative to tax-exempt bonds, the Build 

America Bonds were—delivered the kind of savings we needed and 

wanted. 

We have certainly heard those criticisms about particularly secondary market trading, and how that has improved the pricing, relative to the primary issuance. I think, given our experience, we 

were satisfied with the outcome, and would evaluate the issuance 

of BABs again in the future, with the same process and the same 

methodology that we used the first time. 

Chairman NEAL. And, Mr. Decker, your testimony highlights 

support for the safe harbor provision, allowing banks to invest in 

tax-exempt bonds. You stated that many banks have not followed 

through. And, as you know, I pushed hard for this provision in the 

stimulus bill. 


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It is disappointing to hear what you have suggested. And can you 

explain to me why more banks have not increased their holdings? 

Mr. DECKER. I think part of it is inertia. I think bank—many 

bank investment officers are used to buying bonds that have an explicit opinion, tax opinion, associated with the bonds, that they’re 

bank-qualified. 

And in expanding the eligibility for bank investment to nonbank-qualified bonds—to any bonds that are available in the market, I think it’s just going to take a little time for bank investment 

officers and tax directors to get used to the idea that they can buy 

non-bank-qualified bonds and still not take a tax hit. Forums like 

this I think are good for publicizing that. 

Chairman NEAL. This is very informative, just listening to your 

testimony, all of you, this morning. Very, very helpful. 

Mr. Esposito, I was interested in the chart you presented. It 

shows a peak at the end of 2008 for municipal yields, as a percentage of the 30-year Treasuries. You refer to this as a dislocation. 

And, first, have you seen this sort of dislocation before? And 

what amount of municipal borrowing usually occurs in the last 

quarter of the year? And what happened at the end of 2008? 

Mr. ESPOSITO. Yes, let me start by saying that the dislocation 

that we saw in the capital markets was not specific to the taxexempt market. There was a dislocation, globally, across all asset 

classes, other parts of the debt markets, the equity markets. So, 

this was a dislocation and a severe lack of liquidity. Liquidity left 

the system through a very violent de-leveraging process. 

While, over the years, volume certainly slipped into year-end, the 

end of 2008, for the municipal market, were some of the thinnest 

volumes we have seen in the past decade. In terms of the success 

of the Build America program, and what that meant for issuance 

volumes and lowering the cost of borrowing for municipal clients, 

I think the graph is very telling. And, bear in mind, the markets 

were anticipating the passage of the Act. 

So, while the lines started to fall at the beginning of the year, 

at that point in time market participants were already expecting 

the passage of the Build America program. So I think, in a lot of 

ways, the program should get credit for the decrease in yields, 

starting at the beginning of the year. 

Chairman NEAL. Okay, thank you. Mr. Bornholdt, you suggest 

that Congress should look to extend the Build America Bond’s direct payment model to other types of tax credit programs. Others 

have suggested that private activity bonds might be expanded to 

include these tax credit programs. 

Mr. Houghton, a former Member of this Committee, we worked 

hard on that very issue, and we were very successful. What approach do you think would be better? 

Mr. BORNHOLDT. Regarding either expanding the direct 

pay—— 

Chairman NEAL. Yes. 

Mr. BORNHOLDT [continuing]. Version, or expanding the Build 

America Bonds to private activity bonds? 

Chairman NEAL. Yes. 

Mr. BORNHOLDT. Well, that is a good question. I mean, I think 

Congress has identified certain priorities in authorizing the Clean 


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Renewable Energy Bond programs and the School Construction 

Bond programs, by providing these particular programs with a 

deeper subsidy than provided generally through tax-exempt bonds, 

or even provided through the direct pay for Build America Bond 

programs. 

For example, with the clean renewable energy bonds, Congress 

provides a subsidy that is approximately equivalent to 70 percent 

of the interest costs. 

So, to the extent Congress continues to view renewable energy as 

a priority, school construction as a priority, and worthy of deeper 

subsidies than some other types of programs, the direct pay, which 

would provide a direct pay equivalent to the intended subsidy 

under the tax credit rate, would probably be preferable, in terms 

of delivering that deeper subsidy. 

In terms of long-term—with respect to just general purpose activities, for example, we have seen programs similar to the Recovery Act facility bonds, which are essentially a type of private activity bond for any type of business purpose—that is, any depreciable 

property. We have seen those programs successful in other recovery 

areas, such as the New York Liberty Zone and the Gulf Opportunity Zone. 

So, for more general programs, the private activity bond program 

which allows issuers to issue tax-exempt bonds for basically any 

purpose that the State or local government determines is a worthy 

financing opportunity, the private activity bond program may provide a better general purpose program. But with respect to those 

programs that Congress has specifically identified as worthy of a 

deeper subsidy, the direct pay is probably the more direct approach. 

Chairman NEAL. Thank you. Mr. Tiberi is recognized to inquire. 

Mr. TIBERI. Thank you, Mr. Chairman. Starting with Mr. 

Krueger, over the last 20 years we have seen an expansion on the 

use of tax-preferred bond financing through incentives in the 

amount of private activity bonds that the States can issue, and the 

addition of activities, as well, that qualify for tax-preferred bond financing. 

In your view, what impact has that had for State and local governments in financing what we would all look at as traditional 

functions, like building bridges and roads, if any? 

Mr. KRUEGER. I’m sorry, I’m not sure I understand the question. The question is how has the balance with private activity—— 

Mr. TIBERI. Yes. How has the expansion of activities and the 

use of these bonds for State and local governments impacted the 

building of roads and bridges by the whole government? 

Mr. KRUEGER. I—this is not an area that I have studied directly. 

Mr. TIBERI. We can go to other panelists and come back to you. 

Mr. Culver. 

Mr. KRUEGER. But I would just emphasize that the private activity bonds are subject to the volume cap, which is going to, you 

know, often be a constraint on the amount of private activity that— 

private activity bonds that are issued, and that take place. 

Mr. TIBERI. Thank you. Mr. Culver, any thoughts? 


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Mr. CULVER. I agree. I mean, the—they are a good addition to 

the debt that is already—needs to be incurred for these. If you look 

at our issue of the big dig and other issues that we deal with, they 

will not affect us in that financing, per se, if you will. I mean, we 

are still subject to a lot of other financing mechanisms. 

But the—what is happening right now, in terms of the new 

issuance that you are considering, is really going to help us, in 

terms of what I deal with, small businesses, and assisting cities 

and towns, by giving them access to tax-exempt debt that they 

have not heretofore had. It will take some time, as has been noted, 

for the markets to get used to this. And it will also take time for 

these businesses and the smaller cities and towns to believe that 

they have the cashflow to pay the debt service, even though it is 

becoming more efficient and the cost of issuance is becoming less 

for them. 

And that is why we’re basically asking please extend this. Give 

us a little bit more time with this, because this—these new products will be more effective in the areas that we deal with, as the 

economy begins to pick up, and the markets begin to understand 

how to use these. 

Mr. TIBERI. Mr. McCoy. 

Mr. MCCOY. You know, I think our experience with the Build 

America Bonds issuance that we had last month was very successful. We improved our cost of financing, relative to tax-exempt financing, on a present-value basis. We saved approximately $46 

million using the Build America Bonds, relative to doing that in a 

tax-exempt market. 

