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An exceptionally alarming bit of highly obfuscated news (as you'll see once you read Naked Capitalism Publisher Yves Smith's post, farther down, below) about the Bush tax-cut extension story is, just now, starting to go viral in the blogosphere. Romy Varghese and Kelly Nolan over at the WSJ blog posted a piece about some of it on Tuesday afternoon, and Reuters' James Pethokoukis elaborated upon the hidden implications of it, a few hours later.

(And, before anyone says anything in the comments, I know that states cannot formally "go bankrupt." That's why there are quotes around the word in the headline.)

Here's Varghese and Nolan at the WSJ blog (h/t to Zero Hedge):

Extension of the Build America Bonds program isn't included in a wide-ranging tax agreement between President Barack Obama and Republican congressional leaders, Senate aides said.

The Build America Bonds program provides federal subsidies for taxable bonds issued by state and local governments. It is set to expire Dec. 31, but won't be part of a broad outline agreement to extend expiring income tax breaks that Mr. Obama announced Monday evening, according to senior Democrat and Republican aides.

It is possible the bond program could be added in subsequent negotiations as the tax package is finalized, but that is unlikely due to Republican opposition.

Build America Bonds came to the market in the spring of 2009, aiming to provide state and local governments with a lower-cost way to finance capital projects. More than $150 billion of the bonds have been issued to help finance projects including upgrades to Alaskan airports and to school, water, sewer and electric facilities across the country.

Here's more background via Zero Hedge, from Douglas Borthwick at Faros Trading...

Faros Special Report On The Severe Consequences Of The "Build America Bond" Program Expiration
Submitted by Tyler Durden on 12/07/2010 18:05 -0500

...Today's tax compromise in the US extended all expiring Bush tax cuts by two years.  The story though does not end here.  The most important thing missing from the tax extension was the expected extension of the Build America Bond program.  The Build America Bond program has been the municipal market's saviour over the past 18 months.  Since their introduction in April 2009 more than 174 Bio USD of taxable securities have been sold by municipalities backed by the program, one where the US pays 35% of the interest due on the debt.


On a day when the market focussed on the Budget vote in Ireland, a country that makes up about 1.8% of Europe's GDP, we are concerned that no one is looking at the growing problems in New York, California and Illinois, three states that comprise 25% of the US GDP.  The expiration of the Build America Bond program could prove to be a terrible price for the US to pay and we expect squabbles in the US Congress regarding the bailing out of States in 2011 that could easily rival that which we have witnessed from the European Union over Ireland and Greece.

Bold type is diarist's emphasis.

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(Diarist's Note: Naked Capitalism Publisher Yves Smith has provided written authorization to diarist to reproduce her blog's posts in their entirety for the benefit of the DKos community.)

Trojan Horse in Tax Compromise: GOP Plan to Bankrupt States, Break Unions (Updated)
Yves Smith
Naked Capitalism
December 7th, 2010   7:01PM

This alert came via James Pethokoukis of Reuters:

Congressional Republicans appear to be quietly but methodically executing a plan that would a) avoid a federal bailout of spendthrift states and b) cripple public employee unions by pushing cash-strapped states such as California and Illinois to declare bankruptcy. This may be the biggest political battle in Washington, my Capitol Hill sources tell me, of 2011.

That's why the most intriguing aspect of President Barack Obama's tax deal with Republicans is what the compromise fails to include -- a provision to continue the Build America Bonds program. BABs now account for more than 20 percent of new debt sold by states and local governments thanks to a federal rebate equal to 35 percent of interest costs on the bonds. The subsidy program ends on Dec. 31. And my Reuters colleagues report that a GOP congressional aide said Republicans "have a very firm line on BABS -- we are not going to allow them to be included."

In short, the lack of a BAB program would make it harder for states to borrow to cover a $140 billion budgetary shortfall next year, as estimated by the Center for Budget and Policy Priorities. The long-term numbers are even scarier. Estimates of states' unfunded liabilities to pay for retiree benefits range from $750 billion to more than $3 trillion.

