(Episode 1 – Background and Arbitrage Basics)
Sometimes it is a good exercise to remind ourselves of some basic rules governing tax-exempt bonds. One such rule is that bonds are taxable arbitrage bonds if an “abusive arbitrage device” is used in connection with the bonds. An abusive arbitrage device is any action that has the effect of: (1) enabling the issuer to exploit the difference between tax-exempt and taxable interest rates to obtain a material financial advantage; and (2) overburdening the tax-exempt bond market.[1] (Keep in mind that an “abusive arbitrage device” is only one specific type of “arbitrage bond.” We chose to cover abusive arbitrage devices because they are of renewed relevance and they touch on many arbitrage concepts.) The first element of an abusive arbitrage device has been difficult (to the point of impossibility) to satisfy since Mad Men first aired.[2] However, the Federal Reserve’s hawkish monetary policy has now made it much easier to exploit the difference between tax-exempt and taxable interest rates. Thus, it’s time to get reacquainted (or acquainted, depending on where you are in your career) with the concept of abusive arbitrage devices. The Public Finance Tax Blog is here to help, with a three-part mini-series of posts on this topic.