At the end of the day, we used both tax-exempt and taxable, because we want to have flexibility, we want to be able to enter the 

market in ways that continue to tap into these different investor 

pools. I think, to the extent that we will come back to the market 

later in the year, and certainly next year—again, with heavy 

issuance—we’re going to continue to look at this program as a tool 

that we would absolutely look to use. 

Chairman NEAL. Mr. Decker. 

Mr. DECKER. There are some uses for private activity bonds 

that are traditional infrastructure-type projects, not roads and 

bridges, but projects like water and sewer systems or airports, that 

are eligible for private activity bond financing. And I think that 

that—those provisions in the Code allow State and local governments to use public-private partnership arrangements, which are 

sometimes very efficient ways of financing traditional infrastructure projects when you have an element of private participation. 

So, in that regard, I think the private activity bond authority has 

been helpful, in some cases, in helping get those kinds of projects 

financed. 

Mr. TIBERI. Mr. Esposito. 

Mr. ESPOSITO. I have nothing additional to add. 

Mr. TIBERI. Okay. Mr. Bornholdt. 

Mr. BORNHOLDT. Just with respect to private activity bonds, 

generally, I would note that, again, in the cases of the New York 

Liberty Zone and the Gulf Opportunity Zone, we saw a pretty rapid 

utilization of the additional 30 that was provided in those particular cases. And I think it was more than just because of the ecoVerDate Nov 24 2008 07:21 Mar 29, 2011 Jkt 062996 PO 00000 Frm 00062 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\62996.XXX APPS06 PsN: 62996

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nomic distress those areas were under. It was also because Congress provided fairly open-ended definitions of the type of property 

that could be financed. 

For example, State and local governments could decide what type 

of private property could be financed. We see this again in the Recovery Act with the recovery zone bonds. It is basically any depreciable property. I think that has certain elements of efficiency that 

are more advantageous than the current structure of many of the 

private activity bonds. 

For one example, solid waste facilities, which are a defined type 

of private activity bond, the IRS and the industry have spent years 

and countless dollars arguing over what is the definition of a solid 

waste facility. And this is a definition that was established under 

regulations dating back to the early 1970s. And obviously, as times 

have changed, we have different needs with respect to solid waste 

and recycling facilities, generally, but the Code and the regulations 

have not kept up. 

To the extent Congress provides more of these open-ended definitions of economic purposes that can be financed in State and local 

governments, I think that has real advantages. 

Mr. TIBERI. Thank you. I yield back. 

Chairman NEAL. Thank you, Mr. Tiberi. Mr. Thompson is recognized to inquire. 

Mr. THOMPSON. Thank you, Mr. Chairman. Thanks to all the 

witnesses for being here. I would like to carry on the discussion 

about the private activity bonds, and based upon what we did in 

the Recovery Act, and the success that the expansion of the private 

activity bonds have had in regard to renewable green projects. 

I am pursuing legislation that would even expand that—I plan 

to drop the bill here as soon as we get back from the break—that 

would allow the use of the private activity bonds to fund, to a 

greater extent, renewable energy-type of projects. 

In my home State of California, our treasurer came to me and 

said, you know, ‘‘I can use these to fund traditional energy facilities.’’ But at a time when we are trying to decrease the amount of 

money we are paying for foreign oil and to move toward more renewable energy, he believes it would be advantageous to extend 

that ability over to the green technologies. 

And I would like to hear what you think about that in regard to 

two issues: One, what would it mean, from an economic stimulus 

perspective; and, two, any comments you might have on how this 

will help expedite our move to a renewable energy society. And we 

can start wherever you would like. 

Mr. ESPOSITO. Well, why don’t I start by trying to frame some 

guiding principles, as you think about any changes or tweaks you 

make to existing programs, as well as think about what has been 

successful with what’s been rolled out to date. 

I think we can glean some very important learning lessons from 

the Build America program. We at Goldman Sachs are also confident that the qualified school construction program will ultimately prove successful. 

So, what is it about these two programs that are going to lead 

to success and a lot of investor receptivity in the capital markets? 

I think the first guiding principle that you need to bear in mind, 


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that the size of the program matters. And I’m not just talking 

about the overall size of eligible debt that can be issued under it, 

but I am talking about the actual issuance amounts by any one 

entity. 

What we have seen to date is that investors are willing to embrace programs that either have a lot of eligible size behind it, or 

at least individual issuance that will be of reasonable size that will 

merit their time, energy, and intention. So this is a place where 

size does matter. 

Mr. THOMPSON. And doesn’t size differ between projects? 

Mr. ESPOSITO. It does, and that will be one of the issues that 

Congress will have to grapple with. And maybe there are other 

thoughtful ways that, together, we can think about efficiency gains 

by thinking about ways to roll up various issuance strategies into 

more liquid debt issuances. 

Because, clearly, the marketplace is demonstrating a propensity 

to want to invest in more liquid alternatives. So that is point one. 

Second—— 

Mr. THOMPSON. Before—— 

Mr. ESPOSITO. Sorry. 

Mr. THOMPSON [continuing]. You drill down too deep on the 

specifics, maybe I could get a commitment from you to work with 

my office to try and define some of these specifics that would make 

this bill an even better tool for what it is we want to do. And, because we’re limited in time, maybe just hear, generally, what people think about the idea of whether or not the expansion will create 

economic activities and get us to where we need to go quicker. 

Mr. ESPOSITO. We would be delighted to follow up with your office. 

Mr. THOMPSON. Thank you. 

Mr. DECKER. I think that would be a very welcome piece of legislation, Congressman. Members of ours tell me that—bond dealers 

that work with State and local governments tell me that they have 

projects that are ready to go that are related to energy generation 

or energy conservation, retrofitting buildings for energy conservation, or alternative energy-generating projects that are ready to go 

that don’t make sense if the borrowing is taking place at 6 or 7 or 

8 percent, but do if the borrowing is taking place at 2 or 3 or 4 

percent. 

And so, I think your idea would result in some very quick and 

meaningful investment activity. 

Mr. KRUEGER. I would highlight that the Administration has 

made renewable energy a priority. And the President, you know, 

has strongly supported cap and trade policy. And the budget would 

use much of that revenue—I think it was $15 billion a year—for 

renewable energy research and development and implementation 

projects. So, we very much agree with the goal of trying to expand 

renewable energy. 

As far as private activity bonds, I think a very important issue 

has to do with the revenue costs, which would have to be considered, how it relates to the current volume caps, and so on, which 

are issues that we would very much like to look at and work with 

after you do develop the bill. 


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The last question you raised about the economic recovery, I 

think, as an economist, I would say that it depends upon the speed 

in which the programs are put in place. And—— 

Mr. THOMPSON. Now, with the support of you and Goldman’s, 

I think we can move it out pretty quick. 

[Laughter.] 

Mr. KRUEGER. Yes. 

Mr. THOMPSON. Thank you. 

Mr. CULVER. If I may, in the spirit of the size does matter, especially when you are on the little side of size matters—and for 

those of us who come from the New England States, there are 

many smaller entities that will be seeking to issue under this. And 

they may have a different experience in the markets than the larger issuers would. And I hope that they would not be discriminated 

against, because of their size. 