This report has serious, and apparently unrecognized implications:

1. The cheery observations that state tax receipts and spending are set to increase in 2011 by 5% will be more than undercut by budget brinksmanship in key states

2. This GOP strategy sounds troublingly similar to the famed scene in Blazing Saddles where the new black sheriff, getting a less than welcome reception from townspeople, threatens to shoot himself. The GOP is willing to shoot the economy to precipitate a crisis with the hopes of forcing the most favorable resolution possible to a long-standing desire of theirs. But the collateral damage will be considerable. Uncertainty over the muni bond market will likely extend well beyond particular states (many people invest in munis via funds rather than specific bonds, and if they exit that market, it will damage all sorts of blameless government entities who have the vast misfortune to need to access the market in 2011). And it is also not inconceivable that unions might actually get the balls to strike, shutting down critical services. If a drama of civil unrest takes place, this will damage the markets (and hence the wealthy GOP investor base) and the economy generally.

3. It isn't hard to recognize this move as part of an effort to push America further into banana republic land, with a small and wealthy elite controlling the government and a greatly disproportionate share of the wealth. As we've indicated, those sorts of societies are unhealthy, even for those at the very top, but that does not seem to deter anyone behind this campaign. Notice that the objective here is not to do the responsible thing, which is to figure out the fairest and least destructive way out of the states' budget woes; it's instead to push this festering problem to a crisis to achieve another goal, namely, break unions, with the objective of transferring even more to the rentier class. Now that we've had stagnant average worker wages for over thirty years, government worker pay, which used to lag considerably, now looks not too bad (although various studies have pointed out that government pay is not out of line when you look at job skill requirements; you have more white collar jobs in government than in the private sector. Cherry picking examples of arguably overpaid government sector workers is no different than trying to base private sector tax policy on examples of ostentatiously overpaid private sector workers, like John Thain's driver, who made $230,000 in 2008).

And note that those stagnant average worker wages resulted not from some widespread failing of US workers, as some critics like to allege, but because the benefits of productivity gains, which used to be shared between workers and the companies, now accrue entirely to companies.

Update 3:00 AM: Bruce Krasting, who is not at all left leaning, sees the elimination of the Buy America Bonds Program as a disaster, a black swan in the making:

It wasn't the political muscle that lead me to believe that BABs would be extended. I saw it as a critical component in municipal finance. If it was eliminated I thought we could quickly evolve into a crisis with certain states debt. I was by no means alone in that observation. This comment from the rag for the muni market, The Bond Buyer:

If the Build America Bond program expires at the end of this year, long-term tax-exempt bonds could lose their latest pillar of support.

Parts of me want to be proved right about the significance of this development. I am one of those who thinks there is too much debt creation at the governmental level. Well, it just got more difficult for munis to borrow. By itself, that will curb debt creation.

There is another part of me that is saying "gulp". By definition, you do not see a black swan in advance. I did not see this at all. I don't count, but the market does. If you follow markets you now have to have a screen for muni pricing. As this sorts out over the next 60 to 90 days the muni market might drive the global markets.

I'm thinking to myself, "How could they have blundered on this?" They extend the Bush cuts for everyone. They tack on another 120b of deficit spending with a cut in SS taxes. And they throw in another year of unemployment checks. They threw the sink at the economy at the sake of the deficit. But they failed to pass BABs? Knuckle heads. If there is a hiccup that takes a big state out of the market for a spell it will trump the economic benefits of all the new deficit spending. It might do it a few times over.

End of Naked Capitalism post.
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I'll repeat this sentence from Reuters' Pethokoukis because I think he might be spot-on...

"This may be the biggest political battle in Washington, my Capitol Hill sources tell me, of 2011."

I've also read speculation around the blogosphere (not really worthy of linking, in terms of specificity, but something that is conceptually plausible, nonetheless) that one way to deal with this would be for Bernanke to divert quantitative easing funds to the bond market, which happens to be something I've covered in quite a few posts, but from a myriad of vantage points:

"Are State/Muni Defaults, Mtge Fraud Crises Hitting The Fan?" November 17, 2010

"Mtge. Fraud Cost Escalates As Stiglitz Bashes Bernanke's QE2" October 19, 2010

"Guess who's going to pay the bill for the foreclosure crisis?" October 13, 2010

I've also posted quite a few diaries (and portions of diaries) on rampant Wall Street fraud in the municipal bond market, going back to 2009 and earlier this year. And, I'm reminded of this due to yet another travesty of "justice" that occurred on Tuesday, wherein Bank of America received a wrist-slap for ripping off investors in the municipal securities market: "Bank Of America Sued By SEC For Muni Securities Fraud, Settles For $137 Million."

Yes, it appears we've reached a point in U.S. society where Wall Street fraud is just about as American as apple pie, isn't it?

Originally posted to on Wed Dec 08, 2010 at 02:50 AM PST.

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