‘I meant by “impenetrability” that we’ve had enough of that subject, and it would be just as well if you’d mention what you mean to do next, as I suppose you don’t mean to stop here all the rest of your life.’

‘That’s a great deal to make one word mean,’ Alice said in a thoughtful tone.

‘When I make a word do a lot of work like that,’ said Humpty Dumpty, ‘I always pay it extra.’

‘Oh!’ said Alice. She was too much puzzled to make any other remark.

‘Ah, you should see ’em come round me of a Saturday night,’ Humpty Dumpty went on, wagging his head gravely from side to side, ‘for to get their wages, you know.’[1]

Rick Weber of Norton Rose Fulbright is the Editor-in-Chief of The Bond Lawyer, NABL’s quarterly journal. He writes a wonderful column on language that introduces each issue, and in the Summer 2016 issue, he posed the following question: When issuers are required to pay arbitrage profits earned on investments of tax-exempt bond proceeds to the federal government, why is it called “rebate,” when the arbitrage profits were not the federal government’s money in the first place? “In order to have a “return” or “refund” or “pay-back” of funds to the US government,” Weber notes, “the funds must start there.” We venture an explanation below.

(Before we begin, a hearty “thank you” to our retired partner Jack Browning, who remains a boundless source of knowledge and wisdom, the elucidator-in-chief of hopelessly opaque topics like single family mortgage bonds, and a dear friend, for collaborating with me on this effort.)

These days, there are literally a million examples of words in the dictionary that mean the opposite of what they originally meant. “Rebate,” as used in this context, is one of them. What we now call “rebate” was once the payment of excess earnings on investments of tax-exempt single family mortgage bond proceeds that issuers made to the federal government instead of giving mortgagors a rebate on their mortgage interest payments.

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In the late 1970s, issuers of tax-exempt bonds could use governmental bonds to finance mortgages for owner-occupied residences, generally referred to as “single family mortgages.” These bonds were not “industrial development bonds” because there was no private business being transacted at the home, and these bonds did not violate the restrictions on bonds issued to finance private loans, because those restrictions did not exist yet. The amount of tax-exempt bonds being issued to finance single family mortgages had risen dramatically, as illustrated by the following table. [2]

In addition, issuers could retain any permitted arbitrage generated from investments of single family mortgage bond proceeds in a reserve fund, other nonmortgage investments, or investments enjoying a temporary period from yield restriction. The legislative history notes: “In some instances, these profits will be used to provide interest rebates to mortgagors. However, in most instances, these profits will revert to the issuers.”[3]

Congress responded to the explosion in governmental bonds to finance single family mortgages and these perceived abuses with The Mortgage Subsidy Bond Act of 1980, referred to below as “The Act,” which was enacted on December 5, 1980.[4] The Act created new Section 103A of the Code, which placed a number of restrictions on tax-exempt single family mortgage bonds. One of these restrictions required issuers to pay, “as rapidly as practicable,” the arbitrage earnings on nonmortgage investments above a certain threshold to the mortgagors to reduce the interest that the mortgagors were required to pay on their mortgages. The new section imposing this requirement featured a header that said “Arbitrage and Investment Gains to be Used to Reduce Costs of Owner Financing.” The new provision did not actually use the term “rebate,” but another provision in new Section 103A, which referenced the new requirement, referred to it colloquially as a “rebate of arbitrage profits.”

At first glance, the concept of paying excess investment earnings to mortgagors sounds simple. Congress did not want issuers keeping unlimited investment earnings, and so it required issuers to pay those earnings to the people that the bonds were intended to help in the first place. In practice, though, the mechanics of paying the rebate back to the mortgagors would be devilishly complex, and this was clear to stakeholders as soon as the Act was enacted. (If you aren’t convinced, take a look at the last couple of pages of Private Letter Ruling 8212056.)

To provide an alternative, just a few weeks after the Act, on December 24, President Carter signed into law an amendment (known as the “Williams-Roth” [5] amendment), which provided an alternative to this rebate procedure under which an issuer could pay the excess investment earnings to the federal government rather than the mortgagors.

