Dave Davies last week expressed his doubts about Mayor Nutter's plan to not only save the pensions by issuing a bond, but to also give the City a cool 50 million dollars per week.
I really don't entirely get how issuing the bond even works, but I would think this is not good news:
Feb. 22 (Bloomberg) -- California, Florida schools and the owner of John F. Kennedy International Airport joined a growing list of municipal borrowers exiting the U.S. auction-rate bond market as record failures push taxpayer costs higher.
Thousands of auctions run by banks to set rates on the debt failed this month as investors shunned the securities and bankers refused to submit bids, sending interest costs to 10 percent or higher on some bonds. Auctions covering as much as $26 billion of bonds a day failed to attract enough buyers since Feb. 13, according to Bank of America Corp.
Florida's Palm Beach County Schools converted $116 million of the securities into fixed-rate debt this week, while the
Rates in the more than $300 billion auction market, where local governments, hospitals, museums, student-loan agencies and closed-end mutual funds borrow, are determined through a bidding process every seven, 28 or 35 days. Auctions fail when there aren't enough buyers. That's left bondholders who wanted to sell stuck with the securities and taxpayers or other backers of the debt such as fund holders with higher interest costs.
And, there is this nugget:
Today, 386 auctions of publicly offered bonds resulted in 258 failures, or 67 percent, according to data compiled by Bloomberg from four auction agents, Deutsche Bank AG, Bank of New York Mellon Corp., Wilmington Trust Corp. and Wells Fargo & Co. The firms are responsible for receiving orders from broker- dealers and determining the winning rate. They also perform some administrative services for the borrower.
About two-thirds of auctions have failed per day since Feb. 15, according to data compiled by Bank of America and Bloomberg.
I don't entirely get it. I do know that our bond rating generally sucks. And cities and institutions (like Children's Hospital, for example) are trying to get themselves out of the bond market.
So, if so many places are having trouble actually issuing bonds, and the costs are becoming out of hand, it seems a little crazy that we are relying on a bond issue not only to fix the pension problem, but to flood our coffers, as well.
What am I missing here?
Update: First, as I mentioned in the comments, I don't know that the Bloomberg article necessarily matters, because it is talking about a specific type of bond that the City will not likely use.
S&P Gains 2001-2007: S&P Gains, or losses, from 2001-2007.However, courtesy of DailyKos, the chart below displays the danger of assuming that borrowing money, and then putting it into the stock market, will provide us with a yearly bounty that we can simply expect.
What the chart shows is that if you invested 10k in the S&P in 2001, as of 2007, not even accounting for inflation, you will still have less money than what you started with. Long term, stocks are still likely a good bet. But, can we really expect to not only have this to fix the pension problem, but provide us with money every single year? Seems crazy to me.
Or, to put it another way, if this is so magical, why wouldn't we just issue bond after bond?
Do we have a resident municipal finance expert?
If not, we should get one.
I think you know one I would
I think you know one I would like to ask, jennifer. Unfortunately he does not blog.
-Sean
MrLuigi, my cat, actually only types half as badly as I do.
Muni Bonds are tax
Muni Bonds are tax deductable at a Federal level, but there is another interesting tidbit. I will have to check the exact facts, but I believe that if you buy a bond in the state that you live or do business in, then it is also often times exempt from that states tax (double tax free). Also, if you buy a bond in the city that you live or do business, then it is exempt pretty much from all taxes (triple tax free). It's been a long time since I've studied up on such things though.
It could be possible, however remote, that they expect to get people from or around the city to invest in these things because of taxes, but I doubt it. The whole Bond market is one complex boondoggle that even people in the industry don't understand.
This has a lot to do with the real estate bubble going pop
These bonds are typically insured by private insurance companies like Ambac. These companies also insured mortgage debt, much of which has become soggy, wet paper. So the insurance companies are in danger, and therefore their guarantees are looking less than rock solid. That results in scared investors which in turn results in failed auctions.
I don't think that's the whole story, but it's a good part of it.
Update- maybe not a concern
I talked to a friend who works in this stuff. I think the Bloomberg article, which focuses on auction rate debt, is probably not a huge concern- because the City will likely issue fixed rate bonds, or something like that.