Mr. BORNHOLDT. And I would just like to briefly add that Congress has recently authorized two tax credit bond programs for renewable energy: the Clean and Renewable Energy Bond program, 

which is a $2.4 billion program, as well as the recently enacted Energy Conservation Bond program, which is a $3.2 billion program. 

And, to the extent that Congress is considering providing additional financing for these types of projects, I would urge Congress 

to continue to look at the existing programs, and ways to enhance 

those tax credit bond programs. For example, given the success 

with the Build America Bond programs, and the lack of a liquid 

market for tax credit bonds, generally, additional refinements to 

both the CREBs, as well as the Clean Energy Conservation Bond 

program might be warranted. 

In addition, to echo the point regarding size, as I said, you know, there is $2.4 billion of clean renewable energy bonds authorized for 

the entire program, but public power, you know, in 1 year, issues 

approximately $19 billion. And that $2.4 billion for clean renewable 

energy bonds is actually divided into three parts for both State and 

local governments, which has been used primarily, for example, to 

put solar panels on top of courthouses, one-third for cooperative entities, and one-third for public powers. 

All of those are, obviously, worthy goals. But, by splitting that 

$2.4 billion among the three different classes of issuers, it has obviously diluted some of the benefits of the program. 

Chairman NEAL. Mr. Linder, the gentleman from Georgia, is 

recognized to inquire. 

Mr. LINDER. Thank you, Mr. Chairman. Mr. Bornholdt, California’s bond rating has recently been reduced to the lowest in the 

country of any State, from A+ to A. What kind of difference does 

that make in their interest payments, the cost—— 

Mr. BORNHOLDT. Well, as I said—and I think most of the witnesses said this morning—we are seeing some improvements in the 

markets, but that has generally been at the higher end of the ratings scale, for example, at the AA level. 

When we get into the A level and the BBB level, and even lower, 

we are still seeing some difficulties accessing the market, which 

has impacted across. But I probably have other witnesses here who 

are more qualified to testify today regarding the pricing, with respect to California’s—— 


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Mr. LINDER. Mr. Esposito. 

Mr. ESPOSITO. Sure. I would just point out that investors rely 

upon a lot of different factors and judgments to make a decision 

whether to purchase a bond or not. And, while clearly ratings are 

one of the important variables that go into that decision, investors 

do a lot of their own credit work. 

And many of the investors had already factored into their analysis the credit conditions prior to the actual—— 

Mr. LINDER. Maybe somebody could try and answer the question. Would anybody like to take a shot at this? What difference 

would it make, in the savings or cost to a State, if their bond rating 

went from AA to A? 

Mr. MCCOY. At the MTA, we have been looking at this issue, 

as our existing credits—we have had stability over the past few 

years. 

But, as we look forward and look at stress in our own system, 

we have looked at the scenarios that we would confront. And a simple 1-notch downgrade for the MTA could cost us approximately 25 

basis points. A 2-notch downgrade could—we estimate—could cost 

us approximately 75 basis points. And these are estimates, but obviously we are very sensitive to that, and work very closely with 

the rating agencies to maintain those ratings. 

But given all the economic pressure that our revenue streams 

are under, you know, it is one of those scenarios that we have to 

be aware of and sensitive to. 

Mr. LINDER. What would happen if the Federal Government decided—and this is just a matter of discussion right now; the Fed 

says no—but if our government decided to back-stop or guarantee 

California’s bonds, would it raise the rating? Would it just lower 

the interest rate? What would happen? 

Mr. Bornholdt, do you want to take a shot at that? 

Mr. BORNHOLDT. Well, it wouldn’t raise California’s rating, per 

se, but it would certainly raise the rating on the underlying debt 

that the issuer—because, obviously, investors in that case are looking through to the ultimate guarantor on the bonds, which would 

be the Federal Government. 

Mr. LINDER. So it would save California money? 

Mr. BORNHOLDT. It would save money. 

Mr. LINDER. The equivalent of 75 basis points? 

Mr. BORNHOLDT. I don’t know that I can testify regarding the 

pricing element—— 

Mr. LINDER. Mr. Decker, do you want to—— 

Mr. DECKER. I would say, based on where California is now, 

versus where they would issue if they got a full faith in credit Federal guarantee on their debt, it would be significantly more than 

75 basis points. 

The credit spreads in the market now, the difference in borrowing costs between different rating categories, are some of the 

widest that I have ever seen, as a result of the credit crisis, and 

de-leveraging, and illiquidity in the market. So there are big differences between rating categories now, much bigger than there 

had been for a long time. 

Mr. ESPOSITO. You can also look to the FDIC, TLGP program 

as a proxy for what happened when the government started to 


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guarantee individual commercial bank’s debt. The savings to the 

banking system was more than 200 basis points in that example. 

And I think that’s a pretty good place to borrow for what the impact would be on the State of California, as a place to look at for 

a judgment. 

Mr. LINDER. Thank you. Mr. Esposito, I just can’t—this is not 

on the subject of our hearing, but I can’t resist asking you, from 

Goldman Sachs. 

When the face value of credit default swaps exceeded the total 

economic output of all of this planet’s nations, why didn’t somebody 

say, ‘‘What the hell is going on?’’ 

Mr. ESPOSITO. One thing I would point out is when you read 

about the amount of credit default swaps outstanding, bear in mind 

those are notional amounts. Many investors, many commercial 

banks, many Wall Street marketmakers, have offsetting positions. 

So, while that headline number is obviously enormous—— 

Mr. LINDER. $62 trillion. 

Mr. ESPOSITO. Absolutely. If we were to net out the actual economic counterparty exposures, it would be significantly less than 

the number you just referenced. 

Mr. LINDER. How is that hedging working so far? 

Mr. ESPOSITO. I think it depends on each instance. There have 

been places where credit default swaps have been an effective 

hedging tool. And, clearly, there have been other places where it 

has worked far less well. 

Mr. LINDER. Thank you, Mr. Chairman. 

Chairman NEAL. Thank you very much, Mr. Linder. The gentleman from Connecticut, Mr. Larson, is recognized to inquire. 

Mr. LARSON. Thank you, Mr. Chairman, and thank you for 

holding this hearing. I thank the witnesses for their testimony. 

My question is for Mr. Krueger. Both Mr. Culver and Mr. Bornholdt stated in their testimony that the direct payment approach 

employed by the—that class of Build America Bonds has resulted 

in strong demand, and both favor extending the direct pay option 

to other tax credit bonds. 

Could you please discuss Treasury’s thinking on this matter? 

Mr. KRUEGER. Well, the program, as I say in my testimony, is 

only in place for about a month. And while we’re very pleased by 

the initial response, it is premature to say how successful the program will ultimately be. 

The characteristics of the municipal bond market, tax-exempt 

market, tend to be different from the corporate taxable bond market. So, going forward, we need to study the reception of the bonds 

to reach a more informed judgment about the program after it’s set 

to expire. What—— 

Mr. LARSON. What would you guesstimate that to be, in terms 

of time? 

Mr. KRUEGER. How much time do we need? 

Mr. LARSON. Yes. 

Mr. KRUEGER. You know, I don’t think I could put a figure on 

that. I think, as I said, the initial reports that we’re getting, and 

as you heard on this panel, have all been very enthusiastic, and it 

seems to be very successful. But the financial markets are going 


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through a serious evolution right now. And it’s just very difficult 

to give you a precise timetable. 

One thing I would point out, which is also, I think, worth paying 

attention to, is that the way that the Treasury has been computing 

the credit for tax credit bonds has changed. In January 2009, IRS 

implemented a new approach, which changed the tax credit bonds 

from being linked to AA corporate bonds to a blend of A, BBB ratings, in order to adjust the rates so that the bonds sell at par, as 

opposed to a discount. So, hopefully going forward, one of the 

issues which Mr. Bornholdt raised would be a less serious concern. 

Mr. LARSON. Now, are you referring to Mr. Bornholdt’s notion 

that with—the demand in liquidity in this market could be increased if Treasury were to rule that underlying tax credits may 

be sold separately from a principal component of the bonds? 

Mr. KRUEGER. Well, my comment was just on how the tax credits were established, and how the rates were—— 

Mr. LARSON. Well, would you agree with that? Would that 

work? 

Mr. KRUEGER. I agree that allowing investors to strip the credits would broaden the market for the bonds. 

Mr. LARSON. So, what can we determine will Treasury have for 

rulemaking with respect to that, with this notion? And—— 

Mr. KRUEGER. Treasury has been working, together with IRS, 

to develop accounting rules and tax compliance rules to permit the 

stripping of the credits. And that is something that is a priority 

within the Department. 

Mr. LARSON. How long a timeframe on that, do you think? 

Mr. KRUEGER. I would—you know, if I were forced to give 

you—as an economist, I try not to answer questions about timeframe. But if I were forced to, I would probably say within the next 

few months. 

Mr. LARSON. Well, as legislators, you can understand why—— 

Mr. KRUEGER. Yes. 

Mr. LARSON [continuing]. With the economy being where it is, 

we are interested in time. And that is why it is always distressing 

when everything seems open-ended, and we go back to our districts 

and people are looking for—just a—thank you—a followup with Mr. 

Esposito on Mr. Linder’s question, as well. 

With regard to credit default swaps and derivatives, et cetera, 

the 60 Minutes piece that was out there, et cetera, some have 

noted with great interest that maybe those numbers are true and 

maybe they’re not. How do we ascertain those numbers? 

And would taxing those things be of interest, in terms of revenue, or a way of limiting the positions that are taken? 

Mr. ESPOSITO. Well, we at Goldman Sachs are supportive of 

some of the initiatives to establish a clearinghouse by which credit 

default swaps will be settled, and it will be a very simple mechanism by which we can reduce the counterparty exposure between 

those that are engaging in trading of CDS, and legitimate hedging 

activities. 

In regards to your point about taxing the trading of CDS, clearly 

any form of taxation will limit and reduce the activity. And I think 

it would just be a decision by Congress as to whether or not that 

is in the best interest of the marketplace. There are plenty of 


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counterparties that require legitimate use of CDS for hedging and 

other purposes. And any form of a taxation will clearly limit the 

trading activity of those securities. 

Mr. LARSON. How do you distinguish between those that are 

regulated, and those that have no regulation? 

And is this—what would you put on a number? If it’s not the 40 

to 60 trillion that Mr. Linder talked, where do you think the ballpark is? You said it wasn’t there, but where do you think it is? 

Mr. ESPOSITO. I think it is significantly less, but it is just not 

my—— 

Mr. LARSON. It is significantly less than 30 to 40 trillion. Is it 

20 trillion? 

Mr. ESPOSITO. It is just not my area of expertise at Goldman 

Sachs, so it is difficult for me to give you an estimate on that. 

Mr. LARSON. Who could give me an estimate on that? 

Mr. ESPOSITO. I will work with my colleagues back in New 

York, and see if we can’t come up with a netting number, which 

is, I think, what you’re after, not the notional amount of CDS outstanding, but what we think the real exposure is, and see if we 

can’t come up with that—— 

Mr. LARSON. Thank you, Mr. Esposito, and thank you, Mr. 

Chairman. 

Chairman NEAL. Thank you, Mr. Larson. Perhaps we could get 

an answer in writing from Goldman. If we inquire, they could help 

us with that detail. 

Mr. ESPOSITO. We will do our best to provide that. 

Chairman NEAL. Sure, sure. Mr. Heller, the gentleman from Nevada, is recognized to inquire. 

Mr. HELLER. Thank you very much, Mr. Chairman. And I want 

to thank you for putting this panel of experts together. I have—it 

has been a very interesting hearing. 

I wanted to move back to this chart that you showed recently, 

and I guess if there was a comment to be made on that, I would 

say that it looks pretty volatile, and—going back from September 

of 2008 through this month. 

I guess, with the dislocations and everything that you spoke of 

on this particular chart, I guess my question is, as I look at something like this, I am more concerned about where we’re going to be 

a year from now, or 2 years from now. Is there any work that is 

being done, in trying to anticipate, with our current economic conditions, what that red line is going to look like, as opposed to where 

it is today? 

And the reason that I bring that up is that, you know, I think 

there is going to be an economic recovery. And I think most people 

agree that within—perhaps by the end of the year, first part of 

next year, but they are also talking the impact of inflation and 

higher rates, because of some of the activities in this Congress. 

I would like to know what is going to be the long-term impact 

of this red line by decisions that are made in this Congress, as it 

pertains to unemployment, inflation, and perhaps higher rates—if 

that is a fair question? 

Mr. ESPOSITO. It is a fair question, and I think part of the answer to your question will also depend upon whether or not Congress considers expanding and extending a program like the Build 


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America Bond program. You have successfully addressed the demand side of the equation. You have allowed States and local governments to tap into a much broader and larger pool of liquidity. 

In a world where supply has remained somewhat static, at least 

into 2009, by addressing the demand side of the equation, you have 

helped lower that red line that represents the borrowing cost to 

municipalities. If you consider extending that program, as we look 

out into 2010 and 2011, I think we would be much more optimistic 

that that red line can continue to trend lower, and remain that way 

almost regardless of what the economic backdrop plays out to be. 

That demand side of the equation is incredibly powerful. The investment grade corporate market is deep, and it is liquid. And so, 

if we can consider extending the program, I think you will be much 

more successful, regardless of the economic backdrop, to keep borrowing rates low for States and local governments. 

Mr. HELLER. I don’t know if there is anybody else that wants 

to comment on that. 

But I just wanted to bring up one other question, and that is we 

seem to have an interest in what’s going on in California right now. 

Based on the activities just this week, their inability to balance 

their budget, what impact does that—and, keep in mind, I’m from 

Nevada, so we are right next door—what impact is this lack of— 

the financial crisis in California right now going to have in their 

municipal bond ratings, and perhaps long-term impact, nationally? 

Mr. ESPOSITO. Well, one thing I would say about California, it 

is simply too big not to cause any knock-on effects to the broader 

credit markets, and specifically to the municipal market. 

