Debt Administration

Troy University

PA6650- Governmental Budgeting

Chapter 15

Overview• Debt is a result of governments borrowing from

individuals and institutions• Bonds represent a debt that gives the

borrower’s long-term promise to repay the lender– Bonds have a face amount and a maturity date– The nominal return on a bond is stated as its coupon

rate

• DEBT RESULTS FROM:– Covering deficits– Financing capital projects– Covering short periods when bills exceed cash on

hand

Federal Debt• A result of:

– War finance– Attempts to stabilize the nation’s macroeconomy– Miscellaneous political disputes

• The federal deficit– The difference between total federal spending and revenue in a

given year

• Federal debt (national debt) - Two important measures:– Gross debt

• All federal debt outstanding

– Debt held by private investors• All federal debt except that held by federal accounts and the Federal

Reserve System

Federal Debt• Figure 15-1 on page 577 shows Federal

Debt relative to GDP

• Table 15-1 on page 578 shows history of federal debt...it has grown considerably!

• Over 50% of privately-held debt is foreign-owned

• Most federal debt has short-term maturity (average 4 yrs/10 months)

State & Local Government Debt• Currently near $2 trillion• States, counties, municipalities, townships, school

districts, special districts• Mostly long term• Two types of debt

– Full-faith-and-credit debt (unlimited claim), usually issued as a General Obligation Bond (GOB)

• Schools, police stations, bridges

– Non-guaranteed (or limited liability) debt, issued with a Revenue Bond

• Toll roads, water plants, revenue-producing infrastructure

State & Local Government Debt• Municipalities are the largest users of debt

markets

• Special districts are the heaviest users of non-guaranteed debt (waste, transit, water)

• School districts are heavy users of full faith and credit debt (schools don’t generate revenue)

• Non-guaranteed debt has significantly increased

Municipal Bonds and the Tax Reform Act of 1986

• Interest on state and local government bonds is exempt at federal level

• Industrial Development Bonds (IDB’s) offer tax-exempt status for private development (controls)

• Registered bonds – owner specifically named

• Bearer bonds – whoever holds the bond

Appropriate Debt Policy

• Borrowing provides funds to acquire resources for public use– Debt must be repaid, with interest, in the

future– Borrowing commits future budgets– Don’t issue debt for a period longer than the

project’s useful life

• Economic growth requires infrastructure, and debt is not necessarily a bad thing

• Debt must be handled with care

The Mechanics of Bond Values• Coupon bond example (p. 588)

– 15 year maturity (m)– 30 semiannual periods (m x 2 = 30)– 8% interest coupon rate C, but must use C/2)– $5000 face value (F)– 6% market interest rate ®– Bond Price = $6,006

Debt Structure Decisions

• Type of security• Term to maturity• Call provision• Rating

– US government not rated (A+)– Three firms do bond rating

• Mergent• Standard & Poor’s• Fitch Investors Service / ICBA

Bond Rating

– Rating criteria• The economy• Debt• The government• Financial analysis

Credit Enhancements

• A way to reduce the interest rates

• Third-party guarantee– State credit guarantees– Bank letters of credit– Municipal bond insurance

Underwriting, Interest Rates, and Ownership

• Bond bought by an individual investor, then sold at a slightly higher price (spread) to individual investors

• Important underwriter documents– Official statement– Legal opinion

• Bond issue…Sidebar 15-3

Lease-purchase Financing & Certificates of Participation

• Lease-purchase financing– an installment purchase– When fully paid, owner gets full ownership of

the property

• Certificates of Participation– Investors buy them– Federal tax-exempt– Uses a nonprofit trustee– Useful to fund public infrastructure

Conclusion

• Debt exists because expenditure exceeds revenue

• Federal debt from annual deficits, state & local debt from capital projects

• Debt management important, and results in good ratings, careful tailoring of maturities and timing of debt issues, guarantees, etc.

• Debt itself is not evidence of poor fiscal management