The Recovery Act contained a provision authorizing the issuance of up to $15 Billion in Recovery Zone Facility Bonds. The authorization was divided among the States and within each State among cities with a population of over 100,000 and all counties within the State. For example, entities within Illinois received a total allocation of over $1 Billion, and entities within Indiana received a total allocation of over $469 Million. The amount of each entity's allocation was based on the relative increase in unemployment between December, 2007 and December, 2008.

 

Recovery Zone Facility Bonds allow private entities to obtain the benefit of tax exempt interest rates usually only available to local governmental units to reduce the cost of borrowing. A local governmental unit issues the tax exempt bonds, loans the proceeds to a private company, and the private company repays the bonds. This program was intended to encourage private entities to expand their businesses and increase employment opportunities in areas of the country hit the hardest by the recession. The authorization expires at the end of 2011, and there are no carry over provisions for unused allocation.

 

For the first six months or so after the Recovery Act was passed and the volume allocation was made by the IRS, we spent most of our time explaining to private companies and local governmental units that this program did not consist of federal grants to private entities. There was no "stimulus money". Nor did the federal government or the local governmental units serve as guarantors on the bonds. The bonds were intended to be purely and simply loans to private entities at lower, tax exempt rates.

 

Although many private entities have sought an allocation of the Recovery Zone Facility Bonds for their projects, a relatively small number of deals representing a small percentage of the total allocation have been done across the nation (less than $1 Billion of the $15 Billion has been issued with only 5 months remaining in the program). Why so little activity? The reason is simple. For these types of bonds to be marketable, one of two situations must exist. Either the private company must be an established entity with a proven financial track record or a bank with an acceptable credit rating must be willing to fund the loan to the private entity. The bank funds the loan indirectly by providing a letter of credit as security for the bonds. If the private company defaults on a payment, the bank pays the bondholders and steps into the bondholders' shoes as the new bondholder. Banks are not direct investors in the bonds because banks do not get the full benefit of tax exempt interest.

 

Banks were major players in causing the financial crisis that has triggered the recession by being too lenient in their lending practices. They did not absorb the losses that would have normally resulted from bad lending policies because they either dumped the bad loans (especially home mortgages) on other entities and funds or the federal government as part of the TARP (aka bad loans) buyout. They have compounded the recession by becoming overly conservative in their lending practices now. As a result, start up ventures are not able to obtain letters of credit from banks to support the bonds unless one of their members, partners, stockholders, etc. has very deep pockets.

 

We have been working on a number of potential projects for which Recovery Zone Facility Bonds would facilitate the commencement of the construction project that would generate hundreds of construction jobs and ultimately hundreds of permanent jobs. In most of these projects, the private company owns the land and may even own a shell of a building and have up to 30% equity for the project. However, because they are not operating yet and have no financial track record, banks will not participate in the financing. Regardless of the strength of the business plan or the feasibility study, financing cannot be obtained.

 

If I were King, I would extend the Recovery Zone Facility Bond program for 2012 and 2013, even if only to use the original allocation provided by Congress in the Recovery Act. However, I would modify the program in two ways to make it more useful:

 

1.       Include a federal government guarantee of a portion of the bonds.

2.      Allow banks to treat the interest as fully tax exempt.

 

Federal government guarantee: I would suggest that the federal government guarantee up to 50% of the debt if a bank provides a letter of credit for the entire debt. In that manner, a bank would be on the hook for 50% of the loan and the federal government would be on the hook for 50% of the loan. The liability would be prorated so that both are on the hook dollar for dollar to give the bank an incentive to make good loan decisions but without putting the federal government (and you and me) on the line for the first 50%. Unlike an SBA loan or USDA loan, I would not establish or authorize a federal department to approve the loans. I would require the bank to take the lead on approving the loan so we do not have the inordinate delay that normally accompanies working with the federal government--on anything. With federal participation in the guarantee, banks would only be exposed for 50% of the loan which should encourage them to participate in this job creating activity. If the private company has 10% or 20% equity, the exposure of the bank (and the federal government) is even further reduced. Maybe this would help open up those tight bank wallets that were filled with dollars from the federal government in 2009.

 

Bank qualification:  I would make the interest on the bonds tax exempt to banks. In other words, I would make them bank qualified like their predecessors (industrial development bonds) were prior to the 1984 and 1986 tax acts. If they are attractive to banks, maybe banks would buy the bonds directly thereby reducing the paperwork and costs (wait a minute, my fee too?) of the transaction. Anything that lowers the cost of financing will encourage companies to undertake projects that result in jobs. Jobs will come from private industry, not the government. We need to do something to cause those jobs to be created.

 

The Recovery Zone Facility Bond program is on the books and has not been utilized to any significant extent. Let's modify it to make it attractive and effective. Your thoughts?