Mr. HELLER. I would agree. 

Mr. ESPOSITO. And so, that is just something I think Congress 

will need to bear in mind. We are not just talking specifically about 

California. There is no way we can isolate the credit situation in 

California from the broader markets. And we think that is going 

to be a very important consideration as we play forward over the 

coming months. 

Mr. HELLER. Thank you. Any other comments? 

[No response.] 

Mr. HELLER. If not, I will yield back, Mr. Chairman. 

Chairman NEAL. Thank you very much, Mr. Heller. Just a couple of thoughts. 

Certainly the use of referendum questions comes to mind in the 

current crisis in California, and how they have been utilized. At 

the same time, I think that Mr. Esposito touched on a very key 

point. That was the whole idea of stimulus, to address the issue of 

demand. And slowly, but surely, I think that we are making some 

progress on that front. 

As panelists, you were terrific. And I think this is very, very 

helpful. You reminded me of my work with Mr. Houghton on private activity bonds, the AMT holiday, things that a Subcommittee 

can accomplish. I am very pleased with the dialogue today. 

Are there other Members of the panel who would like to ask additional questions? 

[No response.] 

Chairman NEAL. If not, I want to thank you for your good time 

and good work today. We will, perhaps, have some followup quesVerDate Nov 24 2008 07:21 Mar 29, 2011 Jkt 062996 PO 00000 Frm 00070 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\62996.XXX APPS06 PsN: 62996

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tions. And you will hear from Members, and we hope that you will 

respond promptly. 

And, if there are no further comments, the hearing stands adjourned. 

[Whereupon, at 11:22 a.m., the Subcommittee was adjourned.] 

[Submissions for the Record follow:] 

Statement of Cadmus Hicks, Nuveen Investments 

Over the years, some have argued that tax-exemption is an inefficient way for the 

Federal Government to help State and local governments lower their borrowing 

costs, because tax-exempt bonds may be held by people in the highest tax brackets, 

even though they are priced to produce the same after-tax returns as taxable bonds 

held by investors in lower tax brackets. For example, during 2006 and 2007 (before 

turmoil in the credit markets caused Treasury yields to plummet as investors became extremely averse to risk), the average yield of 10-year, triple-A rated, tax-exempt general obligation bonds was 81% of the average yield of 10-year Treasury 

notes, which implies that an investor with a marginal tax rate of 19% would have 

the same after-tax return from either security (based on the Thomson Reuters, Municipal Market Data scale, ignoring differences in credit quality, call provisions, 

etc.). However, if the investor were in the 35% tax bracket, the tax-exempt bond 

would produce a much higher after-tax return than the Treasury note. If a Treasury 

note yielded 5.00% before tax, its net yield after paying taxes at a 35% rate would 

be only 3.25%, which is well below the 4.05% yield of a tax-exempt bond that yielded 

81% of the Treasury yield. 

To the extent that tax-exempt bonds are held by investors in the highest tax 

brackets, it would appear that the reduction in State and local borrowing costs made 

possible by tax-exemption is less than the loss of tax revenue to the U.S. Treasury. 

By this reasoning, in our earlier example, the Federal Government’s tax revenues are reduced by an amount equal to 35% of the interest that would be paid on 

a taxable bond, but the municipal issuer’s costs are only 19% lower than they would 

be if the bond were taxable. This lost Federal tax revenue is viewed by some as a 

‘‘subsidy’’ from the Federal Government to municipal issuers. However, this paper 

argues that such reasoning fails to allow for the fact that taxable municipal bonds 

may be purchased for tax-deferred and other accounts that have lower effective tax 

rates. Consequently, the amount of tax revenue that the Federal Government 

forgoes due to tax-exemption is considerably lower than it would be if the only alternative to buying a tax-exempt bond was to purchase a bond whose interest is 

fully taxable in the year it is received. This paper also shows that the relative pricing of tax-exempt bonds reasonably reflects the benefit of tax-deferral on taxable 

bonds. 

The issuance of taxable Build America Bonds (BABs) illustrates the dynamics at 

work in the relative pricing of tax-exempt securities. On Wednesday, April 22, the 

State of California sold $3 billion of BABs, maturing in 2039 with a yield of 7.40%, 

which was approximately 3.60% above the yield on 30-year Treasury securities. Because the State chose to retain the tax credit rather than pass it on to investors, 

the State will receive payments from the U.S. Treasury equal to 35% of each interest payment, which lowers the State’s net cost from 7.40% to 4.81% (7.40% × (1 ¥ 

0.35) = 4.81%). This effective interest rate was well below the yield of 5.47% that 

the State’s outstanding tax-exempt, 30-year bonds were offering at the time of the 

sale. The after-tax return of the BAB and the tax-exempt bond would be the same 

if someone had a 26% marginal tax rate (1 ¥ (5.47 / 7.40) = 0.261), which means 

that tax-exemption reduces that State’s interest cost by 26%. (Unlike the State’s 

BABs, the tax-exempt bonds are subject to optional redemption at par in 10 years. 

Without that call provision, the yield would have been 0.10% to 0.15% lower.) 

This discrepancy between tax-exempt yields and the net borrowing costs of BABs 

raises several questions. Is the State’s tax-exempt borrowing rate higher than it 

should be? Is the Federal Government giving up more in potential tax revenue than 

the municipal issuers are saving through tax-exemption? Is the amount of tax revenue the Federal Government will collect on taxable BABs at least as great as the 

amount of the payments it will make to the issuers of BABs? For tax receipts to 

equal payments to issuers, all BABs would need to be held by investors in the 35% 

tax bracket, which is clearly not the case, since many of the BABs have been sold 

to pension plans and foreign investors. This implies that the amount of tax revenue 

that would be lost if the bonds were tax-exempt will not be as great as the cost of 

the tax credits paid to issuers. 


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Tax-exemption is efficient if the savings enjoyed by municipal issuers are at least 

equal to the amount of tax revenue the Federal Government would receive if the 

bonds were taxable. In such an analysis, the tax generated by BABs is a measure 

of how much Federal revenue would be lost if the bonds were tax-exempt. Thus, the 

reason why net borrowing costs are lower on BABs than on tax-exempt bonds is 

likely to be because the U.S. Treasury has agreed to pay more to issuers than it 

will collect in tax revenue. To the extent that taxable municipal bonds are held by 

investors with effective tax rates of less than 35%, tax-exemption is a more efficient 

way of supporting State and local issuers than might appear at first glance. In the 

case of the California bonds discussed earlier, the effective tax rate on its BABs 

must be at least 26% in order for Federal tax revenue from BABs to exceed what 

the State would save if it sold tax-exempt bonds instead. 

The Ratio Curve 

From the time when BABs were first proposed, market participants recognized 

that issuers would enjoy the greatest cost savings on bonds with the longest maturities, because tax-exempt bonds with longer maturities tend to have yields that are 

higher as a percentage of taxable yields than do shorter maturities. The question 

is whether the upward slope of the ‘‘ratio curve’’ implies that tax-exemption is less 

efficient for longer maturities. Various factors have been cited to explain the upward 

slope of the ratio curve: 

(1) Compared to most taxable debt, municipal issues tend to be structured with 

multiple serial and term bonds, which are more heavily weighted toward the 

long end in order to produce level debt service (with principal payments increasing and interest payments declining over time). The added supply of long bonds 

causes their yields to rise relative to taxable bonds. 