Senator Pete Williams, Jr. (D-NJ) noted in floor discussion of the amendment that the budget reconciliation process, which provided the vehicle for the original passage of the Act on December 5, did not give the Senate adequate time to “deal with the complexities of mortgage revenue bond financing.”[6] He noted that “the provision requiring excess arbitrage . . . to be calculated and returned to the mortgagors would be administratively unworkable for many States and local governments.” (Incidentally, Senator Williams was at that very moment entangled in an affair involving “rebates” of a different sort, one that would end his career soon thereafter.)

Over in the House, Representative Bill Frenzel (R-MN) noted in floor discussion that housing officials had described the required rebate to mortgagors as “an administrative nightmare, if not an impossibility.”[7] The amendment would allow “Treasury to recoup some of its losses as an alternative to mandating a bonus for those already receiving the benefit of a subsidized mortgage.”[8]

So, semantically, this “alternative” to rebating excess investment earnings on investments of mortgage bond proceeds to the mortgagors wasn’t “rebate;” it was “the thing that one does instead of rebate.” Anti-rebate. Rebate-1. Indeed, the Preamble to the first Treasury Regulations to implement the new requirement described the situation this way: “Section 6a.103A-2(i)(4)(v) provides that, in lieu of making rebates to the mortgagors, the issuer may elect to pay the arbitrage earned on nonmortgage investments to the United States.”[9]

But in 1984, in its zeal to curtail the proliferation of industrial development bonds, which are the predecessor to what we now call private activity bonds, Congress imported this “alternative-to-rebate” requirement into industrial development bond rules in the Deficit Reduction Act of 1984. This is the point in the story where the train went off the tracks (or Humpty Dumpty fell off the wall). In the process of adding a new rebate requirement to the IDB rules, Congress botched the terminology.

The legislative history shows that Congress was concerned about the volume of private activity bonds, and Congress seems to have tacked on the rebate provisions from the single family mortgage bond area to generally decrease the attractiveness of industrial development bonds.[10] There was no alternative recipient of the excess investment earnings in this context, of course, although one can imagine some interesting scenarios where a company benefiting from industrial development bond proceeds could choose to pay rebates to its commercial customers.

The text of the 1984 Act appears to be the first time that the payment to the United States (as opposed to the mortgagors) of investment earnings above a permitted amount was referred to explicitly as “rebate.” Section 624 of the Act added new Section 103(c)(6) to the 1954 Code, and the heading of new Section 103(c)(6)(D) read “REBATE TO UNITED STATES,” although the operative provision says that amounts must be “paid to the United States.” The Joint Committee on Taxation’s Blue Book for the 1984 Act noted that “[u]nder the Act, certain arbitrage profits earned on nonpurpose obligations acquired with the gross proceeds of IDBs must be rebated to the United States.” As Congress borrowed the concept of rebate to tamp down IDB issuances, it also borrowed, inartfully, the terminology, applying the term “rebate” to “the thing that one does instead of rebate.”

In 1986, Congress would further extend the alternative-to-rebate to all other tax-exempt bonds, including governmental bonds. In 1988, Congress eliminated the ability of issuers of single family mortgage bonds to pay the rebate to the mortgagors – they would evermore be required to pay the “rebate” to the federal government. The option to pay rebate to mortgagors remains in the Code, in Section 143(g)(3), but it applies only to mortgage bonds for veterans of the armed forces of the U.S., governed by 143(b) of the Code, a very limited subset of the tax-exempt bond universe. (For example, these bonds may only be issued by States that were issuing them before June 22, 1984, which applies only to 5 states – Alaska, California, Oregon, Texas, and Wisconsin.)

What started as the thing done in lieu of rebate is now called rebate, and the practice has completely dwarfed the practice that originally gave rise to the term. Someone should tell “rebate” to report to Humpty Dumpty next Saturday; it’s earned a handsome reward.