Agreed, not a concern but for an additional reason
Yes, a friend of mine who works in this stuff also said the auction rate securities aren't an issue and will probably work themselves throughout pretty simple market mechanisms anyway. You are correct that the City won't using auction rate securities for the pension obligation bond. For municipal agencies that do operate in that market, the problem isn't that bad. If you consider that these auctions occur at regular frequencies - weekly or monthly - and that the penalty for not being able to sell the (ie auction failure) is that the interest rate jumps to double digits, then they'll just end up selling them at the next auction.
For example... New York Port Authority issues bonds on the auction rate market for 4%. Folks (institutional investors mostly) see that as a good, short term deal. They just hold onto the bonds for a couple weeks, earn their interest and then can turn around and auction them off. If the auction fails, the interest rate shoots up. That sucks for the Port Authority. But two weeks later, when the auction happens again, they'll have a ton of buyers (who wouldn't want the relatively safe debt of a major municipal agency for a double digit interest rate?) bidding that interest rate back down until it settles at a reasonable rate. That's how I understand my friend's explanation but if anyone knows more about this, feel free to correct as necessary.
If anyone else can explain that better, please do. Though, since your original point - that the city won't be using them - holds true, it doesn't really matter.
Dan, as I understand it
Auction bonds are a specific type of bond issuing process, which may or may not apply to other bond types. And as I understand it - auction bonds are having a specific difficulty recently - because their interest rates are reset (like every months or so).
Is the Philly bond in question an auction bond?
(btw - this comment is consistent with my tendency to comment on issues which I know nothing about).
The bigger question
OK, I think I get the auction question- I appreciate the help.
But I think the more fundamental question remains: My momma always told me, borrowing to invest is pretty risky. (OK, she never told me this, but she does have some generally sage wisdom.) If this is so great an idea-and can produce so much revenue, and fix the pension liability- why wouldn't we do this every year?
It's not about investment
At least not mostly. The proposal is to amortize the City's debt (which it has for the pension liability under federal - I think) under favorable terms and spread out the payments in a more manageable, reliable fashion. This kind of fiscal responsibility can often improve a governments credit worthiness.
It's a longstanding way for governments to work their way out of debt; like Hamilton put together under the assumption plan to retire the war debt from the Revolution. And why the city has a sinking fund in the first place.
But isn't it all predicated
But isn't it all predicated on the City doing well taking the debt issuance and investing it, to get a return higher than they have to pay on the bond? I am all for doing it what it takes to shore up the pension fund, but, didn't we try this exact thing before?
If
the plan is too make money rather than structure the debt - it's about that. I can't buy a house outright - that's why I have a mortgage. I may hope the house appreciates - but I'm really buying something to live in that has managable and reliable payments first and foremost. The city by doing this doesn't have to come up with a boatload of money at once in a few years when a lot of people retire. And they do have this If they had been paying into the fund what they had committed to - there wouldn't be this necessity. If they could in reality pay up the fund through regular taxes, it wouldn't be needed. But we've all seen that that isn't possible from how we got here in the first place.
If they wait and do nothing - they have to drasticaly cut services & raise taxes. Which would be devasting. Spreading the paynments out obviates that problem. If they're lucky enough to make a bit more than costs due to investment (which seems likely given mutual bond rates vs. long term stock market rates - so much the better.
Thanks, Kathy. I appreciate
Thanks, Kathy. I appreciate the input of people who get this more than me.
We have tried this before, right? Any insights into what went wrong in 2000?
Well, I may have bungled the auction bond issue
because I confused it with a conventional bond issue. But what went wrong in 2000 is clear; the proceeds of the bonds were not invested well by the Pension Board, and/or were just invested at a bad time, i.e., when the market was going down. There's market risk whenever a Pension Fund, or any part of it, is invested in financial instruments. Whatever day the Fund reaches the value that it's supposed to have might be the day before the market, and the Fund, takes a dive. It was only about 25 years or so ago that the Fund first began being invested in stocks; before then it was mostly invested in relatively stable bonds. But even bonds, and indeed, CD's can be volatile. You have to have good fund managers, and even then, crashes can happen.
This is...
an important question. The city has historically awarded bond work via no-bid contracts to connected law firms with the explanation that it is such specialized work that you can't open the process. It often went to connected firms (Ron White among them, I think.)
Sorry
I meant that to nest under Jennifers question.
Thanks Kathy
I had actually meant "on YPP," but you are right, it is a good larger question.