(2) Investors want to be compensated for the possibility that tax policy could change 

over time in a way that makes tax-exempt bonds less attractive. 

(3) Yield quotes on municipal bonds generally are based on bonds that can be redeemed, or ‘‘called,’’ at the option of the issuer many years before their stated 

maturity date. In exchange for this option, issuers pay higher interest rates 

than they would on noncallable bonds, which are more common in taxable markets. 

(4) Relative to Treasuries, municipals have more credit risk, and the longer the maturity, the more time in which negative developments could occur. 

The Benefits of Tax-Deferral 

Another factor that may affect the tax-exempt/taxable ratio curve is the fact that 

tax-exempt bonds do not just compete with fully taxable securities, but also with 

what might be termed ‘‘tax-deferred investments,’’ i.e. bonds held in vehicles where 

the income is not immediately taxed in the year it is earned. Furthermore, since 

the benefit of tax-deferral increases with longer time horizons, and since tax-deferred vehicles are typically used to fund long-term liabilities (such as pension obligations and individual retirement plans), one would expect bonds with longer maturities to be favored for such vehicles. 

The longer a security is held on a tax-deferred basis, the lower the effective tax 

rate on that security. For example, suppose that someone places into an Individual 

Retirement Account a taxable bond that cost $100,000, matures in 30 years, and 

yields 7%. Suppose further that the investor expects to be in the 35% tax bracket 

when he or she withdraws bond principal and accumulated interest from the account. If interest on the bond were reinvested at 7% and allowed to accumulate taxdeferred, at the end of 30 years that investment would be worth $761,226, of which 

$100,000 was the original principal and $661,226 was the amount of interest 

earned. Tax on the interest earnings would be: 

$231,429 (0.35 × $661,226 = $231,429). 

The ending value of the investment after the payment of taxes would be $529,797, 

which represents an annual rate of return of: 

5.72% ((529,797 / 100,000) ∧ (1/30) = 1.0572). 

This return of 5.72% is 81.6% of the 7.00% pretax return, which implies an effective tax rate of 18.4%. The following table shows the calculation of the implied effective tax rate for bonds held on a tax-deferred basis for different periods of time. 


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After-Tax Rate of Return and Implied Tax Rate on a Tax-Deferred 

Investment of $100,000 Yielding 7% With Earnings Reinvested 

Number of 

Years 

Ending 

Value 

Tax 

Liability 

AfterTax 

Value 

AfterTax 

Rate 

AfterTax 

Ratio 

Implied 

Tax 

Rate 

1 107,000 2,450 104,550 4.55% 65.0% 35.0% 

2 114,490 5,072 109,419 4.60% 65.8% 34.2% 

5 140,255 14,089 126,166 4.76% 68.0% 32.0% 

10 196,715 33,850 162,865 5.00% 71.4% 28.6% 

15 275,903 61,566 214,337 5.21% 74.5% 25.5% 

20 386,968 100,439 286,529 5.40% 77.2% 22.8% 

25 542,743 154,960 387,783 5.57% 79.6% 20.4% 

30 761,226 231,429 529,797 5.72% 81.6% 18.4% 

Past performance is no guarantee of future results. This hypothetical example has 

been provided for illustration only. Other methods may produce different results, 

and the results for individual portfolios may vary depending on market conditions. 

The table demonstrates that the longer the maturity, the greater the potential 

benefit to the investor from deferring taxes on the security, and, therefore, the 

greater the potential present value loss of tax revenue to the U.S. Treasury from 

tax deferral. When estimating how much potential revenue the Treasury loses when 

municipalities sell tax-exempt bonds, one should deduct the amount of revenue that 

could be lost if the municipalities sold taxable bonds that were bought held in taxdeferred accounts. 

Tax-Deferral and the Ratio of Tax-Exempt to Taxable Yields 

As it happens, the ratios of after-tax to pretax returns on investments held in a 

tax-deferred account for various lengths of time resemble the ratio curve of tax-exempt to Treasury yields. The following table shows the average ratio of municipal 

to Treasury yields during 2006 and 2007, and compares those ratios to the aftertax ratios from the preceding table. 

Years to 

Maturity 

Muni/ 

Treasury 

AfterTax 

Ratio 

2 77% 66% 

10 81% 71% 

30 88% 82% 

Sources: Federal Reserve Board constant maturity Treasury series, Thomson Reuters Municipal 

Market Data. 

While the ratio of municipal to Treasury yields is generally higher than the aftertax ratio (owing to differences in credit quality, call provisions, liquidity, etc.), the 

differences between the ratios for different maturities are comparable. For example, 

the 10-year municipal/Treasury ratio is four percentage points higher than the 2- 

year ratio, while the 10-year after-tax ratio is five points higher than the 2-year 

after-tax ratio. 

The effect of tax-deferral on the relative yields of tax-exempt bonds has important 

implications for tax policy. Congress has estimated that the BAB provision will cost 

the Federal Government $4.35 billion over 10 years. Given the fact that over $7.5 

billion of BABs were issued in just the last 2 weeks of April, and that most of these 

issues had maturities as long as 30 years, the Federal Government may find that 

the cost of making direct payments to issuers is considerably higher than the ‘‘subVerDate Nov 24 2008 07:21 Mar 29, 2011 Jkt 062996 PO 00000 Frm 00073 Fmt 6633 Sfmt 6621 I:\WAYS\OUT\62996.XXX APPS06 PsN: 62996

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sidy’’ produced by tax-exemption. If the Treasury Department and Congress were 

to compare the costs of payments made under the BABs program with the Federal 

tax revenue derived from such bonds, we would not be surprised if they concluded 

that taxable bonds with tax credits are not really any more efficient than tax-exemption as a means of lowering the borrowing costs of State and local governments, 

and may even be more costly in the long run. 

Cadmus Hicks, 

f 

Nuveen Investments 

Statement of Dean A. Spina 

I propose that Congress eliminate the current penalty on religious organizations 

that results from application of the Federal tax-exempt bond laws. Religious organizations, from churches to religious colleges and schools, are denied the low rates of 

interest available through tax-exempt bond financing. This is because tax-exemption 

is derived from the issuance of bonds by a State or local issuer and the loan of bond 

proceeds to the borrower. 

The First Amendment is an obstacle to the use of tax-exempt bond financing for 

religious organizations. As a result, religious organizations, and some related organizations such as schools, are denied tax-exempt bond financing that is available 

under Internal Revenue Code Section 145 to all other 501(c)(3) organizations. 

A direct exemption of religious organization debt would not violate the Constitution. A direct tax exemption is different than the use of the State or local governmental power to issue debt and loan the proceeds to a religious organization. 

Amending the Internal Revenue Code to exempt interest on debt incurred by a 

religious organization (to the same extent it would be so recognized for debt issued 

by a State or local unit of government for a 501(c)(3) organization under IRC Section 

145) would remove the penalty on religious organizations without the necessity of 

the involvement of any unit of State or local government. 

Following this statement is a draft of legislation to enable a religious organization 

to elect to be covered by certain tax-exempt bond provisions and thus have tax-exempt debt and substantially lower interest cost. Borrowing $1,000,000 for 20 years 

at a taxable interest rate of 8.5% requires payment of $370,000 more interest than 

the same loan at a tax-exempt rate of 5.95%. 

This proposal will benefit tax revenues. Tax revenues should be increased if lower 

borrowing costs enable religious entities to proceed with projects that might not otherwise be undertaken. More construction generates a demand for goods and services, 

and creates more taxable income. Moreover, Federal and State tax revenues could 

be positively impacted by lower borrowing costs. If religious organizations need 

smaller charitable contributions to finance a project, charitable tax deductions 

should be smaller. Most church financing is ultimately paid for by deductible charitable contributions. 

I am an attorney and I am active in the use of tax exempt bonds for 501(c)(3) 

organizations. This proposal is not made on behalf of any client. This proposal is 

driven by the belief that Congress should act to rectify the current tax-exempt bond 

laws to enable religious organizations to enjoy the same rates of interest enjoyed 

by all other 501(c)(3) organizations. 

Thank you. 

Dean A. Spina 

DRAFT LEGISLATION—TITLE 26—INTERNAL REVENUE CODE 

PART IV–TAX EXEMPTION REQUIREMENTS FOR STATE AND LOCAL BONDS 

Subpart A—Private Activity Bonds 

Sec. 145. Qualified 501(c)(3) bond 

Add to Section 145 of the Internal Revenue Code the following: 

(f) Election by religious organization 

This section shall apply to a religious organization obligation if— 

the religious organization elects to have this section apply to such obligation, and 

the religious organization reports the election in such form as the Secretary may 

require. 


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1 Bond maturity. 

2Prohibited uses. 

3Limit on costs of issuance from obligation proceeds. 

4 501(c)(3) bonds are exempt from certain limitations. 

5 Arbitrage. 

6 Reporting requirement. 

7 Change of use. 

8 Educational organizations affiliated with a religion have been able to use tax-exempt bond 

financing. This provision would overcome concerns about entanglement. 9 Acquisition includes an existing facility without a requirement of rehabilitation. 

10For example, religious worship and education. 11Food pantries, clothing and household distribution, shelters and education and training for 

the poor and distressed. 12This would allow a separate organization to be formed to operate a preschool program or 

summer program for disadvantaged youth and use the facility. 13 Avoids tax-exempt debt being used to build ‘‘Sunday school’’ classes that are used throughout the week for non-affiliated daycares or preschools, some of which may be for profit entities. 14 Church extension funds oftentimes borrow from church members to fund loans to churches 

within the denomination. 

For purposes of this subsection, the following shall apply to the religious organization obligation: Subsection 147(b),1 Subsection 147(e),2 Paragraph (1) of Subsection 

147(g),3 Paragraphs 2 and 3 of Subsection 147(h)(2),4 Section 148,5 Subsection 

149(e) 6 and Subsections (b) and (c) of Section 150 7 and in applying the foregoing, 

the religious organization shall be deemed to be an issuer. 

For purposes of this subsection a ‘‘religious organization’’ means a 501(c)(3) organization which is exempt from tax under section 501(a) as a religious or religious 

education 8 organization and a ‘‘religious organization obligation’’ is any debt obligation of a religious organization incurred by the religious organization on or after the 

date of enactment of this subsection and prior to January 1, 2019, for 

—the religious organization’s financing or refinancing of the acquisition,9 con- struction, reconstruction, or renovation of a facility to serve the needs of its 

members 10 for appropriate objects of the religious organization and to serve the 

community (including providing services such as preschools, daycare and assistance 11 to the needy through the religious organization or an organization controlled by or affiliated 12 with the religious organization, provided such use of 

the facility does not result in an organization having income subject to tax 13

under this Subtitle A) or 

—to make one or more loans to an affiliated religious organization for such a facility.14

The religious organization that makes the election under this subsection with respect to its obligations for a facility (but not for an obligation to fund loans to affiliated organizations) shall be a qualified small issuer for purposes of subclause I of 

Section 265(b)(3)(B)(i), provided that in any calendar year the religious organization 

designates no more than the amount that may be designated under subparagraph 

(C) of Section 265(b)(3) and the designation is reported by the religious organization 

in the manner required by the Secretary. 

f 

Statement of Peter B. Coffin, Breckinridge Capital Advisors, Inc. 

Breckinridge Capital Advisors, Inc. strongly supports the new Build America 

Bond program, but we are concerned that institutional investors are unlikely to 

make a meaningful long-term allocation to these issues if the program expires on 

December 31, 2010. We firmly believe that to ensure the continued success of the 

Build America Bond program, its term must be extended. The sooner this extension 

takes place, the sooner Build America Bonds will be established as a credible asset 

class for institutional investors. 

A Registered Investment Advisor, Breckinridge Capital Advisors manages over $9 

billion in municipal bond portfolios on behalf of institutions and high-net-worth individuals. We believe the Build America Bond program provides much-needed depth 

to the municipal market by broadening demand beyond the traditional buyers of 

tax-free bonds. This has already significantly lowered municipal borrowing costs 

while improving secondary market liquidity. 

To date, Build America Bonds have been attractively priced as new issues, and 

are performing well in the secondary market. As such, they have been a good 

‘‘trade’’ for investors and the appetite for the bonds has been solid, reflecting positive momentum from early success. However, sustainable demand cannot be based 


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on short-term profits. Eventually, Build America Bonds need to be recognized as an 

important core allocation in an institutional fixed income portfolio. 

Institutional investors prize the safety, reliability and the relatively long duration 

of Build America Bonds. This is especially true after the recent difficulties in other 

sectors of the fixed-income markets. Moreover, many public pension funds and charitable endowments will welcome the opportunity to invest in communities through 

Build America Bonds, but only if the current expiration date of December 2010 is 

extended. 

The Federal Government has long seen value in subsidizing State and local government borrowing. Today we understand that the traditional form of that subsidy—exempting municipal interest from taxes—is not always completely effective 

in reducing a municipality’s borrowing costs and maintaining its access to capital. 

The Build America Bond program introduces a new form of subsidy that has had 

early success in broadening municipal demand thus, improving the overall effectiveness of the Federal subsidy. Breckinridge believes an extension of the Build America 

Bond program will ensure even greater and more sustainable success for the future. 

f 

Statement of Seamus O’Neill, Liscarnan Solutions 

Mr. Chairman, Members of the Subcommittee—Good morning, I am Seamus 

O’Neill of Liscarnan Solutions, LLC based in McLean, Virginia. I have more than 

28 years experience as an investment banker and financial advisor. For the past 20 

years, I have been a financial advisor and project consultant to the student loan industry, including the nonprofit lenders in California, Ohio and Montana, who have 

a combined debt outstanding of approximately $4.5 billion. 

While this hearing is aimed at addressing issues facing government issuers of 

both tax-exempt and taxable debt, I would like to discuss very similar issues concerning nonprofit and State agency student loan issuers. 

