2. Good Borrowing
• Governments borrow to build our
essential infrastructure through
the $3.6 trillion muni bond market:
– Schools, universities
– Government buildings
– Water and sewer systems
– Roads, bridges, highways
. . . and much more
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3. Bad Borrowing
• It is also how they get in trouble:
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- Detroit Free Press, April 5, 1993
- Chicago Tribune, Nov. 1, 2013
- The Bond Buyer, Feb. 12, 2014
- ProPublica, Aug. 7, 2014
- Boston Herald, June 10, 2012
- BenefitsPro Feb. 12, 2015 - USA Today, Dec. 3, 2013
- Wall Street Journal, Jan. 26, 2010
- Voice of San Diego, Aug. 6, 2012
4. The Problem
• Bankers’ interests ALWAYS come
first, no matter what they say
–The fine print is in MSRB Rule G-17
disclosures – here’s what they say:
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- MSRB G-17 disclosure provided to Niagara County officials by Raymond James Associates for tobacco bond deal
5. Things To Watch For
• These bonds cause taxpayers
pain again and again:
1. Capital appreciation bonds
2. Pension obligation bonds
3. Moral obligation bonds
4. Bond guarantees
5. Borrowing to fill budget holes
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6. Capital Appreciation Bonds
How they work:
• Capital appreciation bonds
do not pay annual cash
interest
• Instead, interest grows on
the original principal and
accumulating balance until
it comes due, often decades
in the future
• Can easily turn small sums
borrowed into hundreds of
millions, or even billions
due at maturity
• Get the cash now, let future
generations worry about it
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7. Capital Appreciation Bonds
The power of compound interest:
• Ohio’s tobacco capital appreciation bonds:
– Series 2007B: $191.3m borrowed, $3.2bn due
at maturity in 2047.
• Interest accrues at 7.25% interest rate
– Series 2007C: $128.2m borrowed, $3.4bn due
at maturity in 2052.
• Interest accrues at 7.5% interest rate
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8. Capital Appreciation Bonds
The power of compound interest:
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• Ohio’s Series 2007B debt burden over time
9. Capital Appreciation Bonds
The power of compound interest:
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• Ohio’s Series 2007C debt burden over time
10. Capital Appreciation Bonds
Why would anyone do that?
• If an issuer doesn’t have any
more capacity for debt
service, it’s a way to take on
more debt and not have to
pay cash interest
• School districts are big users
of these bonds because they
allow them to borrow even
when they’re up against
their property tax limits
• This is still a problem:
– “Today’s Debt Is Tomorrow’s Burden In Some School Districts”
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11. Pension Obligation Bonds
How they work:
• Government borrows cash
to put in the pension system
• The bet is that, by investing
the money for more than
what they borrowed, they’ll
come out ahead
• IRS doesn’t really like them
to do this, so bonds are
taxable
• General obligation debt
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12. Pension Obligation Bonds
Go big or go home
• If the market turns against you, the obligation to repay the
bonds doesn’t go away. All you’ve done is made your
financial situation worse
• Illinois went big on pension obligation bonds; its pensions
are in crisis and it has the worst credit rating of all 50 states
• Smart analysis of what the bonds did for Illinois’ pensions:
– “Illinois Bond Disclosures Show Risk of Pension Borowing”
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- Thomson Reuters SDC
13. Pension Obligation Bonds
Mix-and-match
• Governments that can’t afford their pension contributions
sometimes sell capital appreciation bonds to fund them
• San Bernardino, California:
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- San Bernardino Comprehensive Annual Financial Report Disclosure
14. Pension Obligation Bonds
Mix-and-match
• It’s a true sign of distress when you see a government sell
capital appreciation bonds to fund a pension; in August
2012, San Bernardino filed for bankruptcy:
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- Reuters,, Nov. 13, 2012
15. Moral Obligation Bonds
How they work:
• Issuer has authority to
ask the government to
make appropriation to
cover debt service in case
of a shortfall
• Government has a “moral
obligation” to honor the
request
• Not a legal obligation
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16. Moral Obligation Bonds
What can go wrong:
–Surprise! You now owe millions of dollars:
–The advice? Pay up:
• “ … the state will be better off honoring its moral
– State’s financial advisor, SJ Advisors LLC
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- Report on Rhode Island’s Moral Obligation Bonds on the 38 Studios Bonds , May 8, 2014
17. Moral Obligation Bonds
• What happens if the government
doesn’t honor the obligation?
• Swift punishment:
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- The Bond Buyer, Feb. 12, 2014
- The Bond Buyer, Jan. 14, 2014
- The Bond Buyer, Dec. 13, 2013
18. Bond Guarantees
How they work:
• Government promises to
make good on the debt by
whatever means necessary
to make sure bondholders
get repaid in full
• Lowers the risk for the
bondholders, taxpayers on
the hook to if anything
goes wrong
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19. Bond Guarantees
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• The legalese leaves little to the
imagination – Harrisburg example:
“Under the City Bond Guaranty, the City has
unconditionally guaranteed, for the benefit of the
registered owners of the 2003 Bonds, the full and
prompt payment of principal and interest on the
2003 Bonds when due according to the terms of the
City Bond Guaranty, for which obligation the City
has pledged its full faith, credit and taxing power.”
- The Harrisburg Authority, Series 2003 Bonds Official Statement
20. Bond Guarantees
• Easy way to end up in
bankruptcy court:
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- Bloomberg News, Oct. 12, 2011
21. Where To Get Stuff
• Useful sources for muni bond data:
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What You Want Where to Get it Website
Bond documents EMMA www.emma.msrb.org
Bond ownership
data
Lipper, Morningstar
(mostly mutual funds)
www.lipperweb.com
www.morningstar.com
Bond issuance
data
Thomson Reuters
(SDC Platinum)
www.thomsonreuters.com
Bond reference
prices
S&P Capital IQ
(J.J. Kenny)
www.capitaliq.com
Issuance calendar Ipreo www.ipreo.com
Bond ratings S&P, Moody’s, Fitch Available upon request
Yield curves TM3 www.tm3.com
