Watchdogging

Watchdogging Public Spending: The Borrowing

Side of the Equation

Cezary Podkul | @Cezary

3/7/2015 1NICAR 2015 | Atlanta

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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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

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

Things To Watch For

• These bonds cause taxpayers pain again and again:1. Capital appreciation bonds2. Pension obligation bonds3. Moral obligation bonds4. Bond guarantees5. Borrowing to fill budget holes

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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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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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The power of compound interest:

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• Ohio’s Series 2007B debt burden over time


The power of compound interest:

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• Ohio’s Series 2007C debt burden over time


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 Tomorr

ow’s Burden In Some School Districts”

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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 debt3/7/2015 NICAR 2015 | Atlanta 11


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


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


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

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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What can go wrong:–Surprise! You now owe millions of

dollars:

–The advice? Pay up:• “ … the state will be better off honoring its

moral obligation” – 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


• 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

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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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

Bond Guarantees

• Easy way to end up in bankruptcy court:

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- Bloomberg News, Oct. 12, 2011

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.comwww.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

Questions?

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[email protected] @Cezary

Documents

Watchdogging