What’s Happening with ARRA’s Qualified School Construction Bonds

Last February when the American Recovery and Reinvestment Act was passed, school facilities advocates across the country celebrated what was considered a victory for school construction – $22 billion in federally subsidized bonds for school repair, renovation, and construction over two years. But in the almost year since the law was passed, the Qualified School Construction Bond (QSCB) program has proved to be somewhat less revelatory than expected. Specifically, schools and school districts that were allowed to issue the bonds are having trouble finding buyers for the bonds.

The QSCB program allows school districts to issue $22 billion in bonds for school construction, half in 2009 and half in 2010. Sixty percent of the bonds were allocated to states according to federal Title I formulas while the remaining 40 percent were allocated to the 100 school districts with the largest impoverished populations. Schools and school districts that could issue bonds were determined by a competitive process overseen by each state.

Entities that purchase the bonds receive federal income tax credits in lieu of interest payments on the bonds, ideally making them interest free loans for the schools or school districts that issue the bonds. The bond issuers must repay the principal of the bond but the interest payments are made by the federal government in the form of tax credits to the bond holder.

Reports from around the country suggest that most potential investors are uninterested in buying the Qualified School Construction Bonds because the federal government set the effective interest rate on the bonds too low. In other words, the income tax credits provided by the federal government have not encouraged banks and other investors to buy the bonds. Some newspapers even report that investors are asking schools and districts to provide additional funds to make the bonds more attractive.

The limited market for QSCBs could mean disaster for the hundreds of school districts that have gained voter approval for construction bond measures but are unable to find buyers for the bonds and therefore can’t begin construction or renovations. Additionally, it means that billions of dollars in bonds may go unissued, squandering what could be a one-time opportunity to fix the sorry state of many of the nation’s schools.

However, some school districts have managed to find QSCB buyers. For example, Los Angeles Unified School district sold more than $300 million in bonds to Guggenheim Partners LLC, a private investment firm, in October 2009. In fact, Guggenheim currently owns nearly half of the nearly $2.5 billion in bonds that have been issued, representing a significant share of the market.

Guggenheim has devised a plan that it believes makes the bonds of greater value to investors despite the low interest rates implied by the federal tax credits. The firm hopes to “strip” the tax credit from the bond principal and sell the tax credits or the principal separately to investors. Although Guggenheim claims that tax credit “stripping” makes the bonds more attractive and will benefit schools by boosting demand, Senator Grassley (R-IA) has proposed a bill to prohibit for the practice for QSCBs and other tax-credit bonds because of potential abuse. At the same time, the Department of Treasury, which administers the program, is attempting to write rules regulating tax-credit stripping, which it has previously allowed for Department of Agriculture programs.

Clearly, the Qualified School Construction Bond program has hit up against some major snags with detrimental effects for schools and districts. Hopefully Congress and the Treasury will be able to deal with them before the next round of QSCBs are released.