Nonprofit and State agency student loan providers, who combined have more than 

$30 billion of outstanding taxable and tax-exempt debt financings, are facing two 

significant issues caused by the financial markets meltdown. The first issue concerns their outstanding tax-exempt financings, which have been damaged by the financial crisis, and what needs to be done to make these financings marketable. The 

other issue concerns the ability of nonprofit and State agency issuers to access financing for new student loans. 

Unmarketable Outstanding Financings 

In February 2008, the financial markets meltdown impacted the tax-exempt student loan sector. This meltdown has produced two results—(1) it has destroyed 

much of the balance sheet value of the student loan non-profits and State agencies 

due to the failed financing structures; and (2) it has prevented such issuers from 

refinancing these failed bond issues because their access to the tax-exempt bond 

market has been cut off. 

When the variable rate market for student loan notes froze, billions of dollars of 

tax-exempt variable rate student loan financings became unmarketable. Investors, 

including pension funds, institutional investors and individuals, were no longer willing to buy or sell student loan securities. In addition, the interest rate on these 

financings went to a maximum rate, meaning that these financings have been paying the maximum rate of interest allowable under their financing documents—a rate 

that was never contemplated for the life of the bonds and is unsustainable in the 

long-term. 

One of the important reasons for our inability to restructure failed tax-exempt 

financings is the lack of variable interest rate financing in the tax-exempt bond 

market. The tax-exempt student loan bond market is primarily a fixed interest rate 

market, while our Federal student loan assets earn floating interest rates. Thus, we 

have a mismatch between the interest earned and interest expense. This mismatch 

was solved in the past by creating tax-exempt variable interest bonds synthetically, 

either by using a bank liquidity facility or an auction mechanism. However, in today’s dysfunctional financial markets, these options are no longer available, meaning that the rates cannot be matched. As a result, tax-exempt financings for Federal 

student loans are unmarketable and the frozen financings cannot be restructured. 

Fortunately, there are solutions. Tax-exempt student loan bonds have already 

been temporarily relieved of the Alternative Minimum Tax. Unfortunately, this benefit does not solve the mismatch between interest earned on loans and interest expense on bonds. Our proposed solution is to expand the availability of the Taxable 

Bond Option to student loans. We believe that our solution should produce a neutral 


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budget score given that we are substituting Taxable Bond Option bonds for existing 

tax-exempt bond authorization. 

Expansion of Build America Bonds 

The subject of this hearing involves the ‘‘Build America Bond’’ included in the 

American Recovery and Reinvestment Act. The ‘‘Build America Bond’’ is essentially 

an idea referred to as the ‘‘taxable bond option.’’ The ARRA allowed for the use of 

this bond by State and local governments to help these governments restructure existing debt, as well as issue new debt. As student loan debt is facing many of the 

same problems as State and local government debt, it would be consistent to extend 

the ability to issue these bonds to tax-exempt student loan issuers. 

By extending this bond, issuers of tax-exempt student loan bonds would be permitted to issue taxable bonds and then receive a rebate of 35 percent of the interest 

they pay to investors. This credit would have the effect of reducing the taxable bond 

interest rate down to a tax-exempt rate while permitting the issuer to access the 

taxable market. The issuance of these taxable bonds would be subject to all Federal 

and State limitations currently affecting the issuance of tax-exempt bonds. 

The taxable bond market is much more accommodating to the issuance of variable 

interest rate bonds; thus, permitting issuers of student loan bonds to better match 

the interest rates on their loans and liabilities. Access to these bonds will remarkably improve the potential for restructuring the damaged balance sheets of student 

loan non-profits and State agencies. In the end, the marketability of these bonds 

would be restored and billions of dollars of frozen financings could be restructured 

saving hundreds of millions of dollars for the benefit of students and their families. 

Access to New Financing for Loans 

This hearing is concerned with the taxable bond option but there are other issues 

that can be addressed in this area that would greatly impact the availability of 

funds from tax-exempt financings for the benefit of schools and students. 

While the taxable bond option would greatly help tax-exempt issuers in restructuring existing financings, steps can be taken to permit tax-exempt issuers to utilize 

the tax-exempt market for new loans, most notably in the area of private loans. 

Even with the increase in Pell Grants and Federal loan limits, there is still a 

great need for private loans, i.e. those loans not guaranteed by the Federal Government. Historically, these loans have been provided by banks, for-profit lenders and 

some State agencies. However, lenders have pulled back in offering these loans. The 

remaining loans are costly for students to borrow. The only bright spot for students 

is in the 13 States that have a private loan product offered by a State agency. 

In addition, other sources of college funding are scaling back. Parents are less 

likely to be able to tap their diminished home equity; 529 education savings plans 

have taken significant investment losses; college endowments have been similarly 

damaged; institutional aid has become strained; and State government resources 

and tax revenues are in decline. 

Students are finding it harder to come up with the resources necessary to fund 

the gap in their education expenses (i.e. the gap between what they can get from 

the Federal Government and what they owe their college). 

Nonprofit lenders would like to help fill this gap by providing low-cost private 

loans. However, nonprofit lenders have been unable to utilize its tax-exempt financing for these loans because of the restrictions of Section 150(d) of the Internal Revenue Code. 

Students would be greatly served if nonprofit lenders had access to tax-exempt 

financing for private loans. As such, the restrictions in 150(d) should be modified 

to permit nonprofit tax-exempt issuers to utilize its tax-exempt financing for private 

student loans. In making these loans, the nonprofit issuers would work in partnership with their respective States to ensure that these loans are providing a benefit 

to the State’s students. The nonprofit status of the lender and the tax-exempt nature of the financings would result in a reasonable, fair, affordable and low-cost private loan to help students fill the gap in their college financing. 

Other Changes to 150(d) 

Section 150(d) should also be reformed to more easily permit nonprofit, tax-exempt issuers to better serve its State’s students and schools by permitting it to directly engage in origination and servicing activities, as well as other charitable activities. Current 150(d) organizations set up an affiliate or similar entity to handle 

these activities, leaving the 150(d) entity to issue debt, and acquire and hold Federal loans. This wall was created in a different time and for a Federal student loan 

program that has been greatly transformed. There is really no good reason for the 

wall to exist in the student loan program of 2009. 


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By removing this wall and allowing one entity to serve as the issuer, originator, 

servicer, and charitable organization, nonprofits can better serve students and 

schools in the same way that State agencies do. There is a need for this change even 

if the Federal Government transitions to the financing of 100% of the Federal loans 

directly from Federal financing. This change would help nonprofits meet the needs 

associated with the financing and servicing of loans already made, the potential 

servicing of loans going forward, and the resources needed for charitable activities; 

in addition to the efforts of nonprofits to meet the private loan demands of students 

and schools. 

Conclusion 

The above three reforms would go a long way in repairing the balance sheets of 

nonprofit lenders, freeing up capital and other resources for student loans and related activities for the benefit of students and their families, at little if any cost to 

the Federal Government. They are commonsense changes to the Internal Revenue 

Code to meet today’s needs. 

Thank you for this opportunity to submit this testimony. 

Seamus O’Neill, 

Liscarnan Solutions, LLC 

7424 Eldorado St., McLean, Virginia 22102 

Æ 


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