The fast-coming fiscal cliff threatens federal subsidies to local Build America Bonds, enacted through the stimulus package.  Through the program, the federal government promised to pay 35% interest on the bonds.  As reported in Bloomberg News,

Localities nationwide sold $188 billion of Build Americas before the program expired at the end of 2010. The issuers [now] face potential subsidy cuts from automatic reductions in federal spending set to take effect in 2013. Payments to states and municipalities for the debt would drop by $255 million, or 7.6 percent, next year, the Office of Management and Budget said Sept. 14.

According to Bloomberg, investors have the option to sell some Build America Bonds back to local governments, which is what they might do if Congress does not act.

About two-thirds of Build Americas have call provisions allowing local governments to buy back the securities, according to data compiled by Bloomberg.

Such provisions often allowed borrowers to repurchase the bonds at a price below so-called make-whole calls, under which investors receive a premium, in cases where the subsidy is cut, according to the National Association of Bond Lawyers.

Investors may sell bonds that can be called at face value if it becomes clearer that Congress will be unable to reach a deal, said Matthew Buscone, a muni bond manager in Boston with Breckinridge Capital Advisors, which oversees about $17 billion.

Maryland counties holding Build America Bonds would see an immediate cut of subsidies in 2013 if the federal government does not preserve their interest payments.

For more information about the impact of the sequestration on the Build America Bonds, see the National Association of Bond Lawyer’s report, Effect of Sequester on Direct-Pay Bonds and the Internal Revenue Service’s, Effect of Sequestration on Certain State & Local Government Filers of Form 8038-CP.