Jun 1, 2009 12:00 PM

, By Matthew Brady

Any new variation on municipal financing is an interesting event to investors. And this innovation is going to represent a tidy portion of the bond market

By Matthew Brady

Among the many economic stimulus provisions in the American Reinvestment and Renewal Act of 2009 is a short-term program to expand financing alternatives for state and local governments. The legislation creates a new category of taxable municipal bonds (Build America Bonds or BABs), designed to facilitate financing of state capital expenditures and operations. New issues of BABs, which must be issued before 2011, already are reaching the market, with implications many investors should consider.

Issuers may elect to treat obligations that would otherwise qualify as tax-exempt (except private activity bonds), as BABs. Interest on BABs will be taxable for federal purposes. While this will presumably increase the yield investors demand, the federal government plans to reduce the issuer's financing cost in either of two ways: